Wednesday, October 06, 2004

Rent, Home Price 'Disconnect' Another Bubble Inflator

Realty Times

The disparity between rents and growing home prices could be another indicator of a growing housing bubble poised to doom the residential real estate market.

Along with Fannie Mae's recent woes, the potential for interest rates to rise to unaffordable levels, financially over-extended homeowners, escalating home prices and other bubble indicators, a "disconnect" between home prices and apartment rents could be more Halloween-Horrors-Come-Early evidence of a real estate market bubble about to go pop, according to a paper from RealFacts, a Novato, CA-based rental market monitor.

The theory's author William Ktsanes, RealFacts' director of research and analysis, concedes his "simplistic explanation does not specifically examine the influence of factors shaping supply-and-demand, such as interest rates, population demographics, employment growth, public policy and individual preferences," but the "disconnect" warrants scrutiny.

Generally, says Ktsanes, in many western housing markets where home prices have climbed the most -- Las Vegas, NV and Orange County, San Diego, Riverside and Los Angeles, CA, among other western markets -- apartment rents just haven't kept pace.

In Las Vegas, for instance, while home prices have risen 52.4 percent from the first quarter 2003 to the same period this year, rents have risen only 2.6 percent.

During the same period, rents have fallen slightly in Boise, ID and San Francisco, CA, where home prices have increased 18 percent and 15.5 percent respectively.

"It is interesting to compare the year-over-year change in single-family home prices with the change in apartment rents. One might expect that those 'hot markets' with the highest increases in single-family home prices would experience similarly high increases in apartment rents," says Ktsanes.

That's because, says Ktsanes, property value is somewhat correlated to the expected return on the investment over time. In a tight market, such as in the (San Francisco) Bay Area, land is scarce and in demand and that should point to higher rents than if the same market had an ample supply of land and a potential for new supply.

"While the cost of the home is rising, its fundamental value as an income-generating asset does not seem to be increasing. In other words, people are paying more and more for something that doesn't seem to be worth more and more as an 'investment'. People are betting that the value is coming at the end, from the appreciation of the house's selling price over time rather than a steady increase in the value of the rents it could get in the market. That's where the bubble concern kicks in," he said.

"Without higher rents to support its value, when the demand for 'for sale' housing slows down as interest rates rise, house prices may drop significantly -- perhaps as much as 15 or 20 percent in some markets," he added.

Take Las Vegas. The high prices happening there may not stay there. Recent ordinances seek to stem the tide of speculators some say were artificially driving up prices.

"From what I've heard, regarding the Las Vegas market in particular, the upward drive in prices was strongly influenced by speculators. I actually know people who purchased several homes there. That makes me question whether the higher prices will hold when the investors move their money onward," said Janet Houde, president of the Santa Clara County Association of Realtors in San Jose, CA.

Give Ktsanes credit for being one of the few doom forecasters to thoughtfully make concessions about what his theory doesn't consider.

He doesn't discuss the habits of renters.

During the last economic boom and bust, a large segment of the technology industry's work force holed up in apartments out West for years hoping to get an economic foothold in the region. After the bust, many of those unable to buy, simply departed for cheaper rents in the West and elsewhere. Rents have only just begun to come back in some Western regions.

Demand for homes, on the other hand, temporarily waned, but in a few years waxed with immigrants, single women, baby boomers, and others who instead of investments, sought a roof over their heads to call their own.

The exodus out of California this time seldom matched the number of emigrants who continued to go West in search of a what many consider an invaluable lifestyle.

Workers who were able to cash in before the dot combustion often found the price of homes as "cheap" as the high rents -- when they compared rent with the monthly mortgage -- not the home's price or appreciation.

That, say critics, is a flaw in Ktsanes' argument.

A fairer comparison would be to consider what consumers actually do -- compare rent with the month-to-month cost of owning, something the growing plethora of loan programs facilitates.

While financial advisors caution easy-money mortgages can be penny wise and pound foolish, the loans have sold consumers out West.

"True apples-to-apples comparison would take anticipated mortgage payments and rents. Rents reflect an amortized value of the property, plus some measure of profit. Since mortgage payments are amortized over 30 years typically, the impact of rapid appreciation is diluted over that period through monthly payments," said Mitchell Kreeger, chief appraiser with Affinity Bank in Ventura, CA, who fired off a missive in response to the Ktsanes' "disconnect" theory.

Fairer still would be to include the value of an apartment complex, said Gardner Rees with Stratus Real Estate in Woodland Hills, CA.

"Although rents have not increased significantly in certain markets, values of apartments have," he said.

The same low financing costs that helped boost home values in recent years can also be attributed to the increased value in apartment investments.

"Rents have not increased because personal income has not increased. People have the same amount of money to pay for their rent or mortgage, they can simply buy more with that money due to lower interest rates," Rees said.

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