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The Uncertain Future for Rental Housing

Adam Rust's picture

Posted June 23, 2010

The recession, coupled with its supporting burst of the housing bubble, is prompting a re-evaluation of the role for rental housing. Knowing that it is time to rethink assumptions about home-ownership and rental housing is easy. It gets harder when people ask what should be done. That is because there is no clear agreement on rental demand.

Let's start with a fact: rents increased this quarter, for the first time since 2008. That should tell us that things are getting better.  However, it gets more complicated when people try to read into the messages underneath the numbers.

Why Rental Housing Is About to Boom

Some would conclude that the foreclosure crisis will put more families into the market for rentals. Call it the Transformation Hypothesis. Homeowners are being transformed into renters. Fannie Mae is foreclosing on tens of thousands of mortgages every day. Certainly, says the reasoning of some, this would mean more renters.That view is

supported by the possibility of a rebound in employment. As more people go back to work, they'll need a place to live. Apartment REITs are reporting that rents have finally found a bottom, and that in some markets, they are actually able to raise prices.

Nicholas Retsinas, an economist at the Joint Center, says that it is only a matter of time. Our country needs to acknowledge that it has a problem - a rental housing problem. “Foreclosures are transforming owners into distressed renters looking for affordable places to live,” he says in an interview with RealtyTrac.

It isn't just that, though, that has him worried. There is the Housing Mismatch Problem. While our nation built plenty of three-story walk-ups for mill workers, secretaries and shop workers back during the War Years, that is not what our country has built in the last two decades. The focus has been on suburban tract developments full of single-family houses.

It is a mismatch, not just in terms of product category, but even within the category. There probably is a need for more single-family rentals. Realistically, though, with real wages frozen or even declining, the need is not for 2,500 square foot homes with vaulted ceilings and proximity to a golf course.  People are going to find a fit with a well-built 1,200 square foot home where the utilities are reasonable and the two-by-fours are not 1 1/2s by 3 1/2s.  A landlord with modest homes in locations that can tap public transportation may be in a good position. Nonetheless, those tract homes out in the exurbs could be in trouble.

I hate to say that James Kunstler is right about something, but this mismatch issue is only going to dovetail with higher energy prices to reduce the desireability of those Beazer homes out in Edge City.  It also reflects what we know about zoning. Many of the best locations are already built, and it is hard to do a lot of infill building after a development has already been laid out. The Mismatch issue suggests that, at least for some homes, there will be more renters chasing a few good homes.

Why Rental Housing is Headed for a Long Decline

That view is contradicted by demographers armed with a housing analysis that is informed by the aging patterns of American's population.  Demand for housing peaked in tandem with the demand among baby boomers for homes. Many attained homeownership in the latter half of their working years. Others purchased second homes. Now, as that group prepares to retire, their housing needs will change. Inevitably, they will become "net sellers," putting more homes on the market and collectively acting to increase the supply of unsold homes.

The demographic doom is compounded by the slow pace of household formation. Think about it - how many 25 year-olds do you know that are living with their parents? Think about it - how many people exiting a foreclosure are renting a home? More often than not, if they had the money for a month's deposit and a first month's rent, they would have used it to pay their mortgage.  Normally, about 1.3 million new households are formed every year. Given that only 800,000 new homes were built last year, there should be a lot of unmet demand coming on to the market. Unfortunately, only 400,000 new households developed. Even with a historic implosion in housing construction, we are still overbuilding.

There are other problems with the Transformation Theory. For one, if it was true, then it would probably hold that there areas with the worst foreclosure problems would then be the locations where rental housing was suddenly revitalized.  That's not true in Florida, where market research firm REIS reports that rents are dropping and homes are staying vacant.

Moreover, the Transformation Theory makes an assumption that a family coming out of foreclosure will seek to rent. That is not always true. Many people appear to be doubling up, either by moving in with their family or by sharing space with another friend. Household formation is not keeping pace with population.

Policy

This is an important question for planners working with affordable housing, for economists concerned with household asset formation, for workforce developers wary of the role between spatial mismatch between housing and jobs, and for demographers.

Sheila Bair would appear to support a policy fix for rental housing.  "Even as we emerge from this crisis," she said in an address to the Housing Association of Non-Profit Developers, "it is worth asking whether federal policy is devoting sufficient emphasis to the expansion of quality, affordable rental housing," Efforts to address the long-term budget deficit and national debt inevitably focus on the home mortgage interest deduction.

The Mismatch concept makes a lot of sense to me. It fits with other long-term trends outside of housing, the most compelling of which is that our economy is running out of cheap energy. Looking around my hometown, I see that a lot of people are living in huge multi-family apartment complexes. Most of those buildings are very old. Most of them are full, to the point where they don't have enough parking spaces for all of the 1982 Honda Civics and 1997 Pontiac Montanas. Some are about to enter foreclosure.

Is it time to do something? It could be time to take a hard look at the mortgage interest deduction.  It might be that the answer will be told with the decision made by the scores of families coming out of a foreclosure.  Will they rent, and if they do, where will they live?