Forget Buying in the Suburbs and Go Rent in the City

It’s getting more expensive to live in Baltimore….at least if you’re a renter.

According to a recent article in the Baltimore Sun rents are up more than 6% over what they were last year in the Baltimore metro area. If you count the drop in various concessions — like waived application fees or initial free rent — then the increase is even more.

There is a drag on the rental market, however: the regretful buyers who now need to rent out the homes they can’t sell.

Lois Foster, a Baltimore real estate agent who helps people find homes to rent and manages properties for owners-turned-landlords, said she’s seeing rents of $200 to $500 less a month than owners could have gotten two or three years ago. There’s just a lot of competition, she said.

The gild is off the buying lily. All the credit that oozed out of the banks found its way into the national psyche. There it gave off a funny smelling gas that puffed up hopes and dizzied senses.

Stock prices were the first beneficiaries. Fattening 401(k)s danced 1920’s-style energetic jigs with dreams of early retirement. Even as those 401(k)s and those hopes tired and finally dropped dead on the dance floor, the Fed held down interest rates and more funny air kept the nation high. People pinned new hopes on — and sent reams of borrowed new money into — real estate.

That’s come to the sort of end you’d expect. While government cheerleading and easy credit drew in increasing numbers of bigger fools, the rental market found itself a lot emptier. All the people who really couldn’t afford to buy and who should have been renting were too busy buying on greater margins and not renting.

Some hotspot cities like New York and Boston saw their rental markets surging along with their real estate markets…but third-stringers like Baltimore… “Cohan, with Southern Management, said some competitors were offering as much as three to four months of free rent to get people in the door in 2008 and 2009. Not anymore.”

It’s no wonder that they were having such a hard time. The real estate market started to crater in 2006, but the ship of public opinion doesn’t exactly turn on a dime. You don’t undo nearly a century of brainwashing at the start of a downturn. By 2008 and 2009, renters were still considered to be socially backward and intellectually impaired…maybe even in need of corrective medication.

Upon finding out that a person was renting, someone else was likely to voice sincere worry: “What’s wrong with him? Is he marginally employed? Illiterate? Dead?”

Being a renter was worse than gauche. For men it was worse than driving a beaten up old car. Even $7-an-hour female filing clerks were all getting mortgage approvals for $200,000 homes. Any man who couldn’t (or wouldn’t) score a mortgage was parading his lack of fitness to breed. To rent instead of own was to advertise your status as a loser, not the kind of sire any sensible woman would settle for. Your only hope was to troll among hipsters and other car-less, urban trash. A corpse could get a mortgage, but a renter couldn’t get a date.

But now opinions are changing, as they must. Reality can only be ignored for so long. According to a 2010 study o the Joint Center for Housing Studies of Harvard University, between 2004 and 2009, the number of renter households rose nearly 10%.

From the article “The Echo Boom: A New Wave of Market Change” on (emphases mine)…

Certainly, most young people rent apartments in their first years out of college, but there are reasons to believe that this generation will be renting far longer than their parents did.  They have the largest college debt load in history – averaging over $20,000 per student.  They also face a very different labor market from their parents: a fifth of them will likely be self-employed following the trend for all employers to offer more and more short-term contracts.  Renting may make economic sense, not just when they are beginning their careers, but for many more years to come. Since the end of World War II, the trend was for more and more young families to purchase a home in the suburbs, leaving rental apartments to young singles.  Based on the economics today, that trend may shift towards renting throughout their lives.

And from a July, 2010, article “Rise of the Renting Class”

In May, U.S. Housing and Urban Development Secretary Shaun Donovan testified before a House committee that the financial crisis proved the need for a better balance between ownership and rental housing. And HUD senior official Raphael Bostic last week told the Washington Post: “In previous eras, we haven’t seen people question whether homeownership was the right decision. It was just assumed that’s where you want to go,” Bostic said. “You’re not going to hear us say that.”

Left to its own devices, the market pretty efficiently figures out who ought to own and who ought to rent. Those who can afford to do so buy a home because under normal circumstances, buying a home is not any more of an investment than renting one.

So the policies from DC that got their start under that busybody Herbert Hoover to “encourage” homeownership were never a good idea.

The article continues…

Hoover signed the Federal Home Loan Act, and in 1933, Franklin D. Roosevelt created the Home Owners’ Loan Corporation to provide low interest loans.

And the government was just getting started: a flurry of legislation was passed over the ensuing decades, helping veterans, minorities and the populace as a whole secure mortgages. But it appears the pendulum has swung.

“The government shouldn’t blindly encourage homeownership,” says Joe Gyourko, real estate finance professor at University of Pennsylvania’s Wharton School. “If the government does anything the government should encourage people to make the right decision.”

Owners don’t pay the landlord, but they pay taxes and maintenance costs on their house, and Gyourko says those costs can end up being roughly the same.

As far as buying a house as a smart long-term investment, Gyourko says that’s not always true. He says between 1975 and 2008, the price for houses of similar quality and size appreciated an average of about 1% per year after inflation. Investors could have earned more by buying Treasury bills.

Turns out that under most circumstances, homeownership is just another form of consumption. You need a place to live. So you can pay rent, out of which the landlord collects some small profit after mortgage, taxes and maintenance…or you can “buy” your house, or more accurately saddle yourself with debt and pay the mortgage, taxes and maintenance yourself.

But when you have meddling federal policies to encourage it…coupled with ever-increasing amounts of central bank credit to fuel the bidding…prices tend to rise enough to make generations sing in unison “housing always goes up!”

It took generations for this debt-addled Ponzi scheme to collapse; years of government meddling finally coupled furiously with easy credit from the central bank. The result is a veritable orgasm of tumbling prices. We’re in the shame and regret phase that follows these sorts of things. Stay tuned for more.

So as house prices start to reflect how little credit is available to buy house, then buying a house starts to look like a good buy.

Houses are still real things with great utility. They’re bad buys when they’re the objects of debt-fueled speculative mania…but they are still real assets, the sort of things that maintain their value as paper money goes to its intrinsic value.

As we’ve said in these pages many times before, however, you may want to be careful exactly where you buy.

Auto-suburbia is losing its utility and its desirability. More from “The Echo Boom: A New Wave of Market Change”:

One overlooked issue in particular about the Echo Boomers will have a meaningful impact on all forms of real estate…they don’t drive.  According to a report by Kiplinger, motorists aged 21 to 30 now account for 14% of miles driven, down from 21% in 1995.  As quoted in that report, William Draves, president of Learning Resources Network pointed out, “This generation focuses its buying on computers, BlackBerrys, music and software and views commuting a few hours by car a huge productivity waste when they can work using PDAs while taking the bus and train.”

This certainly doesn’t bode well for the automotive industry, but it also may not help real estate strategies that rely on communities and suburbs that can only be navigated by car.  The Baby Boomers fueled the growth of cities that revolve around cars, but the Echo Boomers are likely to flock to places where they don’t have to drive every day.  This could be a significant drag on low-density communities without mass transit and a boon to older, more compact cities.  The exurbs don’t hold as much attraction for this new generation as they did their parents.

Few emergent trends to keep in mind when making investment decisions:

  • There are a lot of them – over 80 million people that have to live, work and play in some form of real estate,
  • They are gravitating to urban centers even more than their parents,
  • They are more plugged into the Internet and social networking than anyone before,
  • They are renters, and
  • They don’t drive.

I wouldn’t go run to buy up all those abandoned subdivisions that sprung up in the cornfields.

The baby boomers will scratch their heads at that one. There may even be a snort of derision or two from that crowd. Suburbia and exurbia is all that they’ve ever known.

I’d go with productive farmland…or housing that doesn’t require a car. You know: the old downtown that used to be built before the government threw its weight behind the growth of automobile suburbia.

Gary Gibson
Managing Editor, Whiskey & Gunpowder

January 5, 2011

The Daily Reckoning