I’ve lovingly called the new movement of people leasing homes as Rental Armageddon. A truly first world problem between buying an inflated crap shack or having to rent a property. God forbid you have to lease a place. People quickly lose perspective and that is largely one of the reasons we oscillate between booms and busts in real estate. But the data is very clear and that is, we are in a deep renting trend. We’ve added 10 million renter households in the last decade while being net neutral on adding homeowner households. That is a big deal. The housing market is also facing some massive demographic headwinds. Younger buyers are cash strapped and home builders realize this (this is why home building is lagging the mania because builders realize the demand is for rentals, even higher cost places). Also, you have Taco Tuesday baby boomers entering the twilight of their lives and they certainly won’t be upgrading their properties. A recent study by the Urban Institute sheds some light on this renting trend. There are some serious demographic and economic headwinds favoring the renting trend. One key finding is that for the next 15 years, rental household formation is going to outpace homeownership formation. Let us see where things stand today.
In the last few months I’ve noticed a few more emails coming through regarding transitional areas and the value that is blindly being missed out. A few of the emails in all seriousness pointed out that a Starbucks and new shopping center have sprung out of the ground like a palm tree and hence, a six-figure price appreciation is now worth it. Forget about the lower incomes in these markets or the quality of schools or the fact that families are packing in tightly like sardines just to make rents. Somehow, the fog of gentrification is taking hold of every market equally. Yet the only people I see even remotely thinking about buying in these markets are investors and that is to rent out. There are deals to be found for those willing to take on the vanguard of gentrification. One such area is Compton. Every week I get updates on properties that are priced at non-L.A. levels. Let us take a look at what we can find in the market today. We might even find something that is up your alley.
One thing to understand about California housing is that boom and busts are central to the market. It is fascinating from a psychological standpoint that today, many think that California housing is a simple and safe bet. Casually, they forget the massive destruction that occurred only a few years ago and the echoes of the impact are still around: low inventory, massive Federal Reserve intervention, and a shift to investors buying homes. Looking to buy? Gear up for a sizable down payment and maximum leverage on a low interest rate. Also, it is easy to forget that 1,000,000+ Californians lost their homes via foreclosure and many today are still underwater even with the recent boom in home prices. Even with the trend to higher prices, people have the choice to buy or rent. Unlike stocks, most households have to make the analysis of buying or renting. In spite of rising prices and the meme that home values will only go up, the homeownership rate in California has plummeted. The state is seeing a wave of households opting to rent. This trend started in 2005, while home prices held a plateau up until 2007. In housing, trends reverse slowly. Take a look at 30 years of housing data for the LA/OC markets.
Rental Armageddon continues for California and other expensive metro areas around the country. There now seems to be a consensus that home prices can’t fall and that somehow, the Fed or government will step in no matter what happens. This seems to be odd logic since the Fed didn’t step in during 2007 through 2009 before the market got smashed. Of course in the minds of Californians six years ago might as well be ancient history and the 1,000,000+ Californians that lost their home to foreclosure recently are just like the suckers that lost out during the Gold Rush. The argument for home prices being high usually revolves around the following: the Fed is stuck in low rates forever, inventory is low, foreign money is infinite, your monthly payment is about the same as rent (as long as you make a giant six-figure down payment), local household incomes mean squat. That last point is the most important at least in the long-term. Rents are also a function of how healthy the economy is. Affordability in California is hovering near record lows so it is no surprise that many more households have converted to renters.
The airwaves are now once again blessed with the non-stop talk that accompanies a typical California housing fever. We are in the presence of a powerful headwind with low inventory and cheap money sloshing around the system. There was a story talking about the backlash being leveled on people renting out their Santa Monica homes via AirBnB. The story sounded like our typical Taco Tuesday baby boomer that hit the real estate lottery and is now cashing in on some nice rental cash flow. The issue? Other locals don’t enjoying paying for million dollar crap shacks and living as if they were next to a hotel. People want the Leave it to Beaver neighborhood with a Keeping up with the Kardashians price tag. As usual, people in California want it both ways. The story was interesting because it tried to paint the older person as cash strapped when in fact, they were sitting on an equity goldmine but alas, they would have to sell to unlock that equity. Instead, they would rather rent their Santa Monica pad, cash in some large rental checks, and use the proceeds to shop at Whole Foods and enjoy those delicious Taco Tuesdays. Welcome to the People’s Republic of Santa Monica.