This may be the year of long-expected rental growth as industry analysts have predicted, but economist Stephen Cecchetti believes it could also be a year of stagnating property values.
Cecchetti, professor of international economics and finance at Brandeis University International Business School near Boston, wrote in the Financial Times in December that the gap between homeownership and rental costs was so wide that it would lead to a significant market correction – a potential $6 trillion hit to the U.S. economy if that correction comes from the value of houses alone. Cecchetti has computed a ratio that allows him to compare house values with rents. “House values rise periodically, but normally rents go up with sale prices. This time is different,” he wrote. “The ratio of the market value of the housing stock to its rental price for the country as a whole is now 33% above its historical norm.”
Apartment Finance Today asked Cecchetti, the former executive vice president and director of research at the Federal Reserve Bank of New York, to explain his position.
Q Is there any historical precedent to what happened here in the last five years and the housing/rent ratio?
A No. I computed something that’s equivalent to the price/earnings ratio to stocks. [For] this price-earnings ratio, I have data starting from 1952.
And if we just restrict ourselves to the 1980s and 1990s, the average of this kind of price-earnings ratio for the U.S. housing stock is a number like 14. The peak value for the number before 2003 had never been above 15. It’s now 17.5.
Q You noted in the Financial Times that “the housing/rent ratio has to return to normal.” First, why must it? Second, what are the options?
A This system has to equilibrate in the sense that rents have to be consistent to the price of homes. If they’re not, then people have to sell their homes or renters will decide to buy, or people … sell their rental properties. The idea is that [the] ratio is out of whack by a pretty big amount. In order for it to come back, either housing prices have to fall, reducing the value of the residential housing stock, or rents have to rise. Or a combination of the two. We don’t know which will happen.
This is a pretty big adjustment that has to occur, and so this thing has to adjust by something like 20% to 25%, which means the price of houses has to fall on average about 20% to 25%, or alternatively – this is a national average, we’re not talking about Marin County here – rents will have to go up by about 20%, or there will have to be some combination of those two.
Q Owners of apartments are probably eager to see the rental growth, especially after five years of rental stagnation.
A [The March Consumer Price Index] data suggested there is a little rent growth out there. The data showed that rents were up significantly more in the last few months than they had been in the 12 months before that.
So we are starting to see some rent increases, but they’re around 3% on an annual rate. That’s not quite what we’re talking about here. We’re talking about bigger adjustments [needing to take place].
Q Redressing that big imbalance between housing and rental values could hurt the economy, couldn’t it?
A That could be a big hit to the economy – a big adjustment. But the hope is, if we look around the world, we see [that] more typically housing prices stagnate [instead of] collapse.
What your readers have been seeing happen to their rents, now they could see the opposite, where the resale prices of their properties are stagnating but they might be able to raise rents.
Q So cap rates should increase?
A The return from their rentals should rise. But my guess is that some owners of rental properties might not be happy with that because they were hoping for capital gains on their properties.
I [try] not to make any causal links, but something’s out of whack and I don’t know what happens next. It can’t stay like this. Either way, it looks bad for rental properties. If they can raise rents enough, that’s fine. But I would be surprised if they saw much in the way of capital appreciation on their property.
Q Is this situation unique to the United States?
A There have been huge price [imbalances elsewhere]. The most well known of the last five years have been in southeast England, in the London area, and in Australia.
Those showed big increases [in housing values] of about 20% a year or so, and then they’ve been flattening out. In Australia for the last two years, the market has been very, very flat.