One Sign the Housing Bust Could End Soon

Rents are surging, which eventually could turn tenants into homeowners.

By SHARE

It's not usually welcome news when the landlord hikes your rent. But for the housing market, rising rents may be one of the most hopeful signs in years.

The markets for rented and purchased homes usually move in opposite directions. When the housing market is hot and more people are buying homes, rents tend to stay low or go down, because there are fewer renters. But when high interest rates or other factors cool the housing market, more people rent. Since it takes awhile for builders to add more units, the supply-demand mismatch drives rents up.

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As with many other things, that natural relationship between rented and purchased homes got upended during the recession. Everybody knows about the housing bust, which got started as builders slapped up too many homes and lenders gave mortgages to millions who couldn't afford them and were doomed to default. In the inevitable shakeout, a record number of foreclosures led to an oversupply of homes and a sharp pullback in lending. And many homeowners became renters. But instead of going up, rents fell, too. That's because of the way people reacted to lost jobs and falling incomes. Young people moved back in with their parents. Others doubled or tripled up to cut living expenses. Spouses in troubled marriages toughed it out for a few more years instead of getting divorced, because they couldn't afford two places to live. Overall, the demand for rental units went down.

Now, all those overfilled households are finally starting to get some breathing room. New renters are emerging at rates similar to the late '90s—when the economy was on a tear—as grown kids finally wave goodbye to their parents and many others move into a place of their own. That's pushing high vacancy rates back down toward levels they were at before the recession—and sending rents back up. Research firm REIS estimates that nationwide, rents will rise an average of 3.4 percent in 2011, which is more than inflation or incomes are likely to rise. In cities like San Jose, Calif., Washington, D.C., Seattle, and New York, rents will go up by more than average. And in a few select neighborhoods, rent increases could exceed 10 percent.

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Some tenants, no doubt, will protest that the rent is too damn high. But to economists, that kind of tension is a welcome indication that damaged parts of the economy are returning to normal. As building owners make more money, new construction will pick up, providing badly needed jobs in a sector with sky-high unemployment. And if rents are going up by more than inflation or incomes, renters will start to think about buying, which is just what the dilapidated housing market needs.

The depth of the housing downturn has continually mystified economists, many of whom expected a turnaround by now, thanks to low interest rates and what seems to be a sustainable economic recovery. Yet sales have continued to tumble, pushing the bust into its fifth year. Home prices have already fallen by more than 30 percent since 2006, and most forecasts call for another 5 to 10 percent decline. The high rate of foreclosures is one obvious problem, since it means there's a steady supply of underpriced homes dragging down values. High unemployment has reduced the number of buyers. Banks won't lend to many buyers anyway, since they've gotten religion and are now determined to prevent another spike in defaults. And many potential buyers are waiting for signs that the bust has ended and prices aren't likely to fall any further.

Some renters, especially those on fixed incomes, aren't likely to turn into buyers any time soon. But many renters are the future home buyers of America, just as they always have been. Victor Calanog, chief economist at REIS, points out that about 65 percent of the roughly 1.1 million new jobs created over the last year have gone to young workers between the ages of 20 and 34. More than two-thirds of people in that age group are renters. So the rental boom is being driven by up-and-comers with fresh disposable income and more optimism than older workers facing an underfunded retirement or truncated career that has left them desperate to downsize.

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As apartment costs go up, younger renters are likely to react the same way their parents did: by looking around for a better deal. And buying will look pretty attractive. Falling prices and low interest rates have driven affordability to the best levels since 1970, when the National Association of Realtors started tracking it. All the old reasons for buying instead of renting still exist: getting into a good school district once you have kids, enjoying a neighborhood that seems less transient than an apartment building, and doing whatever you want with your home instead of begging the landlord for permission. Plus, renters don't have to worry about selling an existing home that may be worth less than the mortgage.

It won't happen overnight, and a meaningful pickup in home sales will still require easier lending by banks, lower unemployment, and more confident consumers willing to commit to a big purchase. But rising rents are an important first step. So when the landlord comes calling, negotiate hard, but remember that he might be showing the way to a place you can call your own.

Twitter: @rickjnewman