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CRE Finance World, Summer 2013

come up with a down payment to purchase a home, nor will they be able to service the mortgage loan. Indeed, the rental population skews to lower-income households. Nearly one-half of households earning less than the median family income rent their homes, while less than one-fifth of households earning the median income or more rent. The hit to incomes, jobs and household growth that occurred as a result of the Great Recession hurt overall housing, but the recession also caused household preferences to shift from homeownership to renting. Coming out of the recession, the increase in demand for housing benefited the for-sale and rental markets, but the characteristics of the new households benefited the rental market in particular. Long spells of unemployment mean that once employed, these households may have the resources to rent, but are unlikely to have the resources to purchase a home. Moreover, for much of the recovery, job growth has been weak. Four years into the expansion, the economy has added back only 5.5 million of the more than 8 million jobs lost. Similarly, slow income growth has accompanied the tentative economic recovery. Real per capita income grew at an annualized rate of 1% from 2010 to 2012, compared with 2% growth from 2002 to 2007. Consequently, many households, particularly new households, lack the financial wherewithal to purchase a home and have taken to renting instead. Chart 2 Owning Costs More and Returns Less Source: Moody’s Analytics Economic factors also drive the decision to purchase a house as an investment. Households compare the returns on investing in other assets such as equities or bonds to the return on owning a home. Thus, stock market performance and interest rates can have a bearing on home purchases. The returns on owning are CRE Finance World Summer 2013 52 determined by expected house price appreciation less the costs of owning a home. These costs include home insurance, maintenance costs, property taxes, and mortgage interest payments net of any tax benefits of owning a home.2 Assuming that expected house price appreciation is closely tied to recent price trends, both the return on owning a home relative to other financial investments and the user cost of housing became less supportive of homeownership to the benefit of rental demand until very recently. The Sharpe ratio, or the difference between returns on a typical basket of equity and bonds held by households, and house price appreciation, increased for much of the past several years, while the user cost of housing rose to a record high in 2009 as a result of the collapse in house prices3 (see Chart 2). In the past year, rising house prices and falling mortgage interest rates have lowered the user cost of housing, but it remains elevated, while rising stock prices keeps reducing the relative return on housing. The cost of renting is also key to tenure choice; households will choose to rent if house prices are high relative to rents. Even with the large decline in house prices, the cost of renting continues to be low relative to buying a home, according to the house price-torent ratio (see Chart 3). The price-to-rent ratio is simply the ratio of the price of a median-price home to the average annual rent for an average-size apartment in the country’s largest metro areas. When the current value meaningfully exceeds the long-term average, house prices are overvalued with respect to renting. This rule of thumb is useful to gauge how overpriced housing is with respect to renting relative to its historic norm. The gap has narrowed significantly because of the plunge in house prices and the rise in rental rates, but the gap has benefited rental markets for much of the past six years. Chart 3 Owning Overvalued Relative to Renting Sources: Fiserv, PPR, Moody’s Analytics Multifamily Housing: On a Path of Solid Growth


CRE Finance World, Summer 2013
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