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In this U.S. city, I have the impression that the rents of apartments and houses always go up, say, about a 5% per year, while the prices of buying them fluctuates throughout the same years. If my impression is correct and common,

  1. I wonder how renting and buying prices are related with each other?

  2. In economics, what theory explains/generalizes this housing example?

Thanks!

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3 Answers

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I am from Australia, so my answer is based on my experience over here, however it should be similar for the USA.

Generally, what determines both the price of houses/apartments and the rents for them is supply and demand.

When there is high demand and low supply prices (or rents) generally go up. When there is low demand and high supply prices (or rents) usually go down.

What can sometimes happen when house prices go down, is that the demand can drop but so can supply. As the prices drop, developers will make less money on building new houses, so stop building new houses. Other developers can go bankrupt.

As less people (including investors) are buying houses, and more people (including investors) try to sell their existing houses, there will be more people looking to rent and less rental properties available to rent. This produces a perfect storm of high demand and low supply of rental properties, causing rents to rise strongly.

When the property prices start to go up again as demand increases, there is a shortfall of new properties being built (due to the developers not building during the downturn). At this time developers start to build again but there is a lag time before the new houses can be completed. This lack of supply puts more pressure on both house prices and rents to go up further.

Until equilibrium between supply and demand is realised or an oversupply of rental properties exists in the market, rents will continue to rise.

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+1 for "supply and demand" a universal truth. – JoeTaxpayer Nov 29 '12 at 3:17
+1 too. When will rents start to fall? – Tim Nov 29 '12 at 3:24
The fact that Victor is in Australia aside, no one can answer this. Rents may never drop in the area you're looking at. If rents simply rise less than incomes over some period of time, the effect will be the same, and an observer in say, 5 years, will see rent costing the average tenant fewer hours of labor per month. – JoeTaxpayer Nov 29 '12 at 15:59
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At 5%, this means you expect rents to double every 14 years. I bought a condo style apartment 28 years ago, (sold a while back, by the way) and recently saw the going rate for rents has moved up from $525 to $750, after all this time. The rent hasn't increased four fold.

If rents appear to be too low compared to the cost of buying the house, people tend to prefer to rent. On the flip side, if the rent can cover a mortgage and then some, there's strong motivation to buy, if not by the renters, then by investors who seek a high return from renting those houses, thereby pushing the price up.

The price to rent ratio isn't fixed, it depends in part on interest rates, consumer sentiment, and banks willingness to lend. Similar to stock's P/E, there can be quite a range, but too far in either direction is a sign a correction is due.

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Perhaps 5% in two years for northern part of Baltimore city. I never see rents can go down, but only up in these years, no matter the economics go down or up. I really hope to see rents can decrease or stay. BTW, the rent for a condo in your place is the same as or less expensive than the rent of a studio in Baltimore. – Tim Nov 29 '12 at 3:17
Two year's of data can't forecast indefinitely. What I don't address above is the other equilibrium point, the tendency for rent to be a week's pay or 1/4 of a local average income. Again, a generalization, but it's one of the trend lines the true long term data will tend toward. – JoeTaxpayer Nov 29 '12 at 15:55
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Average rent rates will typically rise and fall, and are market-dependent just like real estate. In the short term, a collapse in housing like the one we saw in 2008 can induce a spike in rental costs as people walk away or get foreclosed on, and move back into apartments. That then tends to self-adjust, as the people who had been in the apartments find a deal on a foreclosed house and move out.

However, one thing I've seen to be near-constant in the apartment business is that a landlord will offer you a deal to get in, then increase the rent on you from year to year until you get fed up and move. This is a big reason I didn't have the same address for two years in a row until I bought my house. The landlord is basically betting that you won't want to deal with the hassle of moving, and so will pay the higher rent rate, even if, when you do the math, it makes more sense to move even to maintain the same rent rate. Eventually though, you do get fed up, look around, find the next good deal, and move, "resetting" your rent rate. I have never, not once in my life, seen or heard of any landlord offering a drop in rent as a "loyalty" move to keep you from going somewhere else. It's considered part of the game; retailers will price match, but most service providers (landlords, but also utility providers) expect a large amount of "churn" in their customer base as people shop around. It averages out.

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KeithS, as a landlord I look for good tenants who are likely to stay long term. We offer market rent when advertising and find that the tenants with a bad history usually ask for a discount or offer you more than you are asking in the hope you will go with them. The better tenants usually know what the market rent is and realise you are asking a reasonable rent. We usually try not to increase rents unless our costs are going up, and in these instances we once again look at current market rents and try to keep our increases below this level. We want to keep a good tenant forever. – Victor Nov 29 '12 at 23:32
@Victor - I probably would have loved to be your tenant. I started renting in 2003 and moved into a house in 2011, and during that time I think I renewed my lease twice. "Market rent" in my market is considered a penalty rate, and like I said, the rate I renewed at, or would have, never decreased. Not once. Even when the housing boom created a glut of apartments. The best you could hope for was to keep "resetting" by moving to a new place offering move-in incentives. – KeithS Nov 29 '12 at 23:55
Now, I'm talking mainly about the world of multi-building apartment complexes, owned by multimillionaire real estate barons and "professionally managed". If you're a relatively average Joe with an income property (a rental house or two, half a duplex, basement apartment, row of townhomes) and you're actually interviewing tenants who are competing to get the space, instead of signing up anyone who has the application fee and no recent evictions, then that's a completely different world. – KeithS Nov 30 '12 at 0:00
I don't know how it works where you are, but in Australia market rents are determined by supply and demand and the rental vacancy rate. If you have a low vacancy rate (meaning not many properties available for rent) rents will increase. If you have a high vacancy rate rents will decrease. It makes no sence for a landlord to lose a good tenant by increasing renst above market rents. If you keep the rent at market or just below, even if the tenant leaves they would generally have to pay a similar rent on a different property of the same size and standard. – Victor Nov 30 '12 at 0:05
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This lower rate reduces the landlord's margins on the property, but he knows what he'll be making for a year, and because he's accepting less than "market" rates, he can buffer himself against real revenue loss from year to year by simply keeping the rate he offers to renewing tenants the same (though that may now be less of a deal as compared to "market" rates than when the lease was first signed). Even though this lower incentive lease rate is the way it works for just about every US landlord, it isn't considered "market" rent in industry parlance. – KeithS Nov 30 '12 at 15:39
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