Hype Dodger: Zillow rent report provokes mass media faux-analysis

New Rent Report Suggests Possible Bubble - CNBC.

That article up there? It's written with one purpose - to make you panic and buy stuff.  Courtesy of CNBC.com comes some hype about the rental market. Apparently a new report from Zillow shows rents rising in almost perfect proportion to home sale price falling nationwide. They specifically talk about the high year-over-year rent growth for Chicago, as shown in this month's Rent Bacon.

Of course, the media will take any statistics on the housing market they can get and turn them into hype. If they don't provoke your emotions, you might use your logic to make a decision, and that never works out well for them nor for their advertisers. But they are trying to manipulate investors in the rental market by using the same tactics as those that worked to make home buyers and sellers all crazy and depressed.

They're doing it wrong.

Fight fear-mongering with research. In this case, the census can help us.

People will always have to live somewhere. The chart to the left shows the home ownership percentage in Chicago from 1986 to the present, based on US Census Data. It's reasonable to expect that those who do not own homes will rent them, and therefore this one line tells us all we need to know about both renters and owners in Chicago.

The graph shows us three things.

A: Even in the peak of the real estate buying frenzy, about a third of the city was still renting.

B. The recent growth of the rental market - the so-called "bubble" - is just a 5% change in the overall balance between owners and renters.

C: If we're talking about a "rental bubble," the past three years were not it. Look at the earliest span on the chart, over to the left. Back in the 1980's and early 90's nearly half the city was renting. They were renting the same standard stock vintage walk-ups and two-flats that populate the rental inventory to this day. Compared to back then, the recent rental boom is just a minor wobble.

There is only one area of the market that is really seeing a "rent bubble," and it's a market that will take care of itself with no help from the media, statistics or any sort of real estate reports. That's the "shadow" rental market of condos and homes that are temporarily withdrawn from the owner-occupied home sales market until prices recover. Currently rents are up because the market is saturated with these luxury, high-end condos that rent for elevated rates. These are properties that were intended for sale, couldn't sell, and therefore turned to rental so that the owners could move on without losing their shirts. The owners in this situation do not want to be landlords. My guess is that the majority of them will get out of the rental business as soon as they're able.

Eventually the high end rentals will stop coming to market in such large numbers. The sales market will level off, condo buildings will reach their maximum limits for rentals, and many of the current high end rentals will leave the shadow market and return to owner-occupied status. Tenants who are coming to blows in competition over the most desirable rentals will realize that they can get a better deal with less competition by just buying a place. These factors will combine to bring rents back down again, by simply removing the most expensive portion of the inventory. It will be very sad when the wealthiest renters no longer are willing and able to rent are are forced to buy something instead, won't it? In that case, do you think the media will call it a "bursting rental bubble?" I'd like to think they'll call it what it really is - a "recovering housing market!"

Here's the thing though - and the main reason why articles like the one in CNBC make me really really angry. According to the State of Rental Housing in Cook County (PDF) report released last year by the Depaul Institute of Housing Studies, Cook County will see a shortage of affordable rental housing until at least 2030. According to a study released last year by Harvard & MIT's Joint Center for Housing Studies, about a quarter of the US population spends over half of its income on housing and another quarter spends between 30-50% - this is, by all measures, unaffordable, unsafe, and ill-advised and possibly one of the main reasons behind the slow recovery of the US economy. The foreclosures that are converted back to rental housing now will become the affordable rental housing of 2018. While fly-by-night investors hoping to nab $2500 a month for a 2 bedroom will be very disappointed, landlords who invest in affordable housing will always see a steady stream of residents in Chicago. The graph proves it.

Chicago needs affordable rental housing desperately. The economy needs Chicago to have more affordable rental housing - heck, the economy needs the entire country to have more affordable rental housing. If the mass media scares investors away from purchasing foreclosures and converting them to rental housing, they are prolonging the problem. They need to be warning the "get rich quick" schemers away from trying to create more high-end rentals, certainly. But what they're doing instead is scaring away the more conservative, studied investors who could actually do some good for the city's housing inventory.

Smart investors will purchase property based on the cash flow numbers from the weakest possible market - think more like the slow 2008-2009 rental seasons - the peak of the chart - and enjoy the richer seasons as they come. Most practiced landlords will raise rents in boom markets and pause on the increases in the weak markets, but rarely will they drop them back down again as the rental market softens.  Besides, it's a rare event when a multi-family (apartment) building is purchased with a traditional 30 year mortgage. The loan amounts are often too high for a traditional loan, and the loan terms are generally much shorter. Investment properties may be used as collateral for additional loans, and a slower rent market might therefore slow the pace of new purchases, but a "bursting rental bubble" even if it does occur is not likely to have the same drastic effect as the recent slump in the home sales market.  With the planning and emotional detachment that accompanies a good investment purchase, landlords are far less likely to lose their shirts as long as they really do their due diligence before buying in.

So, when you see reports like the one linked above, read them with a grain of salt, and remember that investing in the rental market requires an approach that's above all the hype - stay on the level, stick to your guns, and if you feel like you're running to catch up with the market stop and take control of yourself. Oh, and if anyone links you to the CNBC article and believes it, please share this article with them!