The strength of US residential rentals.
Why, data in hand, investing in US real estate and in particular in medium-tier residential properties with rental yield, provides ample guarantees of stability, wealth safeguard and steady cash flow.
Here is what to expect in the near future, according to a detailed analysis on the effects of economic and health turbulences from the recent past, both in the USA and Worldwide.
The countermeasures undertaken by the various governments in order to halt the ongoing health emergency are having a strong impact on financial markets, more volatile than ever. Now, economic analysts are starting evaluating the effects on real economy.
What consequences will have in the near future the powerful mix of restrictive policies and volatile financial markets, on one hand, and strongly expansive measures in favor of citizens and enterprises alike, on the other?
As for today, it is too early to delineate future global scenarios. But, if we take into account a very specific market sector, such as long-term US residential rentals, it is already possible to retain very precise indications.
That is possible thanks to a wide and highly-qualified literature which analyses in-depth how that market behaved in other previous phases of economic and health turbulence both in the United States and worldwide.
In this Blog:
- Health emergency – The first economic countermeasures adopted by US administration.
- US real estate market is not what it used to be in 2008.
- The anticyclical effect of monetary rates at zero.
- Health emergencies, economic contractions and real estate market. What happened in the past?
- The price of residential rentals in the USA does not follow housing price. The figures from biennium 2008-2009 prove it.
High demand VS Low supply. The formula for stability.
From the analysis of such data, in fact, the choice of diversifying an investment portfolio with residential properties rented to the average American could prove to be especially effective, in order to fight the volatility of global markets. That is the case thanks to a stable and continuous yield, plus the fact that the asset is an actual property of which one can own the keys.
In US real estate, indeed, within the context of certain given housing categories, even 80% of residents rent. The average American will always need a roof above his head. This is, in conclusion, one of the main characteristics that made US residential rental market constantly stable.
It has to be underlined how US administration, in particular, is proving to be strongly committed in sustaining real economy with very pragmatic actions, such as:
- Direct checks to all Americans, worth $ 1,200 for adults and $ 500 for minors;
- $ 850 billion in subsided loans and aid to companies;
- Guarantees from FED (US Central Bank) on university loans, financing for purchasing cars, credit cards.
But what do the research and aggregate data analyzed by OPISAS team really tell us?
US real estate market is not what it used to be in 2008.
In order to hypothesize on the future, one has to learn from the past. No sentence could be more true, if the future in question is the one of US real estate market, and the past is the 2008 Subprime crisis.
Everything had begun from one acronym, ARM (Adjustable-Rate Mortgage), the adjustable real estate mortgages which before 2008 were granted to applicants with low or very low credit profile, with no down payment and erratic income. Nowadays it is no more like that. The plethora of high risk mortgages has been eradicated. The notorious ARM, in particular, went through a strict regulation process and now have completely different profiles:
- Limits to the increase of interest rate over time.
- The applicant has to provide with proof of being financially sound even at the high interest rate possible.
- It is requested full documentation.
- Mandatory down payment.
- Mortgage will not be provided with Credit Score below 620.
In conclusion, one thing above all: before the Subprime crisis, at the apex of the real estate bubble, mortgages with the best rate of interest possible were granted to applicants with a Credit Score of 620-640. Today, the average Credit Score of who gets such mortgages is 751.
The anticyclical effect of monetary rates at zero.
No longer than a few months ago, some American analysts, basing on FED’s reluctance to lower interest rates and the subsequent tendency of growing rates among housing mortgages, forecasted a stabilization of the stars and stripes real estate market. The thought was quite linear: if rates keep growing, it will be more and more expensive to get a mortgage, thus excluding some buyers from purchase process. That would bring to a contraction of demand with a subsequent adjustment of prices.
In these last days, FED performed a real U turn on its monetary policy bringing rates to zero.
Moving on the very same reasoning process, with an eye for the medium term, when health emergency will be under control that important decision could prove to be an element for boosting the demand for housing mortgages and the subsequent housing price increase.
Health emergencies, economic contractions and real estate market. What happened in the past?
Zillow.com, one of the major and most respected real estate portals in the USA, has recently released an in-depth research that assesses the effects on real estate market of recent health emergencies. Namely, it focused on the 2003 SARS emergency in Hong Kong and the on the first data coming from China.
The evidence is particularly interesting and helps providing a perspective on what the future may bring in different scenarios:
- During 2003 SARS epidemics in Hong Kong, economy had an abrupt halt, with a 5-10% drop of GDP; the bounce and following growth have been as quick though, as the epidemics ended.
- Such model is different from a standard recession with economy dropping for 6-18 months and then slowly recovering.
- During SARS, housing prices in Hong Kong remained stable.
- What instead had been practically blocked, even though just temporarily, was the volume of transactions, reduced up to 72%.
- Potential buyers simply stopped visiting housing. They avoid human contact due to the so-called “elusion behaviors” such as avoiding travels, restaurants and public reunions, mandatory in the event of social distancing measures.
- Once the epidemics ended, transactions returned to previous volumes.
During the current emergency in China, the first news show how housing price did not diminish but transactions did (up to 98% reduction).
Basing on data from the near past and present China, it is therefore possible to expect a temporary freezing of real estate market for the duration of the emergency, without particular effects on prices.
As for today, it is hard to foresee with precision odds and entity of an economic recession tied to the health emergency. In fact, that depends on how it will keep spreading and on the countermeasures enacted.
Beyond the analysis on SARS, there is a wide literature on the likely effects of a flu epidemics. The US Congress Balance Office (CBO) has summed up a large share of such literature, providing provisional data on GDP contraction in different scenarios:
- With a severe flu epidemic (similar to 1918 “Spanish flu”) the hypothesis is about -4,25% of current GDP.
- With a mild epidemic (similar to 1957 “Asian flu” of 1968 flu pandemic), of about -1%.
In both cases, CBO foresees that economic activity will quickly bounce at the end of the epidemics, which would be coherent with data on SARS epidemics in Hong Kong.
But what happened to housing prices and transaction volumes in the USA, during the most recent “standard” economic recessions?
It may sound somehow counter-intuitive, but recessions do not necessarily imply negative figures for real estate market. Actually, they usually have the opposite effect, as it can be seen the chart below, which takes into consideration housing prices during the last five recessions in US economy since 1980.
- Only twice, in 1990 and 2008, housing prices dropped.
- In 1990 of less than 1%.
- In 2008, economic recession had its origin from real estate market.
- During the other three recessions, housing prices actually increased.
To sum up, real estate market is made up of primary goods and therefore it may not necessarily grow, or maybe it could flatten its curve, but people will always need a place to live in. Therefore, such base need has the tendency to act as a filter on prices volatility.
The price of residential rentals in the USA does not follow housing price. The figures from biennium 2008-2009 prove it
If we analyze the trends of real estate sales and rental markets during the 2008 recession, during the period of most severe housing prices contraction, we will find out that rental fees did not follow the same trend.
Rental fees, indeed, are even less affected by recessions. Suffice to take into account data from the 2008-2009 period.
- The average rental fee calculated according to FMR (Fair Market Rent) for a 3- bedroom unit, grew at a constant rate even when housing prices dropped.
- Rental fees did probably increase when owners saw their houses expropriated and had to rely on rental market, contributing to fuel demand.
- Even in the chart below, drafted by the Federal Reserve Economic Data, it is clear how rental fees kept growing during the timespan under consideration (Section in grey).
- Only in 2010 rental fees had a quick adjustment.
- It seems rental fees are related to personal income levels, instead.
- Rental fees tend to align with them, but only temporarily and with some delay.
- Proof of that can be found in the next chart, which confronts price trends with average income for a household.
In conclusion, during economic recessions rental fees do not follow real estate price trends. They can instead react to income reduction, but with some delay and temporary, mild adjustments.
In this case it has to be kept in mind the quick reaction of American system. As a rule of thumb, income reduction is always followed by:
- Reduction of property taxes
- Reduction of HOA
By keeping de facto rental net yields unchanged, in this kind of real estate.
High demand VS Low supply. The formula for stability.
Similarly, to all other markets, even real estate and rental markets are based on the ratio between demand and supply. At the two extremes we will theoretically have:
Low demand & High supply = lowering prices VS High demand & Low supply = increasing prices.
What is the current situation of these two markets in the USA and what should we expect in the near future?
For answering the question, it would be best to start by looking back to the real estate boom before 2008 crisis:
- Even though there are no historical series available before 2012, the market peak before 2008 was characterized by an incredibly high level of availability of housing for sale = High offer.
- Despite inventory availability, during the real estate bubble we saw a quick growth of prices.
- People did purchase a second or third house in order to benefit from real estate boom, simply starting further mortgages.
- High offer & High demand = Prices growth = Anomalous situation.
- The wave of expropriations in the aftermath of the crisis brought to another increase of the real estate supply stock for sale which, along with the simultaneous demand contraction, caused a quick price adjustment.
What is the current situation?
- In December 2019, Zillow.com estimated that there are 1,489,417 real estates for sales in the United States – 120,009 less than the same period in the previous year.
- The drop of about -7,5% has been the worse since the platform started registering inventory data in 2013.
- The starting figure was of 2.017.000 real estate for sale in January 2013, and decline has been steady.
- There are 1.4 M houses for sale in the USA, for a population of 333 M people; in Italy 1.5 M for 60 M inhabitants.
But what caused such constant trend of stock reduction?
Slowdown in the delivery of existing properties:
At an early stage after recession, the strong cut to mortgage rates made possible for house owners to keep existing mortgages, which in turn quickly corrected to new interest rate as they were adjustable rate mortgages, rather than changing home by subscribing a new mortgage.
Slowdown in the construction of new housing, due to:
- Reduction of appetite for risk among developers and banks;
- Lack of construction workforce;
- Increase of costs;
- Tight control of loan policies.
Therefore, the USA are in a situation of chronic lack of supply for housing. And recent events do nothing but confirm the forecast that such situation will last for a long time.
- In case of resizing building materials availability (partially ongoing due to tariffs war), the cost of new housing could grow further.
- The recent measures of border lockdown do not let us foresee a loosening of immigration policies.
Less immigration = lack of low cost workforce = increase of construction costs.
Finally, what are the effects on rental market?
During a fist phase post 2008, the forced exit of large strata of American society from real estate sales market had an immediate effect on the demand for renting housing.
There has been a correlation between economic contraction and demand growth. That trend consolidated over the years and remained unchanged until today, and that is the case as:
- Access to mortgages has become and remained much more controlled and substantially prerogative of upper and medium-upper classes.
- The progressive increase in interest rates made mortgages more expensive.
- The memory of crisis and wave of expropriations strengthened aversion to long-term debts, typical of 20/30-year housing mortgages.
The current situation is therefore characterized by the fact that:
- Renting a 3-bedroom unit is cheaper than purchasing an average price house in 59% of US counties.
- In particular, renting is more convenient than purchase in the 18 most populated counties of the nation and in 93% of those with a population of 1 million people or more.
To sum up, it is best to consider not only how the ratio between real estate available on market and US population is not changing anytime soon, but also how – within rental market – demand will remain high in particular for medium tier properties.
This in-depth analysis shows how in any macro-economic scenario, investing in long-term rentals in the USA is a countercyclical investment capable of stabilizing wealth and ensuring a steady cash flow.
It is for that reason that since 2008 OPISAS has chosen to focus on competitive residential properties in the USA. On top of that, that is one of the world’s most transparent and owner-friendly markets in the world.
In fact, the advantage lies in renting to the average American, an investment with an immediate, stable and continuous yield.
During a phase characterized by extreme volatility, diversifying part of an investment portfolio in a safe place can be a strategic choice. If such choice is performed by investing in real assets capable of generating yearly net yields from 6% to 11% from day one, it can really become a game-changer.
Long-term rentals in the USA can ensure that, as we have seen, through a steady cash flow. It is not by coincidence that in some real estate typologies over 80% of residents is renting, and it is not an exaggeration to say that these same residents will always need a roof on their heads.