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Are Rising Rents Too Much of a Good Thing?

It seems like such good news—apartment rents are rising faster than inflation. That means more profits for real estate investors.

But there’s also a risk. When rents rise faster than the paychecks of your residents, then that puts pressure on their budgets. Eventually they may look for other options. If you’ve carefully marketed your apartment community to a certain set of residents—say retirees or workers at the local hospital—it’s bad news for you if those people can no longer afford to live there.

“Landlords need to be careful,” says Brad Doremus, senior analyst for data firm Reis, Inc., based in New York City. “They can’t raise rents forever or they come up against that budget constraint.” Property managers should worry about competition from new rental housing, cheaper rental housing and even for-sale housing. Eventually it will become clear to everyone that the for-sale housing market has bottomed and prices are rising, and residents paying sky-high rents will start looking seriously at homes or condominiums.

Increased pressure on renters

How high is the pressure on your renters? The cost of housing rose 52 percent between 2001 and 2010. The cost of transportation rose 33 percent. Taken together, that works out to a 44 percent increase. But over the same period, household incomes rose just 25 percent. Taken together, it adds up to a huge loss of disposable income, according to “Losing Ground: The Struggle of Moderate-Income Households to Afford the Rising Cost of Housing and Transportation,” a new report from the Center for Housing Policy and the Center for Neighborhood Technology.

And a loss of disposable income is a big problem for many renters.

The cost of rental housing has risen even more since 2010. Effective rents on average grew 2.9 percent between end of the third quarter 2012 and the same time last year, inching out the consumer price index, according to Reis. CPI rose 2.0 percent over the year that ended in September. The year-over-year rent hikes were much higher in hot markets like San Jose (4.2 percent) and San Francisco (5.8 percent).

Once you add transportation and housing together, the cost can be overwhelming for moderate-income people. The report defines “moderate-income” as people who earn between 50 percent and 100 percent of the area median income. That’s between $30,000 and $60,000 a year in most markets. These families now pay more than three out of every five dollars—59 percent of their income, on average—on housing and transportation costs.

“The landlord might think there is an opportunity to raise rents, but the market might be volatile enough that they back themselves into a corner,” warns Scott Bernstein, president of CNT. Rental residents may be forced to downsize to other, cheaper housing.

The numbers have a brighter side

But Bernstein also sees an opportunity in the numbers. An apartment community that is located in a place where transportation is less expensive may become much more attractive for households looking to reduce their expenses.

If a moderate-income family can live in a place where the need one less car to get around, that works out to a 10 to 15 percent increase to their disposable income. “It’s the equivalent of 10 percent to a 15 percent raise,” says Bernstein. Smart Growth advocates like Bernstein encourage “location efficient” new development, where residents can walk or take the train to amenities like shopping and employment.

Looking at the cost of housing and transportation together also shows real estate investors what not to worry about. Competition from for-sale housing built far away from jobs and services is probably not coming back anytime soon. “This undercuts the whole idea of ‘drive till you qualify,’” says Bernstein. “I don’t see those markets turning around quickly.”

In contrast, apartments in efficient locations are attractive to renters on a budget. “Press your advantage on transportation,” says Bernstein. “Tell people what it costs to get to a from that building typical locations.”

TAGS: Multifamily
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