“Encouraging” Signs for Rents Are Already Emerging

0:00Affordability is arguably the single biggest factor driving the housing market. And by some measures, it's improving. The median rent is now as affordable as it was before the pandemic. But that positive trend comes with some concerns to investors. Like, is rent growth going to stay low? Will we see a rebound in rents in multifamily? What about single family? These are complex questions, but they are key to formulating a good investing thesis in 2025 and beyond. So today, we're breaking it down.

0:37Welcome back to On the Market. I'm Dave Meyer. And today we're talking about rental affordability, plus a few other topics. And joining us to help is Liu Chen, Senior Economist at Moody's. Liu has more than a decade of experience studying the commercial real estate sector and is great at helping us understand how that commercial activity can actually spill into the residential market as well. In today's show, we'll talk about rent affordability and also break down some surprising regional supply trends and the shifting demographics that could drive market changes, market dynamics, and returns during the next few years.

1:17This conversation was a lot of fun. Lou even brought a housing data quiz to try and stump me. So let's get into it and you can see how I did. Lou, welcome back to On The Market. Thanks for being here.

1:30Lu Chen:Thank you for having me, Dave. I am eager to jump right in because I've been following some of your work. And when I saw the headline recently, I was a little surprised to see it that you're saying that affordability is nearing pre-pandemic levels. Tell us a little bit about that. Yeah, it's all because of the supply and demand, Dave. So there has been significant supply coming online since the beginning of 2024. And we're talking about multifamily housing units here. And that has certainly eased a lot of the pricing pressure, right? So we have just gotten the second quarter data last week. So on the year-over-year basis, the rent growth was fairly moving.

2:11We have been in this 1.5 % to 2 % point on the year-over-year basis over the past few quarters, a little longer than a year. and that is significantly below the long-term average. So on the average basis, we will be looking at somewhere between 3 % to 3.5 % annualized rent growth. But this 1.6 % was a little surprising. But nonetheless, that has been easing the affordability for the American winter household. And that is good news.

2:40Lu Chen:I've gotten the latest rental income ratio just for you and our listener today, Dave. we are officially back to the first quarter of 2020 level, which is you can consider that as a pre-pandemic level, depending on how you define pre-pandemic altogether. But I'm encouraged. That is surprising. Yeah, that is surprising. Wow. Okay. So I just want to make sure everyone listening knows what we're talking about. So when we're talking about affordability, there's different metrics. Sometimes people are talking about home buyer affordability. Right now, it sounds a little like we're talking about rental affordability for the average American.

3:16Is that right?

3:17Lu Chen:That is correct. And there is a simple formula cookbook into there, which is essentially comparing how much our renters are paying for the whole year, 12 months total rent plus utility as a ratio of your household income. So as a standard rule of thumb, if the rent to income ratio is above 30%, meaning you are paying 30 % of your disposable income just on rental is considered unaffordable. Of course, there is an even more severe measure, which is half. If you are spending half of your disposable income on rent, that is severely run burdened. And luckily, we have never as a nation heading into that level yet.

3:59But 30 % was pretty unaffordable for many places, especially some of the gateway metros. New York has always being on the top list, Florida, Los Angeles, right? All these bigger metros, which has more acute affordability issue. But nonetheless, the nation has been seeing some easing over the past year and a half. Well, that is relatively good news in my mind. I do think, obviously, as real estate investors, people who are seeing rent growth stagnate or flatten out, that is not the best for business. But after so much rent growth over the last couple of years, we've been in a situation where there was a period, right, where the whole country was considered rent burdened over 30%.

4:39Is that right?

4:40Lu Chen:That is roughly in 2022. So if we recollect when Federal Reserve started hiking interest rates to tame the run on inflation, so this affordability crisis was most acute in the second half of 2022, which is aligned with the general inflation trend. Luckily, there has been a period of interesting time, which is putting us around the second half of 2021, early part of 2022. And that period features low interest rate, heightened migration flow, internal domestic migration flow. And the rental demand was heightened, also encouraged by this preparation of return to office mandate. So at that period of time, investors and developers have been highly encouraged to have more permits pulled and there's more housing being started on both single family and multi-site.

5:30and accounting for usually about two years of construction period, that pretty much put us to this construction boom in 24 and early part of 25. So that's where we have gotten that pressure easing a little bit over the past year or also. You've noted the multifamily boom in supply. We've talked about that quite a lot on this show. So when you're talking about affordability, That's the whole country, right? So the multifamily rent situation is driving down the overall rents, right? So that would include single family or single family rents outperforming at this time.

6:09Lu Chen:It's interesting, Dave, you brought up single family. Although my team doesn't focus a lot on the single family, single family rental, but we do monitor single family market closely. And the reason being, that's part of the housing ladder, if you were to say, right? So the renter would be naturally moving up the housing ladder to become a single-family homeowner. So anything happens on the single-family side has implication on the rental side as well. So I would say single-family has been also going through a period of rapid price appreciation. And that, of course, has been driving up the single-family rental price as well.

6:45But recent data has been a little discouraging. discouraging in the sense that we are seeing the transaction volume has now been picking up during the spring buying season and housing appreciation. It really depends on which metric we are monitoring, but we are seeing month-over-month price decline, nominal price decline, to be more accurate, which still puts us on the year-over-year gain, but that gain has been fading, that is an indication the renters has been holding up to their rental units for longer. At the national level, we are seeing the first-time homebuyers' average age has been moving up.

7:27And right now we are sitting at 38, which is very daunting for millennials to become a first-time homeowner. But if that situation is easing a little bit because the single-family inventory has been creeping up at the same time with the multifamily construction boom because we are seeing the locking effect has been finally easing a little as people getting acquainted with the six handle, right? And there has been the live events, putting some of the existing home for sale and also the single family building has been churning up the inventory, which has been providing this more benign spring purchasing season for the first time home buyers.

8:07And that has been, I mean, loosening up the price level a little bit. And if that were to persist, and of course, it gives renter a lot more options in the next few months. Does that mean you think rents have further to fall?

8:23Lu Chen:Ah, Dave, don't get me into that loophole. I'm trying to follow along here. Right, I was always following your direction. No, the rent is not falling yet. And as a matter effect. If we look at a quarter over quarter run growth, and there are certainly seasonality baked in, right? So right now, as we speak, we are in this peak renting season, we are seeing the quarterly rate has been slowly but steadily growing up. And the reason there is a very strong reason behind it is because the demand hasn't shown any cracks. Although the supply has been easing a little bit since the beginning of the year, we talk about the construction boom, but that pressure has been slowly but steadily easing because the housing permits and start has been falling from its peak in 2022.

9:10So the supply easing is coming. But on the other hand, this is the encouraging sign for our investors who's listening to our podcast, is the demand factor hasn't really faltered. If you look at the unemployment situation, looking at the labor supply and demand and looking at the wage growth. So looking at the population growth in the short run, we are seeing the main supporting factors for the demographics are still here. And that's the reason we are seeing the rent is not falling and it's actually slightly but steadily accelerating a little bit, very marginal. But the quarterly rent growth has been eking up.

9:53So that pulled year-over-year run growth from low 1 % into the higher 1 % range. So that is the encouraging sign. However, because the demand hasn't really been catching up as strongly as we would expect, right? So it's steady, but isn't as we would predict in the first quarter, we have to lower our outlook for the run growth for the year. So we were at 2.5 % year-over-year run growth for the entire year of 2025. I haven't got out of box numbers.

10:25Lu Chen:So this is my personal bet. And whenever I bet it's most likely I'm going to lose the bet anyway, but I'm expecting it's going to slightly trailing below 2.5 % on a year over year basis. And that's at the national level. So then the affordability that you're talking about, if it's not from rent declines, then it's just because incomes are outpacing that rent growth? Well, given the gap, yes. So we are still having this healthy margin. We are looking forward that income growth will still outpace rent growth, just given how marginal and how much below historical average we are looking at from the rent growth perspective.

11:08I'm positive the housing affordability will continue to improve through 2025. But there is a catch, though. So when we talk about the income growth, it also goes into different occupations, right? So we are seeing this AI has been really playing a much more important role in today's job market. So depending on which particular industry our renter household will be located in, and there may be some different dynamics playing at a more granular level. So that's why it's very important we talk about the national headline number, But there's also nuances at individual match flow because real estate is all local game, but also individual demographic cohort.

11:52Great. Well, I do want to talk about the regional differences because obviously those are super important. We do have to take a quick break, though. We'll be right back. We talk a lot on the show about financial freedom. And for some of you, that means eventually having the choice to walk away from your W-2. But there's one expense I think a lot of investors underestimate when they're calculating their financial freedom number. healthcare. Because once you're paying for health insurance yourself, you might suddenly be looking at hundreds or even thousands of dollars every month. That's a lot more cash flow your portfolio needs to produce before you can comfortably leave your job.

12:26But here's something you may not know. Health insurance isn't your only option. We Share Health is a non-profit alternative to health insurance, and their members pay up to 60 % less than they would for traditional health insurance. You still get access to a nationwide PPO network with over a million physicians plus unlimited telehealth. So if health care costs are making your financial freedom number feel a little further away, run the numbers on another option. Call 1-888-WE-SHARE for a free quote. That's 1-888-WE-SHARE. Or visit WeShareHealth.org. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs.

13:06It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed sponsored jobs. This summer, no excuses. Double down when everyone else disconnects. At Equinox, that's high-performance living. Iconic spaces built to inspire, personal training backed by real data, unlimited signature classes including Pilates and HIIT.

13:47Elevate your post-performance ritual with saunas and steam rooms, as well as innovative treatments at the spa. Everything you need to lock in this summer and unlock your potential at Equinox. Start today at equinox.com.

14:04welcome back to on the market i'm here with economist lu chen we're talking about the surprising headline that renter affordability has been improving over the last several years and is now near pre-pandemic levels or maybe at pre-pandemic levels depending on how you define it as lu pointed out for us before we talked about some of the national trends that rent growth is a little bit sluggish. Incomes have been going up a bit. But we alluded to the fact that there are big regional differences. So maybe, Lou, you can tell us what are the high level trends that you're seeing on a regional or local basis?

14:40Lu Chen:I will talk about some obvious, but then I want to play a game with you, Dave, if you don't mind playing your little statistics game on the show. Uh-oh, putting me on the spot. This will be fun. So people have been talking about Sunbelt, right? I think that's the big obvious. if I say, well, over the past at least one or two years, a lot of the supply increases was highly accumulated in the Sunbelt region, you wouldn't be surprised. So that's the reality. And the reason we are seeing this interesting dynamics going on in the Sunbelt was also because there's a strong demographic factor backing that supply chain, right?

15:19So if you look at the domestic migration, if you look at the job gains, A lot of that has been very active in the Sun Belt for various reasons. It could be because of the local policy, which has been supporting the job growth. It could be because of the weather is more welcoming for the prime age workers and also retirees. And there could be family friends reason and people are moving closer to where their families are located and based on. But this is a very interesting economic phenomenon. Whenever you see some places or some industry has been eking up above average gain, and most likely you will see this mean reversion, which will play a big important role in driving that trend downwards.

16:04Lu Chen:So you ended up having this bigger swing, right? Thinking of the radio waves. So if you have a higher spike and you have a much lower trough. Yeah. So that is essentially putting everybody at the end of the day to that average line. So you will come back together. And that is exactly happening to the Sun Belt over the past year and a half. So we are seeing a lot of those places, including all major metros in Texas, including Greenville, Jacksonville, a lot of those big names during the construction boom. They will see a great moderation coming in the second half of this year, which will pull down their inventory growth from way above average to way below average.

16:44So that's the reality. So on the net run growth level, we are seeing, well, a lot of those earlier gain will be compensated by this moderation, in some cases might be moderate decline. The reason I say moderate decline is because you seldomly see a large drag on the run growth, even during some of the construction boom in the multifamily market. So there would be some moderation, in some cases moderate decline because of the supply side pressure. but that'll also be salvaged by this steady demand factor over the next few years yeah so that is what we are seeing especially happening in the sunbelt but now the game time Dave if you don't mind yes I'm waiting for the game let's do it so we have been talking about this inventory growth

17:33Lu Chen:we have been talking about the construction boom which are a lot of listeners mindset So do you know which state over the past 18 months, which put us to the beginning of 2024, all the way to where we are sitting now, which state has been growing their multifamily inventory most aggressively? You have three tries. Okay. I already can say that I don't know the answer, but I'm going to come up with a guess. Absolutely. Given the context of this conversation, I'm already just thinking it's not in the Sunbelt. Oh, Dave, you're good. Are we talking relative supply or total number of units? You are really good, Dave.

18:15Lu Chen:Let's talk about relatives. Okay. So for everyone listening, I'm asking if it's like how many units compared to the total housing units in a market? Because that helps because you could otherwise I could just guess a high population state like California or New York, and it would probably be right. Okay, so now I'm thinking maybe it's somewhere in the Midwest. Oh, that's a good guess. Okay, it's not right, though, based on your reaction. My second regional guess is the Northeast. Maybe, but I'm wrong there, too. You might not be wrong because a lot of the Northeast states are much smaller. So when you talk about the inventory growth, and that could easily swing left and right easily.

18:59All right. The reason I was saying the Midwest is because I was thinking about states that have relatively more permissive building and zoning. And so like a lot of states like California are tough for that or Seattle or, you know, I would imagine that states that are seeing price declines like Colorado, for example, aren't building that much. but I just read something yesterday that Denver was like adding all this supply, even though they're seeing a huge decline. So maybe that could be right much to my chagrin because I'm an investor in Colorado. So I would hope that's not right. So that's kind of why I was thinking the Midwest and then Northeast, I was just thinking because those housing markets have been hot and it does seem there's been some reversion of migration patterns and people are moving back to the Northeast.

19:45So I was wondering if developers were taking advantage. All right. So I think I'm off base, though. So now I'm guessing, I don't know, do you count like the Carolinas as the sun? You're so good, Dave.

19:59Lu Chen:Wow, you're so good in the sense that you have been catching the right answer for a couple of times, but you flew over it. What is it? So the number one is actually the state of Colorado. Really? Oh, okay. That's the reason that why you invested in there. And among many investors on the number scale, Colorado has been growing their inventory over the past 18 months. 18 months only, right? We're not talking about earlier time. That has been putting Colorado at 5.4%. Colorado, yeah, I am an investor there. And rents are flat or declining there for sure. Anecdotally, I don't know what the aggregate level is.

20:38But yeah, it's tough out there. And they're adding more and more and more. and population growth, I think it's still positive there, but it's slowing. So I think it's not a good time for rent growth. Well, I mean, for this particular period of time, we are probably going to see some corrections. And in the state of Colorado, we are also seeing this interesting phenomena on the single family front, right? So we are seeing the single family inventory has also been growing at a much faster speed in comparison with other metrails. So that really puts the renter household out there with abundant options.

21:13So that is where when you have this inventory abundance, and you will likely see some softening on the on the rent growth and the single family price appreciation. That's probably what we are seeing at this particular moment. But I'm personally have a very hopeful, very positive attitude towards the state of Colorado overall. I do think the young population there, the school, which often serve as a huge magnet to the young population growth will continue to help with the job growth, and in particular, the high-tech job growth. And that is really my best bet in terms of the positive demographic factor for the state of Colorado.

21:53That's good because deals are getting better in Colorado. I haven't invested in Denver in a few years just because everything's super expensive, but multifamily prices are going down just from an acquisition standpoint. And where I couldn't find two to four unit properties that make sense. A couple of years ago, they're starting to make a little bit of a sense. And I think I'll have to consider that rents will probably be flat for a while if I'm going to invest there. But I agree. Everything you said about the schools, the young population, good quality of life, it's a place people want to be.

22:25So I think it's a good place to bet on. All right. So in my head, I was thinking like all the Sunbelt, they've seen this correction. It's been coming for years. People have been seeing it. So development has really stopped, you know, like the pendulum has swung back in another direction. So are there regions of the country where you're forecasting new supply? That's where my head was sort of going. Are there areas of the country that are still building and that may see an increase in inventory in the next year or two? You mentioned the state of California, right? We have always been slowing in putting up the construction, whether on the single family front or multi.

23:02But now we are seeing the state of California is finally playing a catch-up game. So it's interesting, I was looking at the data the other day.