The Sticky Question of Whether Households Can Afford Today’s Sky-High Rents

Cushman & Wakefield listed a number of critical CRE questions as it looked at the uncertainty that is the opening of 2023. One of them was, “Can households afford today’s sky-high rents/?” But the answers don’t necessarily comport with some other views of the question.

“Home prices have already started to decline, but for the market to return to the historical spread between rents and mortgage payments, home prices would need to fall by more than 25%,” the firm noted. “That decline would be more than home prices fell during the Great Financial Crisis (19.8%), insulating apartment demand from further erosion from the single-family market.”

So far, that seems largely clear-eyed. Hope that suddenly the prices on houses, even though they are deflating, would crater to that degree is unrealistic. According to government data, the median sale price of houses in the third quarter of 2022 — the most available data at the moment — was $454,900. In the same period of 2019, that figure was $318,400. The price has risen by 42.9%, a phenomenally high percentage. To return to the perception of affordability, and that ignores the increase in mortgage prices, median housing prices would have to collapse by 30%.

Given how different the housing market is today than after the Great Recession — no large stock of foreclosures about to flood property availability — that sort of crushing fall seems nigh on impossible.

That leaves the rental market, which absolutely has benefited from the lack of houses. As Cushman noted, “The difference between the average principal and interest component of mortgage payment and rent (widest gap in history). Typically, rents are about $65 higher than mortgage payments. Relatively, renting has never been cheaper.” But then the firm added this: “Current average rent-to-income ratios for U.S. multifamily REITs imply renters aren’t having trouble making rental payments. 30% qualifies renters as ‘cost burdened’ by HUD.”

Marcus & Millichap notes that luxury rentals are seeing people of growing income. “During the second half of last year, the average monthly income of a Class A renter was about $10,000, compared to $8,100 in the same period of 2019,” the firm wrote. “Barriers to entering the single-family home market are encouraging more affluent residents to choose high-end apartments. This could produce longer-term tailwinds for Class A apartment demand, once the economy is back on solid ground.”

However, REITs and luxury housing, while one measure of the market, are hardly all encompassing. From the broader view, a large portion of the market of all renters is indeed having problems. As the Census Bureau noted in December 2022, “Over 40% (19 million) of renter households in the country spent more than 30% of their income on housing costs during the 2017-2021 period, according to new American Community Survey (ACS) 5-year estimates released today by the U.S. Census Bureau.”

At the county level, 7.6% of the 3,143 counties in the country had a median housing cost-to-income ratio of more than 30%, meaning more than half of the people in those counties face economic trouble, and those counties house nearly a third of all renters.

“In 18 counties, homeowners with a mortgage had a median housing cost ratio above that of renters,” the Census wrote. “That means the median household with a mortgage had higher financial burden than the median household that paid rent in these counties. The hardship caused by the rise in housing costs persisted despite increases in median household income.”

By those figures, the apartments covered by the REITs may be largely sustainable (although one has to wonder about the distribution if 22% of income is the average, because that may be top-weighted). But for a significant portion of the renters in the country, the situation is not.

That is one reason why flat to shrinking household formation, with the number of households, at 132.5 million, was down 143,000 from the 2021 peak, is putting a lid on apartment rent increases. People are moving toward living with relatives or roommates to control costs. Plus, when enough people complain about housing costs, politicians in the areas hit hardest typically start looking at regulating the industry.