August 9, 2006
"Always" and "Inexorable", Conclusion (2006)
(c) Copyright,
View from Silicon Valley, 2006. All rights reserved.
The "Always" and "Inexorable" series was in response
to a reader seemingly following up on an earlier series, "The moving Chronicles," published October, 2004. It was our
take at the time on the insane valuations put on Palo Alto rentals, not the mention the whole PA "experience."
(Chapter
1 (http://www.viewfromsiliconvalley.com/id102.html)
Chapter 2 (http://www.viewfromsiliconvalley.com/id104.html) &
Chapter 3 (http://www.viewfromsiliconvalley.com/id105.html))
If you haven't read them, we humbly recommend it. They were fun to write, even if the experiences
at the time were not so wonderful...
The series explained how we landed in a house not next to US-101 nor in the flight path of the Palo Alto
airport nor subject to the constant demands for "Mo' Money" from the Palo Alto school system. This ~30 years newer,
50% larger with excellent schools, an actual two-car and air-conditioned house was leased in exchange for less then a 4% rent
increase from our Palo Alto slum. We were hopeful of a job with BLS when we calculated this was roughly a 35% hedonic
decrease. (No such luck hooking on with the BLS.)
Today there is some hysteria that rents are rapidly rising.
The flipper/investors are exultant that their negative-cash-flow purchases might soon begin to flow less negatively.
Extrapolating trends, a skill in which they are obviously expert based on the inflated purchase prices they've proven willing
to pay, such "inexorable" rent increases "prove" they were right all along. (Just ignore cash flow is still negative,
even if they did manage to increase rent this year.)
I know you're all just waiting with baited breath to hear our
opinion, so we will not disappoint. ;=)
The rental-increase hoopla has indeed been deafening the last 90 days or so.
The claims include:
1) jobs are strong and people are flocking to Silicon Valley again
2) Prospective buyers are "forced"
to rent --since they can no longer afford to buy due to higher interest rates.
3) there is a limited supply of apartments,
which will drag up rental home lease rates
and, our personal favorite,
4) renters are stupid and doomed to line
the pockets of smart owners for the rest of their lives. (This is the kind of comment is common on Craigslist housing
forum, among others.)
We're just stupid renters ourselves but, just for fun, let's flip through these claims and see
if we can imagine, with our obviously-limited reasoning skills, any reasonable counter-arguments.
1) Jobs are
strong and people are flocking to Silicon Valley again.
As measured by Santa Clara County (and San Benito
County) monthly employment statistics:
Month/Year Total Jobs
2006-06
775.3K
2005-06 774.7K
2004-06
773.4K
2003-06 776.0K
2002-06
814.3K
2001-06 898.2K
2000-06
906.1K
1995-06 815.0K
1990-06
825.5K
Anybody see a trend here? To be more clear, does anybody see a trend here which explains higher higher
rents? (Or higher house prices, for that matter?)
Not to worry, claim the cheerleaders. Many small businesses
not captured in the mainstream statistics are just reaching the stage where they leave "stealth mode" and their employees
will be captured in the jobs numbers.
Unless these stealth companies do not pay their employees, the state can automatically
count them from payroll withholding receipts and tax returns.
Our "always" and "inexorable" claimant insisted young
people are moving out, getting help from mom and dad and buying homes sooner than in the past and this helps account for higher
prices. Except this would then depress rents since they don't need to rent a house while they try to save for a down
payment. (Anybody remember when it was cool to save?)
In general, demographics issues like this are completely
un-disprovable until years later. However, wasn't there a popular movie released recently about a grown man refusing to move
out of his parents house? Because it's so cushy with mom and dad? And costs are so high? This movie is more
evidence of a "gen Y" trend than provided in any claims we've seen.
As an aside, CEPR reports a big jump in credit
card balances last quarter. If things are so wonderful, why are so many people running up their credit card bills?
2)
Prospective buyers are "forced" to rent-- since they can no longer afford to buy due to higher interest rates.
Owners
should be hoping this isn't true. If there's really nobody left who can afford to buy a house, how do current owners
cash out of their equity?
Ignoring this obvious problem, we saw where 82% of 1Q06 Santa Clara County real estate buyers
financed with ARMs. If interest rates are contributing to rent increases, they're increasing mortgage payments right
along with them. Renters can choose to go elsewhere or downsize for the cost of a moving truck. ARM-financed real
estate owners have fewer options.
3) There is a limited supply of apartments, which will drag up rental home
lease rates.
This may actually be true right at this exact moment in time. However, this is a transitory
side effect of a lot of apartment supply being off the market 2Q06 while they're converted to condos.
Unfortunately
for all parties, as sales volume plummets and prices flatten nationally, the economics of many of these condo projects collapsed.
Unlike amateurs who continue to pour money into negative cash flow deals, the professionals doing the apartment/condo thing
are quickly cutting their losses. A slug of apartments will be back on the market 3Q06. Even more will be back
by the end of the year.
Flippers, tragically unable to sell their newly-built condos will be "giving up" and hoping
to reduce their negative cash flow by renting out their condo over this same time period.
By hard experience, we've
learned not to try and predict the future. However, we are not worried about increasing rents due to reduced supply
riding to the rescue of negative-cash-flow real estate deals. We hope you're not counting on it either.
4) Renters
are stupid and doomed to line the pockets of smart owners for the rest of their lives.
We are right in the
middle of the moment when markets shift from sellers to buyers. And when people with debt (i.e., mortgages) have to
be nice to people with cash (rent money, in this case).
Pretty soon, the press will be reporting shock and outrage
that rents and prices are both crashing. Within a few years, flipper/investors will be getting the headlines as America's
lost generation.
Let's hope the government stays out of it and lets the free market work on the way down the same way
these landlords demanded that it be allowed to work on the way up.
OK, but what about your situation? What is
your personal rental experience?
We moved into our current rental in 2004 at an ~4% premium to the slum we escaped
in Palo Alto. We saw zero increase in 2005. In 2006, we seriously considered moving since prices remain ridiculously-high
in the municipality we live. We only considered rentals which were still close-in to Silicon Valley and also had excellent
schools.
We seriously considered a place ~12% cheaper (less than 10 years old) and several at our current rate plus
or minus 10%. In the end, we decided to accept the landlord's proposal of a 3.7% increase. Divided across the
two years we've already lived here, that's 1.85% /year.
Conclusion:
If these are the big
rent increases flipper/investors are counting on, then I know we're doing the right thing.
By keeping all our options
open, and our money invested in ways which think will do well in the current economy, we retain maximum leverage. Our
eyes are firmly focused on summer 2008...
(We expect to write 2007 and 2008 editions of this series.)
* * * * *
The
above is not intended as advice to buy, sell or hold any stock, bond, real estate nor any other financial product or service.
Invest at your own risk.
