The Economics of Rent

Rushing in where even fools fear to tread, I thought I would look at the rent question from a slightly different angle: the economics of the situation.

There are many different types of landlords. There are wealthy professional investors and aspiring professional investors, who attempt to leverage the little that they have into something bigger. Older people often attempt to add to retirement income by renting property. All of these people face similar costs. 

Renting real property is a business, with the aim of obtaining a reasonable return on investment. Unlike other businesses, many costs are fixed. If a landlord buys rental property, they have to contend with the skyrocketing cost of real property in the San Francisco Bay Area. For example, the overall median home value in San Francisco rose 90 percent between April 2009 and April 2019, from $715,900 to $1.36 million, according to property rental and sales company Trulia. 

Unless the property is paid for, (which is often the case with the older landowner) there is a mortgage to pay. According to Zillow, mortgage rates are from .25 to .75 percent higher for a loan to purchase investment property than for an owner-occupied mortgage. 

The aspiring investor, who typically is highly leveraged (money to buy the property is borrowed from other property the person owns) will end up at the higher end of the scale. The wealthy investor has options besides a commercial mortgage, and will probably pay less. 

The next highest recurring expense is property tax. Property tax is figured on assessed value at the time of purchase. The average effective property tax rate in Alameda County is .87 percent of assessed value plus numerous add-ons agreed to by the voters have agreed on over the years. Homeowners get a small tax break, unavailable to the rental property owner. 

Assessed value is based on when the owner bought the property, so that someone who still owns property they bought in 1980 may be paying less than $1,000 in property taxes a year. The next-door neighbor, who recently purchased, may be paying more than $10,000 dollars a year for an almost identical house. 

A third recurring expense is insurance, and here, too, the commercial owner faces higher rates. Large investors and absentee owners hire a management company to oversee the property and collect rent. The typical managment company charges between 8 and 12 percent of the rent.

The last expense a landlord faces is maintenance. This is the one expense that is not fixed, and can cause serious problems for undercapitalized landowners —such as the retired couple and the aspiring investor. This expense is very variable, depending on the shape the place was in when it was rented, the skills of the landowner, and whether or not the property is professionally managed. 

Licensed contractors are not cheap. A landlord who has good repair skills can keep the costs down. Landlords who try to do it themselves despite lack of skills can make a bad situation worse. Repairs and upgrades are a frequent cause of large rent increases. 

Aside from mortgage and property tax payments, all these business expenses can be expected to rise with inflation. Inflation is measured by the Consumer Price Index. The Bureau of Labor Statistics calculates that $151.99 in today’s money has the same buying power as $100 did in January 2000. 

So here is the problem. Wages have not kept pace with inflation. All services that can’t be outsourced to Third World countries or automated are becoming increasingly unaffordable to working people. Due to soaring real property costs, rents are rising faster than inflation, exacerbating the problem. Today’s wage has the same purchasing power that it did 40 years ago, while average rent has risen twice as fast as inflation. 

An article in the September, 2019 issue of Habitat for Humanity magazine “Habitat”describes the suffering that stagnant wages and escalating rental costs has caused. More that 18 million American households (one out of six) are paying half — or more than half — of their income for a place to live. 

This is obviously not a good situation. However, given the present economic structure in the United States, I have no answers. Building more housing will not fix the problem if the new housing costs the same as the old housing.

Given that so much of a landlord’s costs are fixed, a property owner has little incentive to lower rents. The Habitat for Humanity model based on sweat equity, is an excellent start, but nonprofits can only do so much. Maybe someone else can suggest something? 

 

Margie Seigal is a very small landlord who and mows her own lawns.