Most people in the United States fall into one of two categories; homeowner or renter. The more people who choose to rent, the more demand there is for apartments. That demand is vitally important to you if you’re investing in apartment buildings. Therefore, it’s wise to stay abreast of what’s happening in these two spaces.
For example, did you know that annual renter household formation has outpaced homeownership for more than a decade? And research shows that this trend has staying power. As we’ve reported before, the Urban Institute concluded that, “From 2010 to 2030, we’ll see five new renters for every three new homeowners.”
While there are a multitude of reasons why we’re becoming a renter nation, one of the biggest revolves around the subject of gaps. To better understand this, we need to examine the gaps between median incomes, home prices, and rental rates. So let’s dig deeper into each of these three stats and discover how they interplay.
Median Household Incomes
If you’re going to be investing in apartment buildings, you need to keep track of median incomes. A person’s income is a huge determinant of whether they’re going to rent an apartment or buy a home.
As the graph below shows, real (inflation adjusted) median household incomes have been relatively flat for more than three decades. According to the St. Louis Federal Reserve, while there has been some volatility in this number, it has taken more than thirty years to grow a paltry $10,000 ($51,000 a year to $61,000).
Lately, household incomes have been rising and today we’re at an all-time high. Nevertheless, that improvement represents an increase of just over 2% per year between 2012 and 2017. Growing incomes are great, but are they keeping pace with home prices?
To answer that question, we need to look no further than to the Case-Schiller Index.
As the graph above shows, the Case Schiller Index of US home prices increased 31.6% from January 2012 through December 2017. On average, that represents an increase of almost 5.3% per year. That means home prices are rising two to three times as fast as the median income.
This is further reflected in data published by Redfin. They compared the affordability of housing in the 30 largest metros between 2012 and 2016. They found that 44% of the homes in those metros were affordable to someone making the median income in 2012. Unfortunately, by 2016, that number had dropped 12 percentage points to just 32%.
This parallels data published by John Burns Real Estate Consulting in 2017. They reported that in 2010, 44% of new homes on the market were under $200,000. By 2017, that number fell to only 16%.
In a time when home prices are outpacing wage growth, a larger percentage of people’s income is going toward housing. That gap between median home prices and what people can afford to pay is known as the affordability gap. And that affordability gap is driving more and more people toward the lower cost option of renting.
It’s become so bad that CNBC weighed in by publishing an article in September of 2018 stating, “It’s better to rent than buy in today’s housing market.” In it, they say:
“The monthly costs of buying and owning a home that you occupy are up 14% over the past year, more than three times the annual increase in rent rates nationally…”
The rapidity with which housing prices has risen is staggering. Apartment rents are also rising, but at a slower pace. According to Redfin, rents rose 18% from 2012 through 2016 in the 30 largest metros.
Thus, whether you’re renting or looking to buy, more of your monthly check is going towards housing. However, because the price of homes have surged, renting has become the only option for many people.
This affordability gap for homebuyers has not been lost on the national media. It’s common to see headlines like:
-Priced out of the market? Cities where the middle class can no longer afford a home-USA Today
-Renters now rule half of U.S. cities: The American Dream increasingly involves a lease, not a mortgage-Bloomberg
-10 years after housing peaked, U.S. is more of a renter nation-Chicago Tribune
As long as rent growth continues to rise slower than home prices, apartments will remain the lower cost option. The gap between rental rates and house payments is a big driver of rental demand. And as someone who’s interested in investing in apartment buildings, you should understand the importance of the affordability gap and the interplay that exists between home prices, rental rates, and incomes.
In new research published in October 2018, Freddie Mac Multifamily found that 78% of renters believe that renting is more affordable than owning.
And they are right. All you have to do is compare U.S. Census data for median gross rents with median homeownership costs, and the data shows just how favorable it is to be investing in apartment buildings.
Fortunately, the people over at NerdWallet did that work for us. What they found was that owning is anywhere from 33%-93% more expensive than renting in all 50 states and Washington D.C.
States where owning is 30% – 35% more expensive than renting:
States where owning is 40% – 45% more expensive than renting:
Arizona, Colorado, Delaware, Georgia, Indiana, Nevada, South Carolina, West Virginia
States where owning is 45% – 50% more expensive than renting:
Arkansas, Maryland, North Carolina, Tennessee, Virginia
States where owning is 50% – 55% more expensive than renting:
Alabama, Hawaii, Idaho, Louisiana, Michigan, Mississippi, Oklahoma, Utah
States where owning is 55% – 60% more expensive than renting:
Alaska, Kentucky, Missouri, New Mexico, Texas, Washington
States where owning is 60% – 65% more expensive than renting:
California, Iowa, Kansas, Minnesota, Oregon, Pennsylvania, Washington D.C.
States where owning is 65% – 70% more expensive than renting:
Maine, Nebraska, North Dakota, Ohio, Vermont, Wyoming
States where owning is 70% – 75% more expensive than renting:
Illinois, Montana, New York, Wisconsin
States where owning is 75% – 80% more expensive than renting:
States where owning is 80% – 85% more expensive than renting:
Connecticut, New Hampshire, Rhode Island, South Dakota
States where owning is 90%-95% more expensive than renting:
Investing In Apartment Buildings
In most places, houses are becoming more and more unaffordable.
Anemic wage growth in the face of higher home prices leads people to choose renting over owning. Not only are people renting in higher numbers, but they’re staying in apartments for longer periods of time than ever before.
Yes, rents are rising too, but not as fast as the cost of homes. That affordability gap between home costs and rental rates bodes well for those who are investing in apartment buildings.
It’s allowed our investors to prosper and enjoy the benefits of fractional investing in apartment buildings. These are win-win situations in which they help provide a clean, safe place to live at affordable prices for others while creating stable streams of tax-advantaged passive income and equity growth for themselves.
If you haven’t yet started investing in apartment buildings, what are you waiting for? Be sure to keep track of home prices, rental rates, and median wages in your target markets. These variables and the gaps between them will play a significant role in your success or lack thereof. Also, you might want to check out these following articles for even more insights.
To learn more about commercial multifamily real estate investing, download your free copy of Evidence Based Investing from 37th Parallel Properties.