[David R. Stevenson]

Rents remain flat in Real Estate Star Markets:

Is there such a thing? When I look at the University of Florida in Gainesville from an imaginary position in space say about half a mile high over its central core campus and downtown area of Gainesville; I see a real estate market that is poised and has everything going for it ; yet rents remain flat.

Despite the fact that U of F R&D budgets and education budgets and teaching hospital budgets and any other kind of budget one can think of is rising; rents remain flat.

Despite the fact that the population of the State of Florida is growing at 1,060 people per day (net). Despite the fact that South Florida people are leaving and moving away to other parts of the state ((more are still moving into South Florida, than leaving (net)).

Despite the fact that apartments are being converted into condominiums; rents remain flat.

The bifurcation between rents and prices seems to have no relationship what so ever to value anymore in the phylum of residential real estate.

More or less U of F runs on a government economy that has little to do with private sector in any separate economic sense. The GDP of the U of F economy runs on a psychological dole “in the belief in public higher education” where the seat of political influence and government dollar distribution pulls the purse strings of every parent who is sending their kids to a Southeastern United State epicenter of human entrepreneurial spirit.

Yet residential rents remain flat.

Since World War II prices on average have risen at 3% per annum by some estimates for residential real estate in Gainesville.

Our central banking system which is essentially a state run banking system like Japans’ must now make sure that such epicenters of financial interests and influence have burgeoning real estate markets; certainly U of F must be one of the central banks’ areas where lending must continue to float the hand of national statistics as other residential markets sag.

Certainly a state run banking system must not allow certain areas of the country to falter with macro real estate appreciation numbers. If the bubble in real estate is not to pop; then certainly the U of F market must be one that goes the other way and continues to expand.

Yet rents remain flat.

[Denis DeSaix]

David-

Your observation of "flat rents" is in good company.

I was at a recent conference where Prof. Robert Shiller (author of Irrational Exuberance and development partner in the new residential housing equities options available on the CBE) made this same point on his graphed presentation. His point was that if rents represent the actual "living utility" (my quotes) market value of a residence, and if rents have remained "flat", then how does one explain the significant and recent rise in home prices? One may think that it would be based on the rising cost of land, labor and materials, but when analyzed against those components, Shiller's data still shows a wide gap?

So, his point is, if the value of homes are $X, and
A. Overall costs to replace are can explain 30% X.
B. Land value can explain 25% X.
C. Market value of the living utility can explain 25% X

What explains the remaining 20% increase (run-up) in home prices? (Note: Interest rates are also factored into his equation)

Not everyone agrees with Shiller's analysis (and, its way beyond my pay-grade to ponder), but I think his question is:
When home values are increasing, and the increases are in excess of what can be attributed to cost, interest rates and market value of the utility of a residence, what then has pushed the values to that excess level and what sustains the values at that level?

[George Hatch]

If a home purchase was strictly limited to its current utility then rent vs. buy would be a relatively straighforward comparison. But I think it's fair to say that there is a premium in most any market for being able to lock in the cost of housing at todays dollar. That doesn't even take into account the expectation of future increases upon resale. So I think there should be a good sized margin between the two even in the most stable of markets.

The question is, how much of a margin for those types of expectations? In my market, you can rent a home for about 50% of what it would cost you to own it when considering all the costs of ownership like taxes, insurance, long term maintenance and reserves. An investor looking to come into town and buy rental properties for their monthly positive cash flow is going to find that - no matter how much experience they have in other markets - in this market the cash only flows out. Fast.

So where's the return on an investment like that? If it ain't coming in the form of monthly cash flows then it's gotta come from the expectation of profits in the reversion, and that's where the above cost falls short - by shorting the profit incentive. Investors will take the short term hit on monthly cash flows if they think they'll make up for it and more when they sell. The bigger monthly losses can only be justified by the expectations of big gains over the short term.

[Terrel L. Shields]

Appraisers and investors alike seem to have ignored the rent gap, but I think it mirrors the bubble and the gap will tighten as the housing market tightens.

that gap, long term, may be trending up as a measure of overall wealth of the nation, but nothing says it has to increase, decrease, or stay static.

That reversion idea is not new but certainly has only recently got the attention it deserves. Ag land cap rates were long calculated on ground rents vs sales prices and were extremely low. Currently such a cap rate is running 0.1 - 1.5% because land is in transition to non-ag use and so the cap rates are too low and even in pure ag areas, the cap rate rarely is more than 4%. In reality, if one does IRR of a cashflow with reversion at current land price increases, the reversion is the bulk of "profit" from farmland and it drives the return rate to 10%, maybe more. The trick for the farmer is to survive year after year with little or no returns long enough to cash in the reversion.

[Restrain]

The only thing that accounts for the rent gap is investor expectations. When you factor in depreciation, deductions, etc, and still end up a negative cash flow at the end of the year on the tax form, the only reason to hold the property is the expectation of a return at the end of the holding period to offset the losses. It is, in many places, no longer possible to cash-flow a property, unless you are slum-lording.

That being said, I have noted people who were in the CA run-up selling out and buying low-return properties in the "fly-over" markets as a hedge against losses. This is a prime example of investor expectations. They expect the property to serve as a hedge against losses. They expect the property to increase over the holding period in excess of the losses experienced over the same time period. It is a long-term risk that the investor is willing to take recognizing the potential of return vs. other investment possibilities.

[David Wimpelberg]

What I've found here is that properties (commercial) likely to be purchased only by investors are more likely to reflect reality than than those that aren't. They don't seem to be as willing to have the negative cash flows for several years. If the owner-occupant is a potential buyer, the results of the DCF and the sales comparison approach aren't even on the same planet.

[David R. Stevenson]

[quote=RStrahan]The only thing that accounts for the rent gap is investor expectations.

And the only people bearing the risk are the lenders ..... not the investors ....

If lenders were not involved ..... watch the prices fall ........

[Otis Key]

David, in my observations, I have found that university markets are different animals. The rental rates are something of a different factor for those markets, from what I know.

[David R. Stevenson]

Originally Posted by David Wimpelberg

If the owner-occupant is a potential buyer, the results of the DCF and the sales comparison approach aren't even on the same planet.

Anticipation of negative future reversions in real estate investment horizons switches the mathematics of lending risk to the largest planet within our solar system; Jupiter.

Planet fantasyland has spun to close to the larger planet whose orbit is now influenced.

A borrower lives in Jupiter, FL ....