This post first appeared in the October edition of Cirios Trends: Getting to the Bottom of the Housing Market

For anyone who has tried to rent an apartment in the past six months
– especially in big cities like San Francisco or New York — the
pickins have been extremely good, to say the least.

As the economy has remained mired in its post-almost-financial-apocalypse quagmire, tenants’ willingness and ability to pay what now seem like exorbitant rents has evaporated. In particular, a traditionally reliable source of rental demand which came from new attorneys, investment bankers and other young professionals armed with absurdly large paychecks has disappeared.

(Source: The Wall Street Journal)

Landlords, in turn, are slashing rents as vacancies rise and tenants move out of ritzy buildings in favor of more modest, affordable digs.

In one particularly poignant example here in San Francisco, a renter who paid $2,200 for a 1-bedroom apartment in North Beach last September, just months ago renegotiated his rent down to $1,600 per month. That’s more than a 25% drop in a year! I mean, his landlord is the largest apartment owner in San Francisco and has seen scores of buildings foreclosed on by its lenders, but who’s counting.

As you can see from the chart in the top right of this page and from the table of cities with the biggest rent declines over the past year, California has not been spared in this decidedly deflationary trend.

The easy — and accurate — conclusion to draw from rents tumbling is that sales prices for condo, especially in big cities, aren’t stabilizing any time soon. Rents are typically leading indicators for condo prices (both on the way up and on the way down), since rental turnover is more regular and transactions are much shorter. Rents therefore react more quickly to changing market dynamics.

This analysis, however, isn’t terribly helpful other than for warning would-be condo buyers that now may not be the time to stretch for that penthouse apartment in SoMa.

What is interesting is what these falling rents mean for real estate investment opportunities in the not too distant future. Apartment buildings are traditionally valued using some multiple of the cash flows generated by rents, less the monthly operating costs for the building as a whole (including loan costs).

So, as rents fall, naturally so too do the values of apartment buildings. But, since apartment buildings are not often bought and sold, it can take months, if not years for a drop in rents to translate into meaningful price depreciation for multi-family buildings. Price
Discovery, a concept often-discussed at Cirios, is delayed, as buyers are wary of making investments in a declining rental environment.

And as owners of these multi-family buildings are pinched with weak rents, many will become distressed and motivated sellers. These are the sellers opportunistic investors should look for in the months and years to come.

This post first appeared on Minyanville.

It appears even the embattled homebuilding industry is getting rosy-eyed, finding enough “green shoots” of economic recovery to stick their shovels back into the ground.

In May, US builders broke ground on 17.2% more projects than in April, far exceeding analysts’ expectations. Work on new apartment buildings leaped, while single-family starts continued what’s now become a 3-month rally.

Although the aggregate figure is still well off last year’s rate, economists are breathing a sigh of relief that the worst of the housing market swoon could be behind us. Skeptics, however, are quick to point out that any recovery could be muted, as high levels of inventory, a weak labor market, and mortgage rates that just won’t seem to stay down, could forestall any recovery.

As Kenneth Simonson, chief economist for the Associated General Contractors of America, told the New York Times, “There’s a real possibility [housing starts] will just stall at a low level. If the recent jump in interest rates is sustained, that could choke off buyer enthusiasm for new homes.”

For nearly 4 years, the business of building and selling homes has been, in a word, lousy. As home prices tumbled, the likes of KB Home (KBH), Toll Brothers (TOL) and Lennar (LEN) slashed prices, offered generous incentives, and otherwise bent over backwards to unload inventory. Building all but stalled, jacking up unemployment — particularly in exurbs and sprawling communities whose economies were largely based on the construction trade. An industry that grew fat during the boom was forced to slim down, lay off workers, and hibernate, while the market’s violent correction ran its course.

And although a host of small builders have closed up shop, to date, no major US homebuilder has gone under. Consolidation, too, has been scant. The only merger of note was Pulte Home’s (PHM) purchase of Centex (CTX), a marriage that, once consummated, will create the country’s largest builder.

The outlook for those builders that remain — builders that are bleeding cash while pleading with creditors to extend loan terms and waive busted covenants — is bleak. Last week, the National Association of Homebuilders/Wells Fargo Builder Sentiment Survey ticked down after rising far more than expected the month before. Higher interest rates are mostly to blame, as the specter of bigger monthly payments is quelling optimism that the housing market is on the mend.

The reality — an unfortunate one for builders and their employees — is that for the foreseeable future, their services aren’t needed in this country; we have too many homes as it is. Demand for new ones remains weak as communities just a decade old slip into disrepair, and shoddy craftsmanship and half-finished developments scare off prospective buyers.

Builders are also fouling up the nascent housing “recovery” by turning recently completed condominium units into rentals. Even as demand wanes thanks to job losses and tighter budgets, rental inventory is rising. Rents, as a result, are falling. This is great news for tenants, eager to jump on affordable apartments, but bad news for landlords and even homeowners.

One of the most popular arguments posited by housing-market-bottom callers is that in some of the hardest hit areas, prices have gotten so low that investors can scoop up cheap homes and rent them for an attractive return. What they neglect to mention, however, is that this sort of market-clearing activity also increases the supply of rental units, further pressuring home prices. Even in the worst, most washed-out areas, a bottom remains elusive.