A great recent BiggerPockets blog post outlines some cities where rents are expected to fall, and I wanted to explore what these cities have in common.
Before I continue, I want to explain what drives prices and rents. Both are functions of supply and demand. If there are more buyers than sellers, the price will rise until there is an equilibrium between the number of buyers and sellers. Conversely, if there are more sellers than buyers, the price will fall until there is an equilibrium.
Rents are linked to real estate prices. When prices and interest rates are high, fewer people want or can buy homes, forcing them to rent. Increased demand for rentals leads to higher rents.
Conversely, when property prices are low, more people will buy rather than rent. This decrease in demand will also lead to lower rents.
What do cities where rents are falling have in common?
The main reasons prices and rents stagnate or fall are stagnant or declining population (weak demand) and/or urban sprawl (unlimited supply). Urban sprawl leads to new properties competing with existing properties.
When undeveloped land is cheap, the price advantage of existing housing is small. Given a choice between an older property and a newer one, most people will choose the newer one, even if it costs more.
Below are time-lapse aerial photos of the five cities mentioned in the post: These photos show how these cities continue to expand, adding excess supply and allowing rents and prices to fall.
Because these cities have no geographic constraints on expansion, properties purchased in emerging developments today may become part of the secondary market in the future. This cycle is explained here.
- The first image is of a new property purchased in a hot area.
- The second image shows how rents and prices will rise as the property becomes more developed.
- The third image shows how as waves of development pass, properties become less attractive, causing rents and prices to stagnate relative to new developments.
- In the fourth image, the wave of development spreads far beyond the property, causing rents and prices to fall further. At this stage, the owner’s main option is to sell their existing property and acquire another property in the direction of the new development, starting the cycle anew.
A more effective strategy is to invest in cities with significant and sustained population growth and limited potential for expansion. Las Vegas is a good example of such a city, as shown in the GIF.
With limited undeveloped land available for expansion, new developments will primarily involve redeveloping existing areas. As a result, while housing supply remains relatively stable, rents and prices for properties purchased today are likely to continue to rise due to increased demand from a growing population.
Taking a long-term view
Prices and rents are driven by demand, driven primarily by population changes and the city’s ability to expand: in cities where cheap land is plentiful on the outskirts, new properties cannibalize demand for existing properties.
This scenario creates a difficult cycle for investors, who must either continually sell their current properties and reinvest in new developments or face the possibility of rents and prices stagnating and eventually declining.
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BiggerPockets notes: These are opinions expressed by the author and do not necessarily represent the opinions of BiggerPockets.
