Another bubble is developing in the housing market that may catch people off guard yet again. Froth is building up in the rental sector.
The rental market was re-energized by the record number of people who lost their homes when the housing bubble burst. According to a report released in March 2010 by Deutsche Bank, the ratio of rental costs to after-tax mortgage payments has nearly doubled since 2007.
Spurred by the increase in rental rates, the industry has seen tremendous growth in the supply of rental property. That growth was driven by fundamental demand factors: a decline in the home ownership rate to 66% from 69% in the last five years, along with about 7 million new households over the same period. The combined factors led to a surge in demand for rental homes, which led to an increase in rents.
But growth in rental rates is more likely to head lower than higher. Houses are becoming affordable again. In some places, a 30-year $160,000 mortgage at 4% equates to a monthly payment of $900 assuming 1% property tax and 0.5% PMI. One is hard pressed to find a decent two-bedroom apartment renting for less than $1000 a month.
Consider comments by Stuart Miller, CEO of Lennar (LEN), earlier this year: "Customers are actively disclosing their desire to find a way to purchase a home and avoid the rental market, and its repricing."
Americans are becoming painfully aware that living expenses are constantly increasing and the ability to lock in an ultra-low lending rate when housing prices are this affordable is one way to hold down living expenses. Last month, Wells Fargo (WFC), now the nation's largest mortgage lender by volume, reported an impressive surge in mortgage volume, and management sees that trend continuing.
It's no surprise that multi-family real estate investment trusts like Equity Residential (EQR), AvalonBay (AVB) and Post Properties (PPS) are all trading at 52-week highs and are up between 35% and 50% over the past year. I would also not be surprised to see many investors get burned if they attempt to hold these securities today. The rental market is on fire, but all signs point to it cooling off. Renters and investors beware.