In general, I hate when people over-simplify financial planning with “general rules of thumb.” Nevertheless, a widely quoted general rule says you should not spend more than 25% of your income on rent. Sadly, 11.8 million households in the United States spend a whopping 50% or more of their income on rent. As you can imagine, these severely cost-burdened renters do not have enough money left over for other necessities. This situation is predicted to get worse as rents have been increasing at a faster pace than wages. The number of households that spend more than half of their income on rent will increase to 14.8 million households over the next decade if rents increase by 3% and wages only increase by 2% as many analysts predict.
Why are rents increasing so quickly?
One reason rents are increasing so quickly is a lack of desirable rentals. Millennials (age 24-34), who are the children of the baby boomers, make up a large portion of the renting population. They generally want to live in downtown, urban locations where they can walk to amenities. There is a shortage of these types of properties and they are expensive to construct. As a result, most new construction in these areas has been luxury units, and rents in many growing cities (e.g., San Francisco, Denver, Portland, Kansas City, Austin) have increased at 2-5 times the rate of wage growth in the past couple of years. The rental occupancy rate nationwide has risen to 93.2%, a level not seen since the mid 1980s.
Why aren’t people buying?
The alternative to renting, of course, is to buy a home. Home sales have returned to normal levels and values have jumped 34% nationwide over the past 3.5 years. This increase in home prices, coupled with a 4% decrease in real wages (after inflation) since 2008, has led to the lowest affordability since 2008 according to the National Association of Realtors’ affordability index. The U.S. home ownership rate is now at 63.4% of U.S. households, the lowest level since 1967. Another consideration in the rent vs. buy dilemma is that affordable single-family homes tend to be in suburban areas farther from the city center and often require long commutes. There is also a shortage of starter homes caused by the 25-year trend among home builders to build larger homes. The percentage of homes built that are over 3,000 square feet has doubled since 1992, while construction of new homes under 1,800 square-feet has fallen by 50%.
In theory, rising rents should make home ownership more attractive. However, the lack of supply, low affordability and tight credit are keeping a lid on home sales. Housing is likely to become a larger piece of the overall household budget, as rents and home prices continue to rise. What should you do if you are currently renting? That depends both on your personal / family situation and where you live. Call us or reply to this email if you need some guidance.