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Rent pays for deferred consumption
What rent pays for
Divide your rent by your after-tax pay and multiply by 31, and the result is the number of days a month you worked for your landlord. In return, the landlord might answer a text or two and send over a plumber, but mostly cashes a check. Publicly traded residential REITs spend 15 to 20 percent of revenue on repairs, property management, and recurring capex, so that service is not the main thing renters pay for.
Deferred consumption
For a landlord to own a building, they had to buy it instead of spending that money on something else, and to rent it out, they had to have already taken care of their own housing. Owning real estate you don't personally use lets some people consume less than they earn over time and convert that deferred present consumption into future consumption. The renter is someone who doesn't want to defer a big slug of consumption by buying property, either because they can't afford to or because they would rather put the money to work somewhere else.
Why it lasts
As long as population growth raises demand for housing, and people raise their standards for square footage, this arrangement continues. In cities where housing supply is constrained by geography or politics, prices stay high and landlords capture some of that upside.
How do economists count what homeowners consume?
Statisticians assign owner-occupied homes an imputed rent, the amount the owner would pay to rent the same home. The U.S. Bureau of Economic Analysis counts that figure as consumption in the national accounts. The Bureau of Labor Statistics uses a similar measure called owners' equivalent rent in the consumer price index. Shelter, which includes rent and owners' equivalent rent, has made up roughly a third of the index in recent years.
How do investors turn rent into a building's price?
Investors usually value an apartment building by dividing its net operating income, which is rent after operating costs, by a capitalization rate. A building with a 5 percent cap rate, for example, sells for 20 times its yearly net operating income. Cap rates vary by city and property type and move with interest rates. Brokers and appraisers use the measure as shorthand to compare buildings.
Why do prices stay high where land is scarce?
Economist Albert Saiz measured this in a 2010 paper in the Quarterly Journal of Economics. He found that metropolitan areas hemmed in by water and steep terrain had the least elastic housing supply, meaning prices rise more when demand grows. Among the least elastic areas in his ranking were Miami, Los Angeles, and San Francisco.
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