Rent jumps 22% in Colorado, will real estate values “correct”?  The federal reserve thinks so.

Apartment rents are rising rapidly across the northern Front Range, about triple the rate seen before the pandemic, with annual gains almost 20% in places like Parker and Colorado Springs.  What is causing the large increases in rents?  What did the federal reserve study find regarding rents?  Do rents predict future real estate price increases/decreases?

 

What was in the data regarding rent increases in Denver Colorado?

Midpoint or median rents were $1,460 for a one-bedroom apartment in metro Denver and $1,780 for a two-bedroom unit last month, per the report.

After Colorado Springs, Castle Rock had the biggest gain in apartment rents since the start of the pandemic at 21.6%, followed by Parker at 20.5%, Thornton at 19.9%, Lone Tree at 19.1%, Littleton at 17.7% and Broomfield at 16.6%.

Furthermore, the second-quarter report, sponsored by the Colorado Division of Housing, surveyed local apartment owners and landlords whose properties totaled nearly 23,000 units in the Colorado Springs area. It showed the average monthly rent jumped to $1,429.58 in the second quarter in the Colorado Springs area, up $95.89 over the first quarter when rents averaged $1,333.69. Since the start of the year, rents have climbed by $163.66 and are $183.11 higher than in the second quarter of 2020.

To put those rent hikes into perspective, the average weekly wage for workers in metro Denver rose 4.3% annually in the first quarter of the year, according to the U.S. Bureau of Labor Statistics.

Long and short rents are rising considerably faster than wages which cannot happen forever.

What is causing the huge jumps in rental rates both in Denver and throughout Colorado?

1. Demand: Covid led to huge increases in demand from Coastal markets for more space
2. Supply: At the same time Demand has spiked, supply has not come even close to keeping up which has led to huge imbalances in the market
3. Cost to Build: Build costs have skyrocketed for both labor and materials which has focused more building on the upper end with higher rents. This has essentially “pulled” up rents on lower priced properties.
4. Cost to maintain: Along with build costs, the daily maintenance costs have also increased from roofing, flooring, appliances, maintenance staff, etc.. All these increases are getting passed on to the renters.
5. Taxes: Property taxes in Denver are predicted to increase about 36%; these costs are being passed on to renters.

Will the large jumps in Colorado rental rates continue?

I think we are at the beginning of rent increases as rents have a bit more catching up to the huge increase in prices.  Furthermore, I don’t see much changing with the five variables above to substantially change the dynamic of rent growth.  The one item that will eventually slow rent growth is that wages will not be able to keep up with the huge increase in rental payments.  The rent prices at some point will slow unto themselves for this reason.  Unfortunately, it is hard to predict when this will exactly occur, but I would assume sometime in the next year or so.

What does a large increase in rents mean for Colorado real estate values?

Rent rates are a lagging indicator of values.  As values have increased rents rise to “catch up” with the values.  What does this mean for future value?  The federal reserve did a great study on this in 2004 to see what impacts rent growth had on future appreciation.  Here is what the study finds.

My main findings are that periods in which house prices are high relative to rents appear to be followed by periods in which real rent growth is faster than usual, and real house-price growth is slower than usual, and that the response of prices dominates that of rents. The third analysis provided the most conclusive evidence that house prices correct back to rents.

Essentially the study found that in rapidly appreciating markets, like we are seeing throughout Colorado, it takes some time for rents to catch up to values. Why do rents take time to increase?  Many leases are at least a year which insulates the existing tenant from large increases.  As the leases renew the increases begin to occur.  This whole process could take years to filter through the rental market depending on the lease renewals and turnover of tenants.

We are just seeing the beginning of this trend as prices of real estate really started to take off about 18 months ago.  The Federal reserve study confirms that there is an intrinsic relationship between rent growth and price growth of real estate.  As rents make large jumps, prices will “correct”.  This means that prices will best case stay constant, worst-case fall.  Furthermore, the study found that prices were unlikely to continue the rapid appreciation as rents at some point cannot rise enough to justify the values.  Long and short, the two scenarios are prices will stabilize or fall.

Summary

The federal reserve study shows that there is a historical correlation between rents and prices.  The huge jump in rents is a warning sign for the real estate market.  As rents jump prices will in the best case scenario flatten.  Wage growth is not coming even close to keeping up with the increases in rents.  The median wage in Denver rose only 4.3% while at the same time rents jumped almost 20%.  This is clearly not sustainable.

Unfortunately, the huge rise in rents signify that the real estate party is almost over.  The one question remaining is if there will be a crash or merely a stabilization in prices.  If appreciation continues unabated rents will not be able to keep up and a crash will be in the offing!

 

Additional reading/Resources:

1. https://www.federalreserve.gov/pubs/feds/2004/200450/200450pap.pdf
2. https://www.apartmentlist.com/co/denver#rent-report
3. https://www.denverpost.com/2021/09/07/front-range-rent-increases-apartments/
4. https://www.westword.com/news/denver-rent-prices-way-up-june-2021-update-11988745
5. https://gazette.com/premium/apartment-rents-skyrocket-to-average-of-more-than-1-400-a-month-in-colorado-springs/article_695b85d0-f93a-11eb-b731-53f84a762034.html
6. https://coloradohardmoney.com/denver-property-taxes-rise-36-percent/

 

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine,  The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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