How Will Rising Interest Rates Affect the Rental Market?

The US central bank is using interest rates as a way to control inflation, including home prices and rent price inflation.

Yet this teeter totter mechanism is a top-down force that may not mesh well with what’s actually happening in markets. And landlords and tenants both may not like the end result.

As this post suggests, higher interest rates may ultimately push rent prices up even further. It’s not what tenants are hoping to hear, and many landlords see it as one more bit of trouble for them in 2023.

Such raises make markets unstable, prone to crashes, and when rates are raised during a time of political change, well, who knows what will happen? Even for housing economists, it’s not easy to understand.

Landlords and Tenants Worried about 2023

While rate hikes are considered a reliable way to eventually put out inflationary fires, tenants and landlords will be experiencing the impact of higher rates personally. Our polls show landlords believe rents will rise and that tenants are worried about paying rent next year. Costs are rising, meaning prices are rising.

Is increasing interest rates to blame? Or, is this only the straw that breaks the camel’s back?

After yet another interest hike this week by Jerome Powell and the Fed governors, investors, landlords and tenants are wondering if rising interest rates will ultimately raise home prices, heating costs, and rent prices.

The connection between the Central bank interest rate and the housing sector isn’t easy to see. Yes, home prices will fall, but what about other areas of the economy?

The belief (macroeconomics) by the Fed is that if consumer spending and business spending are reduced, and employment falls, it will automatically lower home prices, rent prices, food prices, and energy prices. Yet prices are the result of many complex sources, including lower supply, and they’re not going down at present.

Fed Central Bank Rate. Screenshot courtesy of Statista.

Fed Rate Announcements: We’re Going Higher!

The US economy keeps performing well (employment high, job claims low, GDP growth still 2.6%). High expenditures helped by continued stimulus money circulating, puts pressure on the Fed to keep raising the central bank rate (It is set as a range, currently today at (3.7% to 4%). The next Fed meeting is on Dec 14th, 2022.

Fed Chairman Jerome Powell said, „We still have some ways to go.“ Target rates, which were just above zero in March 2022, are now above 3.75%.“

The Fed intends to raise the central bank rate continuously for some time.  How long does it take to dry up $7 Trillion? Some expert’s predictions of a „dovish Fed“ seems somewhat naive given inflation hasn’t cooled from the hot 8+% inflation rate as yet.

Raising Interest Rates Fast is Risky Business

Raising the Fed rate quickly is a controversial move.  Rising rates and mortgage costs for home owners (landlords) and investors may result in paint for renters and discourage new supply of rental properties to house a growing population in 2023, 2024 and 2025.

Mortgage rates have been on a steep rise and it’s definitely softening lending activity.

Mortgage Rate Rising. Screenshot courtesy of Freddie Mac.

Is diminishing the economy the right strategy to lower rent prices? Our poll of rental property pros reveals they believe rent prices will rise (50%) while 33% believe they will stay the same.

Survey Shows a Correlation

A recent report from LaSalle Investment Management and Realpage using Census data shows a correlation between interest rates and inflation. Seems common sense when almost everyone has some sort of credit payments to make.

Yet the connection between rising rates and rent prices isn’t so easily understood.

For renters in certain states and cities, rising rates may cause a cascading series of events that makes analysis difficult, as you’ll see.

Rising Fed Rates Only Starting to Create Tidal Waves

Now in November, we’ve seen consecutive Fed rate rises which are beginning to slow the economy. That in itself, if done repeatedly should bring prices of everything downward. Yet last month’s 8.2% reading overall shows something is holding the prices of everything up. And the latest up to date reading on rent prices in the US is upward, against wishes for rents to fall.

Although rents have fallen strongly in some cities, they’re rising fast in others. 6% rises in just one month are alarming but when people migrate simultaneously because of economic changes, they cause shortages in other cities.

Data courtesy of the Zumper rent data report.

Rents Should Fall as Rates Climb

Rents ideally should fall as interest rates climb. Higher rates discourage demand and cripple economic production (GDP has dropped) and will increase unemployment (at some point, but not yet). Increased borrowing rates should reduce renter income and raise their cost of living expenses.

Higher rates should cause tenants to abandon their lease or move in with relatives.  Yet rental housing supply shortages are so severe, the rule simply doesn’t work. Who would give up their apartment in New York?

Not Quite a Direct Correlation

As it turns out, there may not be a direct up or down correlation between interest rates and rent.

Instead, indirect factors may actually determine rent pricing. As landlords and asset managers see increasing costs, they may need to raise rents. Leases don’t expire for quite a while, so rents don’t respond immediately. When losses mount, some will take more disruptive actions to protect their wealth (e.g., selling at a loss).

• When rates rise, new construction stops quickly (as it has) therefore supply begins to taper downward.
• Rising rates push frustrated buyers into the rental market where they compete with full time renters
• Rising rates increases landlords financing costs, and they have to pass that onto the tenant.
• Rising rates discourage investment in everything resulting in production declines (e.g., rental housing, appliances, fixtures, furniture) thus encouraging higher prices.
• When supply is limited and falling, and immigration continues, and more workers return to work (post pandemic return), it means more demand for any affordable apartments, condos or houses.

Changes Bring Costs

It turns out that changes in the lives of renters and landlords can alone cause higher rent prices.  A change in affordability, location, and higher rents creates lease termination.

Tenant churn creates extra turnover costs, and temporarily alters the rental market. An unfortunate few will become homeless, increasing social support costs and cause them to lose their jobs.  The status quo actually keeps rents lower. Anything that forces change, creates vacancies, wastes time, loses rent, and results in moving costs is bound to increase prices.

Disrupting the status quo with higher interest and mortgage rates sets a chain of events into motion that generates more cost and lower revenue and profit.

When Will Home Prices Fall?

People keep asking „when will home prices fall“ and the stats show they are moderating now. However, if the Republicans win the Mid term elections, the economy could reignite. If the Dems can’t enact new tax, regulatory, and spending bills, they can’t suppress the economy.

In fact, a Republican win gives them leverage to support the economy and force the Dems to negotiate for debt ceiling lifts, spending on non-essentials, and more.

If the economy can’t be killed, it puts the Dems and the Fed in an awkward situation with tools that may not work.

If the economy can’t be suppressed, home prices may not fall, and rent prices would likely not decline either.

Changes in Factors, and the Price Hikes Continued

Austin, St Petes, Orlando, Fresno, Boise, Phoenix, Mesa, Irving, Knoxville, Jacksonville, San Antonio, Tulsa, all had 20 to 30% growth in rent prices (year over year) for one bedroom units.  The National Association of Realtors report shows that in Florida, rents shot up 57.2% in the Miami metro area year over year in 2022.

2022 was a good year for rent prices for landlords. And as rent controls and eviction moratoriums have ended, it’s allowed many landlords to raise rents when the eviction moratoriums ended.

Another matter is that of home buyers who are becoming short term renters, perhaps saving money and waiting for conditions to improve. When that happens, they’ll be ending their rental leases to bid on available homes for sale.

Immigration, Employment Trends and Demographics Factor In

A wild card in the rent picture is the arrival of millions of illegal aliens entering the US over the last few years, who need shelter, food, jobs, English training, skills training, and more as they settle into the US melting pot. Social program demand will increase and therefore taxes will rise to service them. Rising taxes will pressure landlords to raise rent prices.

These new residents are increasing the demand for lower priced rentals across the country, and in particular in the south including Texas, Florida and in California.

Unfortunately, few affordable rental units are being built. Rising interest rates make building a risky venture especially for low income units.

Florida and Texas in particular with their lower income taxes are very attractive for renters who can’t find an affordable unit in their state. One report from TransUnion (tenant verification) says more renters are looking outside their state for a rental.

“With remote work firmly in the norm, we’ve seen renters actively seeking new locations that better suit their budgets and lifestyles,” said Maitri Johnson, vice president of tenant and employment screening at TransUnion

Additionally, those who are deciding to sell will often rent in another neighborhood, city or state to gauge whether they like it or not. Many uprooted homeowners endowed with big cash may like the new freedom to move wherever they wish to and could become renters rather buying when interest rates are so high.

Taylor Marr, Redfin Deputy Chief Economist states that in the „Short term, the cooling housing market will prop up demand for single-family rentals, sustaining monthly rental price growth. Long term, it could go either way. The cooling market could continue to intensify demand and push up prices.“

Chen Zhao, Redfin Economics Research Lead states that the „consensus in the economist community is that the Fed will raise interest rates again in July by 50-75 basis points followed by three smaller hikes later this year, and that the Fed could increase rates more than expected and mortgage rates could rise again.“

If mortgage rates rise, it only makes sense that rental owners would pass on the increase in rent prices to the extent they can.

Factors that will drive up rent prices:

1. reduced new multifamily and house construction
2. home prices in many cities continue rising
3. rising financing/mortgage costs for rental owners
4. rising property servicing costs
5. rising taxes, fees, and contractor prices
6. increasing demand from buyers who wanted to buy
7. bigger demand for single family houses and very limited house supply
8. more rental properties being bought by corporate investors

Conclusion About Rate Effects on Rentals

We’ve seen so many factors that come into play when interest rates rise. It’s not just the rise in rates, but the entire context that renters find themselves in.

As construction slows and demand for affordable priced units rises, upward price pressure happens.

Most of the factors presented appear to support continued high rent prices.

As we near 2023, property managers should still consider a recession proof business strategy. That might include shifting service focus to tenant retention, leasing, marketing, and maintenance services. It’s almost certain landlords will cut capital expenditures and operating expenses since no one is certain how the current economic trends will play out.

Regardless of demand and pricing dynamics, using a modern property management software helps you in every way. From automating accounting and rent collection, to streamlining tasks and workflow to cutting costs, ManageCasa™ should be the foundation of your property management related business.

Schedule a Demo, and learn more about the awesome power of cloud based, SaaS property management first hand.

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* the ideas expressed in this article represent those of the author and not necessarily that of ManageCasa, its partners, investors or affiliated companies.