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US Buy to Rent Property is the Perfect Stagflation Hedge Until the Fed Decides It's Not

Updated on January 9, 2013
It is now cheaper to rent than to own US housing.
It is now cheaper to rent than to own US housing.

Rising Rents are a Cause and a Symptom of Stagflation

Uncertainty, created by economic weakness, is driving rents higher. This uncertainty is causing Americans to be better renters than buyers of homes. Economic weakness has also caused the Federal Reserve to lower interest rates; and maintain them at these low levels for an extended period of time, which many think will continue into 2015. Mortgage lenders have tightened lending standards, so that many would-be buyers are forced to rent because they don't qualify for a mortgage.The combination of uncertainty and the Federal Reserve has created a situation in which mortgage payments are lower than rental payments on the comparable property.

In addition to the economic fundamentals, a powerful speculative driver has entered the property market; to capitalize upon the tighter lending conditions, low interest rates and high rental demand. This speculative driver, once again, comes from Wall Street. Well capitalized private investment companies are chasing the offer side of the housing market; to create portfolios of rental properties. Ironically, it is the policy makers who called for the infusion of private capital into housing, to take away the moral hazard for the taxpayers in relation to the GSE's (Fannie and Freddie), that have created this second speculative bubble. The profit motive can be understood as the spread between rising rents and falling mortgage interest costs. The situation is made more risky by the fact that since these private sector funds are well capitalized, the banks are willing to extend them greater leverage than they would to an individual. The banks also have an interest to move their underwater property assets off balance sheet; so in effect they simply transfer the assets to the private sector fund and also lend it the money to buy the assets. The banks have just performed the neat trick of improving their perceived credit risk, by reassigning the assets from individuals to large asset managers and hedge funds. The banks have then totally undermined this improved credit strategy by providing leverage to the private sector funds that buy the property assets. The only good news is that the underlying asset is being transferred at a lower price, so therefore the total financial risk is lower than it was back in 2005 to 2007. When the banks start securitizing the loans that they have made to the private sector buyers, we will be back into familiar bubble territory.

Home prices are now being priced off their rental capitalization rates, rather than the normal supply and demand factors that have traditionally driven the market. Since the weak economy increases rental demand this means that, based on rental capitalization rates, home prices can rise even when the economy and unemployment are weak. A negative feedback loop has been created, in which weaker economic activity actually drives up home prices, because rental demand is rising. Rents and house prices rise, so that inflation is rising at a time when economic activity is falling. This is the classic symptom of Stagflation. The higher rents rise the less money will be available in the economy for consumption. The rise in rents and home prices is therefore a symptom of a speculative form of Stagflation, that is as unsustainable as the property bubble of 2005 -2007.

So far, as rents have risen and consumption has fallen, the Federal Reserve has chosen to ignore the fact that it is creating this unsustainable situation. It seems more concerned with providing the monetary conditions that will allow the banks it protects to move their property inventories onto the private sector. At the point at which this transfer of ownership has been completed, the Fed will then be in a position to think rationally. It will then have to accept that, by providing cheap liquidity, it has actually caused an economic recession by allowing rents to rise and consumption to fall. Far from stimulating employment, Quantitative Easing has killed employment for all except those who are involved in the Buy to Rent sector of the economy.

If the Federal Reserve ever owns up to this unintended consequence, it will then have to normalize interest rates and kill the Buy to Rent speculators. It seems likely that the banks who have moved their assets into the private sector, did so by lending the private sector the money to buy them. We will then have the next property crash. No doubt the banks that kept the loans they made to the private sector buyers of their property assets will then demand another bailout; and no doubt the private sector will raise rents to cover its losses. Holders of the securitized loans of the private sector buyers will have a worthless asset. If rating agencies are involved, it will all look very familiar.

Chairman Bernanke may have managed to retire , as Alan Greenspan did, before the consequences of his policy choices fall due on the Federal Reserve to react to in the same predictable fashion.


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