My blog yesterday, questioning the future value of San Francisco home prices (at least as measured by the Case Shiller SFR index), might have been more effective if I'd detailed my assumption that rents might be a key driver of home prices. Best to read this first, and then go back to the blog on SFR (and keep in mind for an upcoming blog on Austin).
The graphs below illustrate that, while many academics often forecast forward HPA as a function of past HPA, Zillow's posted home price forecasts, seem to suggest that rent increases appear to have more explanatory power.
The top scatter diagram maps the annual percent change in the Zillow ZVI index (through Dec 2021) vs. Zillow's forecast of gains in their ZVI index for the next year, for the 50 largest cities in the US. The relationship is weak.
The bottom scatter diagram takes Zillow's rent increases for the same time period, and maps those against the same home price forecasts. The relationship is much stronger (with an R^2 of >50%). For example, strong rent growth in Tampa (the 26% outlier to the right in the second graph), is associated with a 19% projected gain in home prices, while much weaker rent gains of 5.56% in Minneapolis, are tied to a forecasted rise of 12.9%. (Note that the correlation between rents and forward HPA is the key point here, not Zillow's level of home price forecasts. I'd short Tampa, Minneapolis and a host of other cities at Zillow's forecasted levels.)
Projections of rent increases may then embolden those with bullish views on HPA as the NAR recently posted some stunning expected rent increases. ( One anecdote in support of these numbers is that one of my contacts had his landlord propose doubling his rent in Miami!).
The NAR report observed that most of the areas with high rent forecasts are in the South (from California, through Arizona and Texas, across to Florida). These regions have seen strong population gains (prompted by both Covid/ remote work/ as well as better affordability) and are currently challenged by inventory shortages. However, many are "borderless" cities (i.e. without oceans or mountains to limit growth) so construction may catch up to demand in time, somewhat capping gains in forward home prices (or forward rent increases). In addition, these areas tend to be more car-dependent (with exposure to the recent pop in gas prices), as well as having more (?) exposure to climate change/ weather-weirding.
(I'd note, as an aside, that access to water is also a growing concern in Phoenix, Las Vegas, and San Diego. I'm one of the maker makers in the CME/NASDAQ California water futures. See link for historical prices. Feel free to contact me at johnhdolan.h20@gmail.com, and/or follow me on Twitter (@CMEWaterFutiures) if you'd care to discuss water hedging strategies. For example, if you buy in Phoenix, you may want to get long water. San Diego is pursuing de-salinization, but construction will take years).
Net, strong rent gains (however temporary) seem to be a big factor in Zillow's home price forecasts, and the NAR is projecting strong rent gains across the South. This should intensify the debate as to whether home prices have further to run.
Anyone looking to add/reduce exposure to these cities (and many more) can contact me to discuss this blog, more general hedging strategies, and specific proposals.
Thanks, John