With all the talk about higher rents, inflation, rent control, evictions and the like, people need to better understand how rents are actually determined in the real real estate world.
Rents are determined by decisions made every day by hundreds of thousands of landlords, big and small, who try to fill their apartments. Landlords look at rents charged by their competitors, read the news about higher rents and housing costs, and pay ever-increasing real estate taxes and water, gas and electric bills. They are shocked at enormous hikes in tax reassessments. They have to deal with the costs of repairing roofs and tuckpointing their buildings’ facades. They must replace boilers, hot water heaters and air conditioners and pay for other operating expenses.
With this flood of information and circumstances, landlords make sheer guesses as to what rent amounts to charge to cover operating costs and mortgage expense and still make a profit. If rental prospects do not come knocking, they usually resort to lowering their rents, negotiating with fewer prospects or giving a month or two in rent concessions to secure a lease. This process is being carried out every day by landlords, on a hunch and a hope.
Some of the larger landlords use companies that, by way of algorithms, set rents for them daily. These algorithms consider apartment vacancies, prospect traffic, competitive rents and lease expirations. The result is a more calculated decision than a guesstimate but not certain and, at times, overridden by leasing agents. It is the real estate version of the airline model that changes airfares every few minutes. It is an attempt to automate decisions and take human judgment out of the process. In all, however, this method makes up only a small percentage of the everyday decisions made to set rents.
How rents are determined is systemic in the sense that each piece in the process affects another piece in a ripple effect until you get to the eventual rents. In the end, if real estate taxes go up, rents eventually go up. If utility bills go up, rents eventually go up. If maintenance costs go up, rents eventually go up. Increased costs cannot be pushed upon businesspeople without an economic reaction. It is as simple as that. In a free-market economy, actions cause reactions. Landlords are nimble, creative and risk-taking people. They will find a way to absorb the increased costs of operating their buildings by passing them along in higher rents to their tenants if the demand is there, which is affected by the available supply of housing.
To an economist, supply and demand may look like lines on a graph, but behind those lines are difficult, uncertain decisions made by landlords every day. If they find they cannot pass those increased costs along, landlords will cut back on maintaining their buildings causing deterioration, followed by lower rents to fill vacancies and higher evictions for low-credit nonpaying tenants.
Too frequently, this pattern results in more deterioration, mortgage foreclosures and blighted neighborhoods. “Healthy landlords make healthy housing” is not a hollow declaration. It is a reality often lost on legislators and the public.
Many people call out landlords as the cause of the problem of housing affordability. Yet, just like other businessowners, landlords respond to the costs of producing their product by pricing it accordingly. Ultimately, higher rents are the result, the symptom, of decisions made by county tax assessors, taxing bodies, utility companies and legislators.
If you want to cure higher rents, treat the cause and not the symptom.
____
ABOUT THE WRITER
Stuart Handler is CEO of TLC Management Co., a Chicago-based investor and a manager of multifamily housing in Chicagoland.
