The Rent Price Penalty

As with all things in life, risk is tied to compensation.  Consumers see this relationship particularly in borrowing money.  The payday loan office charges over 300% interest because so many of their loans go to collections.  The risk of lending is very high.  Banks will increase the interest rates on car loans made to individuals with bad credit.  Since most people operate on a fixed budget, the higher interest rate translates into a higher payment for a smaller amount of money.  That smaller amount of money translates into a dumpy car.

This same dynamic typically plays out in the housing market.  Folks with great credit present a low risk.  They can borrow inexpensively.  Since their interest rate is low, their budgeted payment allows them to borrow more for the same payment than someone with bad credit and a high interest rate.  Thus, those with good credit can afford to live more lavishly than their bad credit friends.

So why do I bring this up?  Well, risk runs in many directions.  Tenants typically pay more for a rental space than they would if they owned something.  However, sometimes the spread is not that great.  In fact, during the housing boom, rents were LESS than mortgage payments.  That is normally a good indicator of an overheated market.

Today though we have just the opposite situation.  Good credit buyers are shunning ownership right now and running to rentals instead.  This pushes up demand and rents on the best rental units.  How much does it push up the rents?  Lets look at a recent example:
 
459 20th Street (which you may recognize) has been for sale at $89,900.   Let's assume that a purchase is based on a 4% interest rate with a $3,150 down payment.  The monthly payment for a buyer comes out to $527 (principal, interest, taxes and insurance).

Yet, despite this very low payment, buyers have not been forthcoming.  However, we just leased the property to the second tenants to look at the place for $695 a month net.

As you can see in this case, the tenants are willing to pay 32% MORE to rent the property than to own it.  That is a remarkable thing.

Even more remarkable is that this is not a rare situation.  Demand for rentals is high while demand for ownership is low.  That leaves an abundance of bargain homes in the marketplace that need investors to own and rent to tenants for much more than the mortgage payment. 

It makes sense to be one of those owners.