Observations on the single-family rental debate re: the 21st Century ROAD to Housing Act.

The Senate just passed the 21st Century ROAD to Housing Act. 90% of the bill is probably the best comprehensive housing reform package that has passed a chamber of Congress during the housing crisis era. It was passed with a resounding bipartisan 89-9 vote. But, at the 11th hour, provisions were added that would probably end the market for new build-to-rent single-family homes and the market for large-scale investors in existing single-family homes.

Critics, like me, have come out against the bill. Oren Cass, who has become a favored source of economic punditry for the Trump administration asks some questions of the critics that, frankly, are reasonable questions given the failures of the economics academy to properly understand the most important factors driving the housing crisis.

He tweeted:

4/ What's the argument here? It turns out the Old Right has two complaints and they are, you'll be shocked to hear, directly contradictory. One is that institutional investors don't buy a lot of homes so a ban won't accomplish anything.

5/ The other argument is that this supposedly too-tiny-to-matter set of institutional investors is hugely important to the housing market and restricting their participation will cause all sorts of problems, reduce investment in housing, and so on.

6/ On one hand, we are supposed to believe that institutional investors are not driving up housing costs. On the other, we are supposed to believe that without them bidding, housing prices will be lower and so there will be less incentive to build. Mmhmm.

7/ The reality, of course, is that institutional investors do drive up housing prices, and that's a bad thing. Builders have no shortage of incentive to build, even at prices well below current levels, and other provisions of the 21CRHA aim to clear the obstacles they face.

8/ If removing institutional investors changes the shape of demand and thus the type of houses built, orienting the market more toward what a family could afford, well... good. Making judgments like that about market outcomes is not only OK, it's necessary.

One reason we should not think that large-scale investors drive up home prices is that they never did at any time before 2008. Why? Because they didn’t exist. And they didn’t exist because large-scale investors are never willing to pay more for single-family homes than homeowners are. When homes sold at historically normal prices in the 20th century, large-scale investors sat out. When homes sold at historically inflated prices before 2008, large-scale investors sat out.

In 2008, federal regulators permanently ended access to mortgage access for 1/3 of families who could get those mortgages in the 20th century. That made the prices of homes in neighborhoods full of those families crater - more than 50% in some places. Something like 25% in the average neighborhood.

In the absence of family buyers, investors filled the gap. But, they bought at an extreme discount.

That is the one period of time where investor ownership was associated with rising prices - when prices rose back toward a reasonable price at which new builders could compete.

This is from my “funny chart” posts. The black line is the number of owner-occupied homes and the red line is the real Case-Shiller home price index. From 2012 to 2016, increased investor presence was associated with rising prices. Since then, rising prices have been associated with rising owner-occupier presence. And, in fact, after 2022, when owner-occupier growth slowed down, prices flattened out.

Figure 1

Now, it is true that prices are higher than they were 25 years ago. That is because of a housing shortage, and the housing shortage means that owner-occupiers are willing to spend more for homes.

There is literally no reason using any historical data to ever think that large-scale investors will bid the price of single-family homes. Even in 2006-2007, where home ownership flattened out when the subprime lending boom fueled buying by small-scale investors, the investor activity was associated with flattening home prices.

But, housing economists are neutered when they try to respond to pundits like Oren Cass because they don’t know that the most important economic development of our lifetimes - the elimination of 1/3 of the traditional mortgage market in 2008 - happened. So, they think that the housing market has been rolling along with marginally changing equilibrium conditions, when, in fact, it was deeply in disequilibrium by 2012 and has been struggling to get back to equilibrium since then.

Why does this matter?

Because, under equilibrium conditions, marginal changes matter, and you might intuit that if we keep investors out of the market, then home prices will decline, and renter families that had been priced out of the housing market would now be owners. That’s basically what Cass thinks will happen.

But, the answer, which most housing economists can’t give him, is that those renter families aren’t operating on the margin. For the past 15 years, millions of them have been renting even though there was a clear benefit to owning, under current conditions. Many of them were renting homes for $2,000 that they could have purchased with a $1,200 mortgage payment. There are federal regulators who say they aren’t qualified for that mortgage, but there aren’t federal regulators who say they aren’t qualified for that rental payment.

So, the answer to Cass’s criticism that he isn’t going to hear is that there is essentially no market for increased homeownership above current trends under current lending conditions.

And, the market dynamics suggested by Figure 1 bear that out.

Since 2019, the number of renter households has increased by about 2.8 million households, and developers have constructed about 2.7 million new apartments.

Over the same period, owner households have increased by about 8.5 million households, but only about 6.2 million new homes have been completed for sale. So, owner-occupiers have poached 2.3 million homes from other sources. Some of that has been the reduction in vacant homes. But, most of it has been from owner-occupiers buying homes that previously were rentals. So renting families, who are mostly renting because we, collectively, have supported governance that excludes them from ownership, are left out in the cold.

Owner-occupiers are outbidding investors.

Some investors, including large investors, have built or purchased about 500,000 new single-family homes to manage as rentals. That has only filled a small portion of the gap.

So, even though investors don’t, and never have or will, driven up the price of housing, and very large investors are an insignificant portion of the housing market, they are an important source of new housing. They will increasingly be a source of demand for new homes as completions continue to recover from the 2008 debacle and prices continue to moderate. New single-family homes are now more than 10% of new completions. I expect that number to get much higher as long as mortgage access remains where it is.

You could argue that if we ban new single-family rentals, that owner-occupiers could buy all the new homes, and that investors would then buy older, depreciated homes, like they used to do before 2008. That’s all well and good. Except we need something like 15 million new rental units in order to normalize rental costs and meet pent up demand for household formation with new supply, and this bill also makes it illegal for investors to own a large number of existing homes.

The reason we need large-scale new single-family home investors is that you and I have made sure that the renters who live in those homes would never buy them. So, once builder capacity exceeds the number of households that we allow to buy homes with mortgages, supply will stop growing.

But, you can’t understand that with marginal equilibrium analysis that assumes every family is allowed to make utilitarian economic decisions.

And, while the average economist stands, neutered to respond to these questions, Tobias Peter at the American Enterprise Institute says, “Hold my beer.” He doesn’t argue that prices and supply will decline. He argues that the exiting investor capital will nudge federal policymakers to return mortgage access to looser norms:

If Washington pushes these investors to divest, not only will investor-owned homes come on the market, political pressure will likely follow to loosen credit standards. Lawmakers want these homes transferred from investors to owner-occupants.

The problem is that many of the tenants renting these homes are not mortgage ready under normal underwriting standards. Industry data suggest many renters have credit scores in the mid-600s and limited savings. Purchasing a home requires cash for a down payment, closing costs, and ongoing maintenance.

When it becomes clear that corporate ownership of single-family homes is not the cause of housing unaffordability, Washington will face a familiar temptation: loosen underwriting so renters can qualify for mortgages they otherwise could not sustain.

Lions, and tigers, and bears! Oh, my!

I suppose it is undeniably true that many renters have credit scores in the mid-600s and limited savings. It is also true that the human head weighs 8 pounds.

Another fact, which might be more relevant to the situation, is that in every year before 2008 that they track credit score data, Fannie Mae originated mortgages to borrowers with scores from 700 to 740 that totaled about 60% the value of new mortgages to borrowers with scores over 740. After 2008, it immediately and permanently dropped to about 30%.

Figure 2

In fact, the federal government should do exactly the thing AEI is afraid of, instead of blocking investors. In fact, it would greatly reduce investor activity, and in the long run, it would reduce rents on the homes that investors do own.