A recent, excellent BiggerPockets blog post identified several cities where employment is expected to decline. Here, I will explore what I believe to be a common thread that connects these cities.
Before I continue, I want to explain what makes prices and rents. Both are a function of supply and demand. With more buyers than sellers, prices rise until the number of buyers and sellers reaches equilibrium. Conversely, when there are more sellers than buyers, prices fall to equilibrium.
Rent follows local prices. When prices or interest rates are high, fewer people are willing or able to buy homes, forcing them to rent. The growing demand for rental properties is increasing.
Conversely, more people buy than rent when property prices are low. This decrease in demand causes rent to decrease.
What Do Cities With Falling Rents Have in Common?
The main reasons for stagnant or falling prices and rents are a stagnant or declining population (soft demand) and/or urbanization (unlimited supply). Urbanization—the unrestrained expansion of cities—leads to new goods that compete with existing ones.
Existing homes have only a small price advantage when undeveloped land is cheaper. Given the choice between old and new buildings, many people choose new, even at higher costs.
Here’s a time-lapse aerial view of the five cities mentioned in the post. This observation shows how these cities can continue to expand, adding excess supply and decreasing rents and prices.
Due to the lack of geographic restrictions on expansion in these cities, properties purchased in newly developed areas today may become part of secondary markets in the future. This circuit is shown here.
- The first picture shows the newly purchased property in the future.
- The second image shows how rents and prices are rising as development reaches the area.
- The third image shows how the area has become less attractive as the wave of development passes, causing rents and prices to drop compared to new developments.
- In the fourth picture, a wave of development has overtaken the area, leading to further declines in rents and prices. At this stage, the owner’s main option is to sell the existing property, find another in the way of new development, and start the cycle all over again.
An effective strategy is to invest in cities with strong, steady population growth and limited growth potential. Las Vegas is an example of such a city, as shown in the GIF.
Since there is limited raw land to be expanded, new development will primarily involve improvements to existing properties. As a result, rents and prices for properties you buy today will likely continue to rise due to increased demand from population growth, while housing supply remains relatively stagnant.
Take the Long View
Demand drives prices and rents, which are largely influenced by changing demographics and the city’s potential for expansion. In cities with abundant, cheap land on the outskirts, new places eat away at the people wanted by the existing ones.
This situation creates a challenging cycle for investors: They must continue to sell their current properties and reinvest in new developments, or face the prospect of stagnating—and ultimately falling—rents and prices.
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A Note About BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BiggerPockets.
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