RENTS AND DEFLATION / THE FINANCIAL TIMES LEX ( RECOMMENDED READING )

Rents and deflation

Published: December 5 2010 20:20

Real estate is a funny old business. How else to explain the prevalence of contracts which include automatic rent increases. The assumption across much of the US and UK seems to be that nominal rents can only move in one direction. So-called “cap rates” used across the industry to value properties by dividing net operating income (mostly rent) by the sales price also imply stable rents into perpetuity.


History is to blame. In most countries around the world, rents have only increased during people’s lifetimes. Primary and owner-equivalent rents in the US, for example, have gone up by an average of 2.8 per cent over the past decade and by an average of almost 5 per cent since the Department of Labour started collecting data in 1967. But that does not necessarily mean that rents have to rise. For the 12 months ending in October rents have fallen by 0.3 per cent.


Time for tenants to demand automatic rent decreases written into contracts? It is no more silly an idea than the current practice. But the predictable reaction from landlords highlights one of the big problems when economies turn deflationary. Falling prices require a completely new mindset. Imagine, for example, rewarding your best employee with a 1 per cent salary cut because deflation is running at negative 2 per cent.


Indeed, rents in the medium term move with nominal wages. Earnings are still growing at about 2 per cent per year in the US, but the trend has been sharply down since the end of 2008. There may be some respite for landlords however. High Frequency Economics points out that in the shorter term, rents respond to vacancy rates, and in the US at least, demand has bounced back over the past year. The Federal Reserve may yet succeed in stoking inflation, both in the US and elsewhere. But if pay packets lighten further, expect rents to follow.


Copyright The Financial Times Limited 2010.