Author Topic: What if rental prices grow faster than inflation?  (Read 2764 times)

jaysee

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What if rental prices grow faster than inflation?
« on: October 26, 2019, 06:55:30 PM »
I've been thinking about a potential dilemma faced by those of us who prefer to put our money into stocks, bonds, etc. and stay out of home ownership.

It is this: what if the rental prices in all the attractive parts of the world rise faster than general inflation?

So we might have planned around, say, 7% average annual growth in our portfolios - 3% inflation = 4% real growth.

But what if the rental market goes up by, say, 5% per year on average?

That means that housing, likely our biggest cost, would always be unaffordable.

Has anyone considered the possibility of this occurring?

Papa bear

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Re: What if rental prices grow faster than inflation?
« Reply #1 on: October 26, 2019, 07:14:59 PM »
Just a tongue in cheek comment here, but that would be AWESOME for me! 

Not so great for the renters of the world.

Though if rents are increasing faster, then market value of the property is also most likely rising.  And that means rising wages in the area, and most likely some great macro growth and stock market growth.   


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maizefolk

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Re: What if rental prices grow faster than inflation?
« Reply #2 on: October 26, 2019, 07:42:29 PM »
what if the rental prices in all the attractive parts of the world rise faster than general inflation?

How are you defining "all the attractive parts of the world"? If for you only living in, for example, SFO, NYC, or London is attractive, rents growing faster than inflation for decades to come is within the realm of the plausible. For most broader definitions of "the attractive parts of the world" it seems much less likely.

Also keep in mind that over the super long term stocks have returned on the order of 9.1% CAGR. After adjusting for inflation, that drops to about 6.8%. The reason so many people talk about spending 4% per year is that provides a safety margin against retiring right before a major recession when stock prices drop (sequence of return risk), not because they are counting on 7% nominal returns and 3% inflation.

-During a major recession, rents aren't going to be rising faster than inflation even in places like San Francisco.
-During more average economic periods, as long as you're not too heavily investing in bonds/cash, your portfolio is likely to return 6-7% per year, which, since most of us are only planning to spend 4% per year, provides some level of buffer against rents rising faster than inflation.


jaysee

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Re: What if rental prices grow faster than inflation?
« Reply #3 on: October 26, 2019, 07:52:14 PM »
Though if rents are increasing faster, then market value of the property is also most likely rising.  And that means rising wages in the area, and most likely some great macro growth and stock market growth.   

Does it though? I'm not sure that scarcity of land automatically translates to higher wages or stock market growth.

1. Higher wages - Automation and cheap immigrant labor can pull down wages, while family businesses and elite networks make highly paid jobs unattainable for those not 'in the loop'.

2. Stock market growth - Businesses might not want to grow. If most of the population is ageing and there's a very large, wealthy, property-owning middle-class, what incentive do they have to go into business? They're already rich, they don't care about making more money.
« Last Edit: October 26, 2019, 07:53:54 PM by conwy »

Papa bear

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Re: What if rental prices grow faster than inflation?
« Reply #4 on: October 26, 2019, 09:46:47 PM »
Though if rents are increasing faster, then market value of the property is also most likely rising.  And that means rising wages in the area, and most likely some great macro growth and stock market growth.   

Does it though? I'm not sure that scarcity of land automatically translates to higher wages or stock market growth.

1. Higher wages - Automation and cheap immigrant labor can pull down wages, while family businesses and elite networks make highly paid jobs unattainable for those not 'in the loop'.

2. Stock market growth - Businesses might not want to grow. If most of the population is ageing and there's a very large, wealthy, property-owning middle-class, what incentive do they have to go into business? They're already rich, they don't care about making more money.

Home prices and, in that regard, rental prices, have historically tracked inflation.  Now that’s not true all the time everywhere.  But generally it has been that way since we’ve been tracking real estate prices, going back 500+ years. More accurately, housing tracks wage inflation.

I’m not sure that scarcity of land is a factor, nor will it be for a long time or ever.  Supply restrictions exist on a micro level currently because of zoning issues, not for a lack of buildable space.  There are some exceptions, sure, Manhattan and Hong Kong come to mind, but even places like San Francisco, zoning is more the problem. 

So for you’re particular planning, what are your contingencies? Can you move from Manhattan to Brooklyn? Or San Fran further inland? Or leave Hong Kong or Tokyo for the countryside?

To answer your questions
1) if wages fall, people can’t afford rent. It’s deflationary. Rent prices will fall.
2) businesses exist to make money, I don’t think that will ever change. 




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Seadog

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Re: What if rental prices grow faster than inflation?
« Reply #5 on: October 27, 2019, 04:24:27 AM »
I've been thinking about a potential dilemma faced by those of us who prefer to put our money into stocks, bonds, etc. and stay out of home ownership.

It is this: what if the rental prices in all the attractive parts of the world rise faster than general inflation?

So we might have planned around, say, 7% average annual growth in our portfolios - 3% inflation = 4% real growth.

But what if the rental market goes up by, say, 5% per year on average?

That means that housing, likely our biggest cost, would always be unaffordable.

Has anyone considered the possibility of this occurring?

I see this logic in Canada now, and in the US 10+ years ago. It's the "new normal" That RE increases faster than inflation.

Keep in mind though, that a huge portion of people's general expenses, and thus the inflation index, is housing. If housing is increasing at double the inflation rate, then several other big ticket things need to be below inflation for it to average out, among which is wage growth. This leads to housing taking a bigger and bigger percentage of their income.

The ad infinitum result is that it takes more than 100% of your income to pay for housing. How would that be possible? The market sets prices, and the people looking to buy or rent ARE the market. People can only afford to spend what they make, so in a nutshell who would be renting then? 

Keep in mind too, that income is just a corollary for productive time. Papua New Guinea natives may not have had money, but their group as a whole likely spent ballpark about a third of their productive time securing housing, a third securing food, and a third getting around.

Here's a fun thought experiment. In a closed, no growth system, what should the prices of things do? The same people doing the same jobs, grow similar amounts of food each year, same number of homes each getting maintained, and the children born cover exactly those that die. The answer, is that they should theoretically stay the same.

The difference between stocks and houses is that these companies make life better for the masses over time. Google maps has saved me lots of time by not getting lost, and not having to carry maps anywhere, and not wasting gas. A home does not improve with age or increase the standard of life. Provided it's maintained, a 3 br home does exactly what it did 100 years ago - House a family of 4 in relative comfort.

rothwem

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Re: What if rental prices grow faster than inflation?
« Reply #6 on: October 27, 2019, 06:35:18 AM »
I've been thinking about a potential dilemma faced by those of us who prefer to put our money into stocks, bonds, etc. and stay out of home ownership.

It is this: what if the rental prices in all the attractive parts of the world rise faster than general inflation?

So we might have planned around, say, 7% average annual growth in our portfolios - 3% inflation = 4% real growth.

But what if the rental market goes up by, say, 5% per year on average?

That means that housing, likely our biggest cost, would always be unaffordable.

Has anyone considered the possibility of this occurring?

So, what market forces would cause this to happen? Home prices rise because they’re “investments” that have been speculated higher than their useful value.  Rents, however, unless you come up with some sort of rent futures scheme for residential housing, don’t have any value for investing, you can’t make any money off of it.

For that reason, rents usually track wages/affordability (basically inflation) in the area.  An influx of outside money in an area could prop rents up and make prices unaffordable for lots of people, but they would still be somewhat tracking the inflation index of the region.


Though if rents are increasing faster, then market value of the property is also most likely rising.  And that means rising wages in the area, and most likely some great macro growth and stock market growth.   


Cmon man, you know that’s not how residential housing works. Nobody buys a house to live in (well, present company excluded) based on how much it’ll rent for. Instead most people watch HGTV and look for their barely affordable “forever home”.

BicycleB

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Re: What if rental prices grow faster than inflation?
« Reply #7 on: October 27, 2019, 08:39:27 AM »
Lots of people have considered this.

How big a concern it should be depends on how tight your budget is, and details of your desired housing, including what current prices are. Roughly, it should be of little concern if you have substantial slack, moderate concern if you have little slack, and great concern if your budget is stretched to the limit but you are also very determined to live in an area with high but currently rising rental prices.

My personal opinion is if your concerns are general, you should narrow them down somewhat, because preparing for All Possible Concerns is expensive. If your concerns are specific, you should examine them more directly, perhaps with a case study.

Re rent specifically, rising rents usually are coupled with housing prices that are higher than the rents. So renting is still cheaper in expensive cities. It often happens that you can barely afford rent in a costly city, but you could buy a house in a cheap one.

As a grand generality, my first exposure to to real estate prices came in a "philosophy/literature" book we read in high school English called "On Walden Pond." Home Slice Henry David Thoreau built a cheap cabin by a pond outside of town in 1840s New England (I think Massachusetts) and grandly lived there outside the normal realm of getting and spending, then wrote a book sharing his thoughts about the matter. He didn't include the part about visiting Mom's house for meals sometimes when he was hungry, I'm told. The part I remember was him saying that people usually spent about a third of their income on their house.

Rent details may vary from era to era, but today, ordinary people still spend easily a third on housing. I assume prices can vary by thousands of dollars per year, but not infinitely. Plan for moderate variances.

PS. It's always possible to respond to rent increases with "badassity", in the form of some thrifty behavior change - move, find a work-for-reduced-rent deal, pack in extra roommates, earn more, shift to a custom van, fix up a fixer upper and fill with renters, or other. Flexible badassity is the point of MMM.

"Always" here means "unless you have already found the best possible rent situation, and you have left yourself such a tight budget that's the only thing you can afford." IMHO, FI means leaving yourself more flexibility than that.
« Last Edit: October 27, 2019, 05:11:07 PM by BicycleB »

habanero

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Re: What if rental prices grow faster than inflation?
« Reply #8 on: October 27, 2019, 11:22:00 AM »
"Shelter" is ~33% of US CPI.

"Rent of primary residence" is only about 8%
"Owners equivalent rent of primary residence" is about 23%

So rental prices can in theory deviate a fair bit from CPI. The whole housing spectrum (shelter + all the other stuff that goes into housing (fuel, water, trash, electricity etcet) is ~42% of US CPI, so its limited how much it can deviate as it makes up almost half the index.

The index weights for end 2018 (dont know how often they are adjusted) can be found here:
https://www.bls.gov/cpi/tables/relative-importance/2018.pdf

The left column (CPI-U) is for urban consumers, the right (CPI-W) is for "urban hourly wage earners". The CPI-U is what is refered to as CPI.
« Last Edit: October 27, 2019, 11:24:25 AM by habaneroNorway »

Indexer

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Re: What if rental prices grow faster than inflation?
« Reply #9 on: October 27, 2019, 05:01:03 PM »
I've been thinking about a potential dilemma faced by those of us who prefer to put our money into stocks, bonds, etc. and stay out of home ownership.

How you invest and how you pay for shelter don't need to compete with each other. IMO it's two different questions.

1. How to invest? This could be stock/bonds, buying rental properties, a combination of the two, etc.

2. How to pay for housing? If you need flexibility or if you live in an area where renting is clearly better then rent. If you plan on staying in the same place for more than 5 years compare renting VS owning to see which is optimal in your area. If inflation is a serious concern this will make owning look better.

Plenty of us own a home with a mortgage, and use stocks/bonds as our investments. Since my mortgage rate is low every extra penny of savings goes into stock/bonds.

Quote
That means that housing, likely our biggest cost, would always be unaffordable.

Has anyone considered the possibility of this occurring?

Well if you are on the FIRE path then you will be in much better shape than everyone else if this occurred. Prices also can't rise faster than wages forever. Eventually even the consumerists who overspend won't be able to afford rentals and price increases will slow. In addition, if you are on the FIRE path you have a lot more flexibility. You won't need to live near jobs post-FIRE. There are plenty of nice places to live where housing has been built fast enough to meet demand. A $1.5 to 2 million home in San Francisco is $250-300k in affordable cities like Charlotte, Raleigh, Nashville, Orlando, etc. and $150k in the smaller cities/towns on the outskirts of those major cities.

Badassity answer:  Post FIRE you could buy a home that needs some TLC for <$100,000 and fix it up with your new free time.

Villanelle

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Re: What if rental prices grow faster than inflation?
« Reply #10 on: October 27, 2019, 05:14:30 PM »
I guess I feel like this is sort of like asking whether the prices of utilities, or gasoline, or food grow faster than inflation.  It's possible, but I don't consider any of it actionable.  I can't act on every possibility.   I don't consider this especially likely (beyond specific markets).

But it is an argument for the diversity offered by owning real estate.

I plan on owning a house in retirement.  Fear of being priced out of homes I want is part of the rationale, but it's also simply because I want the stability that comes with owning. 

Ynari

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Re: What if rental prices grow faster than inflation?
« Reply #11 on: October 27, 2019, 08:45:23 PM »
@BicycleB's point about specificity really matters, I think. We are currently in a HCOL area that recently went through a rental "adjustment" due to Big Business Announcements of Hypothetical Jobs that threatened to raise our rent by 16% before we negotiated it down to 5%. If a 5% increase becomes regular, or if they hold fast on the next 16% increase, we would have to consider moving away from the HCOL amenities we enjoy (moving further away from transit/etc. or into lower quality housing, or moving out of the area altogether). Of course, these options are doable both now and hypothetically on a FIRE budget, but it is a consideration that someone who bought their own home in this situation would not have (they may be enticed to sell by the higher home prices, or their property taxes go up a little, but they would not be forced to pay 5%+ more on their mortgage.)

As with everything unpredictable, it comes down to flexibility. That could mean being willing and able to move. Or it could mean more buffer in the budget. I have no idea how to estimate how much buffer, though, would make staying in one place feasible in most common scenarios. I guess looking at worst-case rent increases over a 30+ year time frame? Is that data out there?

FIPurpose

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Re: What if rental prices grow faster than inflation?
« Reply #12 on: October 27, 2019, 10:01:01 PM »
The future of rent prices from two sides:

1. As a renter:

Shelter is part of the inflation index. So as long as your investments are outpacing inflation in general, then you're more or less keeping up with rent prices.

As a renter you can also invest part of your portfolio in REIT index funds. This means that the part of your portfolio that would have been invested in your own home, would instead just be invested across the country. I think this would actually lower your risk of buying into a lemon house/ RE market.

The 4% rule includes increases due to inflation. However, RE markets can go hot and cold quick. So your location may vary. Since this is a FIRE forum, being able to move to lower COL is a huge advantage with an investment portfolio.

2. As a landlord:

Your returns do better when RE inflation outpaces general inflation. It means that the assets that you are more heavily invested in are gaining value faster than the price of goods that you buy.

For example the current 12-month CPI index is the following:

All Items: 1.7
Food: 1.8
     Home: 0.8
     Rest.: 3.2
Energy: -4.8

All Items less Food/energy: 2.4
Commodities: 0.7
Shelter: 3.5
Transport: 0.8
Medical: 4.4

So overall, rent prices are rising 1-2% faster than a typical household budget. However, it has slowed down in the past 5-6 months closer to on pace with general inflation.

However! All RE is local. Your locality really determines the rules, not general CPI. It's just a general measure we can use to discuss general trends. I think in general we will see housing have a lower inflation over the next 5 years. Rent prices are already holding steady in my area, house prices have slowed, and everyone generally feels that this can't keep up forever.

Not all locations' rents are rising faster than inflation either. The West Coast has close to double the inflation as the rest of the country.

This has been something that I think this forum needs more insight on. How exactly does inflation affect FIRE, how does inflation change depending on where you live? Have some areas of the country actually failed a 4% withdraw rate (or vice versa can other areas support a higher withdraw rate?) How does a Mustachian budget differ from the CPI assumptions? I think we in general know the answer, but more specific numbers in this area could really help make wiser decisions in both working years and retirement decisions.

Telecaster

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Re: What if rental prices grow faster than inflation?
« Reply #13 on: October 27, 2019, 11:50:02 PM »
I've been thinking about a potential dilemma faced by those of us who prefer to put our money into stocks, bonds, etc. and stay out of home ownership.

It is this: what if the rental prices in all the attractive parts of the world rise faster than general inflation?

So we might have planned around, say, 7% average annual growth in our portfolios - 3% inflation = 4% real growth.

But what if the rental market goes up by, say, 5% per year on average?

That means that housing, likely our biggest cost, would always be unaffordable.

Has anyone considered the possibility of this occurring?

Overall, this can't happen.  Now, it could happen in localized markets.  But it can't happen overall, because then everybody would eventually be priced out of the housing market and there would be a bunch of rental housing sitting empty. 

So if you want to keep your housing expenses at close to inflation, you have may have to move. But housing costs cannot outstrip wages for any long period of time, for the reasons I mentioned above. And we've seen this historically over long periods of time, so it is a non-theoretical conclusion. 

nancyfrank232

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What if rental prices grow faster than inflation?
« Reply #14 on: October 28, 2019, 12:47:17 AM »
As rent rises, at a certain point renters will downsize

Renters will either get a roommate to share the cost or downsize to a smaller unit or both

Renters will also downsize product. Going from detached, to semi/town, condo/apt, to mobile home, etc
« Last Edit: October 28, 2019, 12:49:53 AM by nancyfrank232 »

jaysee

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Re: What if rental prices grow faster than inflation?
« Reply #15 on: October 28, 2019, 07:23:42 PM »
Overall, this can't happen.  Now, it could happen in localized markets.  But it can't happen overall, because then everybody would eventually be priced out of the housing market and there would be a bunch of rental housing sitting empty.

Well it seems possible that exactly that could happen. A tiny minority of very wealthy people (multi-millionaire and beyond) could end up controlling 90% of the world's real-estate. The rest of the world's poor could be left homeless. I know it sounds crazy, but this is already the situation in terms of monetary wealth. Already a tiny minority own most of the wealth. If that wealth, over time, is used more and more to buy property, which the wealthy consider a safer store of value, then basically everyone who isn't wealthy gets squeezed out of owning property, or even renting it, since the rise in house prices drives up the rise in rent.

Basically there's a very limited and finite amount of urban land (not land in general, but specifically, land that is close to urban centers and has plumbing, sewage, power, etc). As the population in general (and the population of rich people) grows, there will be increased competition for a small amount of urban land.

So if you want to keep your housing expenses at close to inflation, you have may have to move. But housing costs cannot outstrip wages for any long period of time, for the reasons I mentioned above. And we've seen this historically over long periods of time, so it is a non-theoretical conclusion.

Past events don't necessarily predict future events. Maybe the world's population wasn't so large in the past. Maybe there weren't as many wealthy people in the past. Maybe the relationship between government and the private sector was different. Maybe there was more incentive to invest in cities.

-----

I'm willing to accept that this thinking might be a bit paranoid.

I just want to at least explore the worst-case scenarios. There's no harm in imagining what might go wrong. Maybe in exploring worst-case scenarios, you identify very real risks you didn't think of before.

Ideally I'd like to have some kind of hedge against not being able to afford rent. But with house prices so high (especially in major cities in Australia, the country I live in) I don't want to be dropping half a million dollars to make that hedge. It would be nice if I could buy, say, a very tiny piece of land with just a tiny house on it, for say, $100k. That seems to be a more reasonable amount to pay as a hedge.

clarkfan1979

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Re: What if rental prices grow faster than inflation?
« Reply #16 on: October 28, 2019, 09:44:02 PM »
In 2012, I bought a single family home in Fort Myers, FL for 95K and put 15K worth of repairs into it. If it didn't need any repairs, the cost would have been around 125K. If I was to rent it out, it would have rented for $1,200/month in 2012. 

Now in 2019, the rent is $1850 (54% increase) and the value is 250K (100% increase). My old job paid $40,000 in 2012. That same job now pays $43,000.

If I still lived in Fort Myers, FL and rented, my wage would be up 7.5% and my rent would be up 54%.

nancyfrank232

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What if rental prices grow faster than inflation?
« Reply #17 on: October 29, 2019, 03:42:12 AM »
In 2012, I bought a single family home in Fort Myers, FL for 95K and put 15K worth of repairs into it. If it didn't need any repairs, the cost would have been around 125K. If I was to rent it out, it would have rented for $1,200/month in 2012. 

Now in 2019, the rent is $1850 (54% increase) and the value is 250K (100% increase). My old job paid $40,000 in 2012. That same job now pays $43,000.

If I still lived in Fort Myers, FL and rented, my wage would be up 7.5% and my rent would be up 54%.

This is cherry picking dates/data

I typically see stock market advocates doing this
« Last Edit: October 29, 2019, 06:13:21 AM by nancyfrank232 »

CCCA

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Re: What if rental prices grow faster than inflation?
« Reply #18 on: October 29, 2019, 01:06:00 PM »
Inflation is simply the percentage change in the average price of a large basket of goods. Almost by definition, some of the items in the basket will rise in price faster than inflation and some will rise slower (including falling prices).


Similarly in a market like the US (across which the stats are published), some places will rise faster than the average of housing inflation and some will rise slower (or fall in price).


At this point housing costs in the HCOL areas seems to be reaching the point where demand (in the economic sense, i.e. willingness to pay) is being lowered because the price is so high (due to supply shortages).  However, people were probably saying that 5 years ago and 10 years ago as well. 


As homeowners and landlords in the Bay Area, we benefit from having locked in prices awhile ago and rising rents. It does seem like the rental market is cooling down a bit (i.e. not rising crazy amounts like the last 10 years).

Telecaster

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Re: What if rental prices grow faster than inflation?
« Reply #19 on: October 29, 2019, 04:29:40 PM »
Overall, this can't happen.  Now, it could happen in localized markets.  But it can't happen overall, because then everybody would eventually be priced out of the housing market and there would be a bunch of rental housing sitting empty.

Well it seems possible that exactly that could happen. A tiny minority of very wealthy people (multi-millionaire and beyond) could end up controlling 90% of the world's real-estate. The rest of the world's poor could be left homeless. I know it sounds crazy, but this is already the situation in terms of monetary wealth. Already a tiny minority own most of the wealth. If that wealth, over time, is used more and more to buy property, which the wealthy consider a safer store of value, then basically everyone who isn't wealthy gets squeezed out of owning property, or even renting it, since the rise in house prices drives up the rise in rent.

Think about that one for a second.  If the ultra-wealthy bought up all the real estate and raised all the rents to the point where people are homeless, then by definition that real estate is sitting vacant and not generating any income.  In which case the rents would come down until people could afford to occupy the properties.

To your point about owning real estate as an inflation hedge, I think that is a good idea in many cases.  Your mortgage payment is fixed (at least in the US) so it doesn't much matter what inflation does. 




FINate

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Re: What if rental prices grow faster than inflation?
« Reply #20 on: October 29, 2019, 05:08:37 PM »
I agree with @Telecaster -- this cannot happen in a broad sense, though it can happen locally.

Even if the ultra-wealthy bought up all the housing, they would not be able to fix prices w/o violating antitrust laws. Landlords, even ultra-wealthy ones, don't set prices they discover them.

In today's market, with FOMO on future theoretical housing price increases, I'm more concerned about the inverse: Housing that declines or is even just flat for a number of years, vs. other investments. We sold our primary residence last spring when the market here was red hot. Since then the house has declined slightly in value whereas our other investments have done quite well.

IMO, it may make sense to buy something reasonable if you're going to put down roots in a place for 10+ years. But if you're FIRE and renting and the rent becomes too expensive, just move somewhere else.

 

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