The Urban Rental Shift: Why Sprawling Cities Are Seeing Lower Rents

It is crucial to explain the fundamental drivers of prices and rents, which are governed by the principles of supply and demand. When the number of buyers exceeds that of sellers, prices rise until a state of equilibrium is achieved. Conversely, prices decrease when sellers outnumber buyers, again until equilibrium is restored.

Rental rates are closely tied to property values. When property prices or interest rates are elevated, fewer individuals are willing or able to purchase homes, thereby increasing the demand for rentals and, consequently, driving up rental rates.

Conversely, when property prices are low, more individuals opt to purchase homes rather than rent, resulting in decreased demand for rentals and a subsequent drop in rental prices.

Common Characteristics of Cities with Declining Rents

The primary causes of stagnant or declining prices and rents are typically a static or shrinking population (indicating weak demand) and/or urban sprawl (signifying an excessive supply). Urban sprawl, characterized by the unrestricted expansion of cities, leads to new properties competing with established ones.

When undeveloped land is inexpensive, existing homes have only a slight competitive edge in terms of pricing. Given the choice, most individuals prefer newer properties, even if they come at a higher cost.

Presented below are time-lapse aerial views of five cities referenced in the blog post. These visuals illustrate how these cities can continue expanding, thereby contributing to an oversupply of properties and a decline in rents and property values.

Fort Myers, Florida: -6.25% rent growth

Phoenix: -2.25% rent growth

Atlanta: 1.36% rent growth

San Antonio, Texas: -1.26% rent growth

Jacksonville, Florida: -2.26% rent growth

Given the absence of geographical constraints limiting expansion in these cities, properties bought in newly developing areas today could find themselves in secondary markets in the future. This cycle can be illustrated as follows:

A property is purchased in an emerging area.

As development approaches, rents and property values increase.

As development advances beyond the property, it becomes less desirable, leading to stagnating rents and prices when compared to newer developments.

The wave of development eventually extends far beyond the property, resulting in further declines in rents and prices. At this stage, the primary option for the owner is to sell the property and invest in another location on the cusp of new development, thereby repeating the cycle.

A more effective investment strategy involves targeting cities that exhibit significant and sustained population growth coupled with limited expansion opportunities. Las Vegas serves as a notable example of this, as illustrated in the GIF.

In cities with limited undeveloped land, new developments are likely to focus on redeveloping existing areas. This dynamic implies that properties acquired today will likely appreciate in value due to increasing demand driven by population growth, while the housing supply remains relatively constant.

Adopting a Long-Term Perspective

Ultimately, demand is the primary force driving prices and rents, heavily influenced by population changes and a city's potential for expansion. In cities where ample, affordable land is available on the outskirts, new developments often draw demand away from existing properties.

This situation poses a recurring challenge for investors: they must either continually sell their current holdings and reinvest in emerging development areas or face the possibility of stagnating—and eventually declining—rents and property values.

In previous post: "What Does Off-Market Commercial Real Estate Mean?"