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HARM,

Your rental equation doesn’t take into consideration wage inflation. Since wage inflation tends to (and increasingly more so) lags general price inflation, the equilibrium price point in a microeconomic analysis will tend to move upwards for the same supply/demand.

Randy,

When you see a geniune signs of significant broad-based "wage inflation" --Ha Ha being our resident exception of course :-) -- please let me know. I have yet to see any stats that show median individual or HH incomes in CA are going up any faster than inflation (either real or the CPI hedonically adjusted kind). Most people I know in the tech industry are being squeezed by wage arbitration/outsourcing and anemic job growth, while their pay is not keeping up with by skyrocketing gas, food, healthcare & education costs --you know, all the stuff the government conveniently leaves out of its CPI numbers.

I am also not convinced that the rental market is a price-takers market. I think significant price power lies with landlords, some of it legitimate and some of it collusionary. Even ignoring collusion, the structure of the market is anything but a perfectly-competitive commodity market. That means, loose up, sticky down, as the suppliers capture benefit away from consumers.

I agree the rental market is rife with collusion and that much of the inventory is controlled by a few big players. Even so, can landlords simply repeal the laws of supply and demand? Is anyone putting a gun to CA renter's heads and telling them: "Commit 98% of your take home pay to rent or else!" ? Renters do have negotiating power --especially in areas with tons of rental inventory and relatively few renters. They also have choices: as in, move to an area with cheaper rentals/longer commute, double/triple up with other renters, move back in with mom & dad and --my favorite-- join the other 500K of fed-up CA renters who have left the state. Yes, there are some highly desirable and relatively built-out areas that will always have more pricing power than others --downtown S.F., Marin, Pasadena, Laguna Beach, etc. These places already cater to wealthier, non-price sensitive clients and will likely be less affected by high inventory elsewhere. Landlords in less desirable locations will not be so lucky.

@Claire,

You say your landlord wants to increase your rent $150 a month, but you didn't mention what your current rent is (what % increase does $150 represent?) or what type of place it is. The devil is in the details. If it's a cramped 1 Bdm in San Josebag and currently renting for $850, that's an almost 17% hike and you can probably rent something bigger/better elsewhere for the same money. If it's a luxurious $3500/mo 3 Bdm/2 Ba townhome in a nice part of the peninsula, then we're only talking about a 4% increase, well in line with inflation.

If you want to negotiate with your landlord anyway, I'd recommend reading some of the previous posts by DinOR.

Hi Harm,

It's a 6.7% increase for a 3 bdm house, not a luxurious one, but decent in a nice neighborhood

@Claire,

Since it's just a bit higher than overall inflation (the real kind) and you say there are few comparable rentals in your area to use as examples, you might want to negotiate using some of DinOR's tried 'n true methods. Even so, I'll bet you can find some "comps" in your area by checking on Craigslist or with a local rental property management company. Knowing the actual market value of similar rentals would greatly improve your odds of success.

HARM,

Supply and demand work differently (in classical micro economics) when the market is not purely competitive. There are all kinds of fancy formulae and such by which a big "rectangle" appears between the supply and demand intersection (because price isn't set at exactly that point). This is the potential "benefit" which either goes to the supplier or the consumer. In such markets, most of the benefit almost always goes to the supplier (unless it is a monospony--inverse of a monopoly, like Walmart controlling their suppliers).

This may seem like a minor point, but it's important to keep in mind when people trying to rely upon supply and demand intuition. The simple econ 101 curves only work for stylized perfectly competitive markets, of which few exist. Rental RE is a textbook example of anything but a perfectly competitive market. Market power, pricing collusion, pricing cooperation (the legal game theory kind), asymmetric information, lack of substitutes, price stickiness, shifting elasticities, and not least macroeconomic forces pressing down on the market from above.

There is a nice graph of monopolistic competition here.

The important thing to note is that in monopolistic competition (meaning simply that new suppliers cannot readily enter the market), the supply curve becomes either non-existent or de-emphasized. In rental RE the is definitely a supply curve, but it is not nearly as relevant as the demand curve. Part of this is political (NIMBY, regulatory barriers) and part of it is because of the nature of real estate (takes time to develop new units, cyclical, large capital requirements).

In that graph above, the yellow upper rectangle is what the supplier "takes" away from the consumer. The lower unshaded rectangle is the "welfare loss", or the part that neither supplier nor consumer gets as utility value because the market is not perfectly efficient.

Randy H-

I hate to say it, but I don't agree with anything you have said. I suspect I am missing something, thoguh, as you seem well informed on this issue. Could you please elaborate? Maybe then I will understand.

Rental RE is a textbook example of anything but a perfectly competitive market.

Market power

Huh? No landlord has market power. In antitrust law, the FTC has a crude rule of thumb that a competitor must control 60% of the market, and there must be substantial barriers to entry, in order to have market power. What landlord controls 60% of the market? In most major cities I bet you'd have trouble finding someone who controls 5%. I don't see anyone with market power in the residential rental market; on the contrary, market power seems awfully diffuse given that rental property in every major city I am familiar with is owned by thousands upon thousands of landlords.

pricing collusion

No way. There is no way that the landlords are conspiring to set prices. Most don't even know each other, much less communicate and agree upon a common pricing scheme. And even if they did, there aren't any mechanisms for punishing defectors. If landlord A and B agree to fix prices, and landlord B then decides to screw his A by undercutting him in violation of their agreement, there is absolutely nothing that A can do about it. The only companies that can actually enforce price-fixing schemes are ones engaged in regulated industries, government contracting, etc.. These guys can make one another's lives miserable; if you undercut me on this bid, I'll undercut you on the next one, etc. But landlords? There is nothing they can do.

pricing cooperation (the legal game theory kind)

This might happens in large corporate apartment buildings, although I tend to doubt it, anytime the vacancy rates creep up over 10% I would think that cooperation would go out the window. But there is no way that someone who owns a single rental condo is doing the market surveys necessary to engage in pricing cooperation. Your typical small-time landlord just glances at the newspaper to see what everyone else is charging and sets his rental rates accordingly. There is no way that these small time landlords engage in the sophisitcated signaling, etc., necessary to engage in price collusion. And they are a huge percentage of the market!

asymmetric information

How so? Everyone can check craigslist, the newspaper, etc. There are apartment brokers, classified ads, bulletin boards -- there are plenty of places for renters to engage in price comparisons.

lack of substitutes

Yes and no. While the supply of rental housing is relatively static, at least during the month or so that potential renter X is looking for a new place, there is still some substitutiability. A renter can substitute one neighborhood for another; a long commute for a short one; one roomate for another; a solitary apartment for one shared with roomates; etc.

price stickiness
Not necessarily. I guarantee you that rental rates will go down -- fast -- in Phoenix and places like it in the near future. Also, the income of renters is sticky, too.

shifting elasticities

Like what? Incomes of renters aren't rising. The population isn't growing nearly as fast as the supply of rental units in most cities. I just don't see this.

macroeconomic forces pressing down on the market from above.

Which forces? I honestly don't know what you mean here, if you can identify the forces it might help me understand.

I have the perfect cure for the bubble blues: Quasar and Zenith TVs.

Why?

I'm not sure. But I think it has something to do with 1970s Bundt cakes
& Tupperware parties.

I think I'm flipping out...losing it...

My main point is that rental RE is NOT a perfectly competitive market.
Especially when landlords can be picky about the renters. I used to rent a beautiful Victorian flat in north Oakland. The place was a total bargain, but the landlady was super picky about tenants. You never see an advertisement where they tell you the minimum credit score required. It only ever says credit check required. It isn't first come, first rented.