Low vs. high cost-of-living regions: which is better for real estate investment?
Updated: May 27, 2019
To start off, here’s a quick definition: the US Department of Housing and Urban Development (HUD) defines housing as being affordable if it costs 30% or less of your gross income. Beyond that and you’re considered “rent-burdened.”
In San Francisco the median one-bedroom apartment is $3,560. By HUD’s definition you would need an income of $142,400 to avoid being considered “cost burdened.” But the problem is, median household income in San Francisco is $109,601.
In Dallas the median one-bedroom apartment is $1,260 which is affordable if you make $50,400 or more. Critically, median household income in Dallas is greater than this amount at $56,732.
The significance of this is not simply that rent takes up a greater portion of one’s income in high-rent cities. In such cities, renters’ reduced ability to absorb emergency expenses results in greater demand volatility. It’s not just that you’d prefer to spend 30% on your rent vs. 50% so you could spend more on stuff. You also can’t save as much. If you have an emergency expense you are at greater risk of losing your housing if you’re spending more of your income on rent.
There’s another way to demonstrate the precariousness of living in high-rent areas. Let’s use the published median rent and income numbers from above. In San Francisco you’re spending 39.0% of your income on rent. In Dallas it’s 26.7%. Now suppose rent goes up 10%. In San Francisco your rent goes from $3,560 to $3,916 and now it eats up 42.9% of income. In Dallas your rent goes from $1,260 to $1,386 and now takes up 29.3%. In San Francisco rent as a percentage of your income went up by 3.9 points but in Dallas it went up by 2.6 points. The more rent burdened you are, the more difficult it is to absorb further rent increases.
Rent burden is a very serious matter – 38% of renter households (17 million families) were rent burdened in 2015. 17% of renter households (7.6 million families) are severely burdened, paying 50% or more of gross income.
So if your business model involves improving apartments to attract higher rents, what kind of market would you target?
Chihiro Kurokawa is founder of BlackRiver Equity Partners, a real estate private equity firm providing private offerings to investors seeking tax-advantaged cash flowing investments in real estate.