How Drop in Home Prices Benefits Renters

Tenants are more vulnerable to increased risk about their housing stability when the property market soars, but they can find relief when real estate slows down, a new study finds

By Putro Harnowo, Senior Content Manager, China Business Knowledge @ CUHK

Access to affordable housing is a fundamental necessity, yet the scarcity of affordable homes has escalated into a worldwide crisis. Factors such as limited land availability, restricted mortgage lending, labour shortages, and rising material costs have collectively contributed to the increase in real estate prices. Consequently, the path to homeownership has become increasingly challenging, and many find themselves resigned to long-term renting.

Although 2023 has seen major cities worldwide experiencing a slump in housing prices due to inflation and economic uncertainties, the International Monetary Fund’s recent report, Housing Market Stability and Affordability in Asia-Pacific, highlights the rapid growth in property prices that outpaced income growth, leading to a significant deterioration in housing affordability.

In China, the housing market has reached unprecedented price levels in recent decades, leading to a thriving rental market as a result. According to a 2021 whitepaper published by real estate services firm Jones Lang LaSalle titled New Journey: Onwards and Upwards, the total number of rental housing units operated by leading 10 players of rental housing platforms in China’s top-tier cities nearly doubled from 356,000 in 2018 to 730,000 in 2020, with a 97.5 percent occupancy rate on average.

Despite the demand for long-term rentals, most property owners in China prefer to sign a one-year leasing contract with an option to renew for a second year. For tenants, the uncertainty of future housing availability due to short-term leasing contracts, known as “horizon risk”, can cause stress and anxiety as they need to find alternative places.

“Rental housing contracts are typically short-term, and renters face uncertainty regarding the actual ‘horizon’ for which they can occupy their homes,” says Maggie Hu, an Assistant Professor of Real Estate and Finance at The Chinese University of Hong Kong (CUHK) Business School.

“Horizon risk deters renters from making otherwise optimal long-term commitments, such as purchasing durable goods, forming a family, and raising children. Moreover, such risk can lead to increased search costs and relocation expenses while also amplifying rental uncertainty as a consequence of frequent moving.”

Against this backdrop, Prof. Hu and a team of researchers from Peking University investigated the impact of property investors’ housing market expectations on rental supply and contract duration. The researchers discovered that increasing housing prices lead to shorter rental contracts, suggesting that landlords are less likely to offer long-term contracts when they believe that property prices will keep rising.

This way, the landlords can retain flexibility and sell the house or adjust the rent more often to take advantage of the higher prices. On the other hand, when housing prices are expected to decrease, landlords may be more willing to offer longer-term contracts to secure their rental income.

When House Is Not Home

Long-term rental contracts would definitely reduce horizon risk and provide more stable housing for renters, but this practice is rarely seen in the real world. Landlords in general are reluctant to offer long-term contracts due to the uncertainty surrounding future housing market conditions. The prevailing housing affordability crisis makes the concept of horizon risk academically and practically intriguing.

In their research paper, Horizon Risk in Renting: Evidence from a PropTech Rental Platform, Prof. Hu and the team examined a unique dataset obtained from a prominent Chinese property technology platform, consisting of approximately 93,000 rental housing contracts in Beijing between 2015 and 2019. The research was focused on the national capital, where the platform has the largest market share and the longest operating period.

The analyses found that landlords are significantly less likely to renew expiring rental contracts for housing units located in neighbourhoods experiencing recent housing price growth, supporting the hypothesis that landlords offer shorter rental contracts following local housing price appreciations in preparation for a possible sale in the near future.

“Rental housing contracts are typically short-term, and renters face uncertainty regarding the actual ‘horizon’ for which they can occupy their homes.”

Prof. Maggie Hu

This effect is statistically significant and economically sizable, with a one-standard-deviation increase in housing price growth reducing contract duration by approximately one month. Conversely, when housing prices are expected to decline, landlords may be more willing to supply long-term contracts to lock in rental income.

Younger landlords and those with multiple rental units are found to be more responsive to housing price growth than older landlords, consistent with the hypothesis that older generations are less inclined to speculate and more likely to live off rental incomes, and also multi-homeowners are more likely to hold real estate assets for investment or speculative purposes.

Finding the Perfect Abode

Looking deeper into the duration of rental contracts and how various factors influence them, the researchers grouped rental contracts based on their respective durations and plotted them against the mean rental price, creating the “term structure of rental supply” to determine the overall pattern of rental rates. The team then discovered that the housing price growth also impacts the term structure of rental rates.

As housing prices increase, the decline in long-term rental contracts drives up rental prices due to higher demand, which results in a counterclockwise shift in the term structure of rent, with long-term prices rising compared to short-term rates. Conversely, when housing prices decline, landlords are more inclined to offer longer-term contracts to secure predictable rental income and minimise the risk of losing potential gains from property sales.

“The result of our study implies that a market with stable rental and housing price growth will encourage landlords to supply long-term rental contracts and reduce horizon risk for renters,” says Prof. Hu.

The long-term rental housing supply shortage is a key friction when studying the risks and tradeoffs surrounding housing decisions. Policymakers need to consider regulations encouraging landlords to supply long-term rental contracts, such as tax incentives or subsidies. Renters may also benefit from policies that increase the supply of long-term rental housing, as this could lead to more stable and affordable housing options.

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“We believe that future investigations to delve deeper into the implications of horizon risk would be fruitful. In particular, long-term rental housing can provide stability and peace of mind similar to that provided by homeownership,” says Prof. Hu.

“It is possible that the variations in long-term rental supply can help explain the variation in homeownership rates within and across countries. While the survey and anecdotal evidence both appear to support this conjecture, it remains crucial to systematically quantify these effects.”