What Vacancy Rates Tell You About a Housing Shortage (And What They Don't)
Photo by Erik Mclean on Unsplash
A Thought Experiment
You're a landlord and you have an apartment you'd like to fill. For the sake of this thought experiment, let's say you're thinking $1,600 per month is a good rent.
You hold an open house and, to your astonishment, more than 50 people show up. The line is out the door and down the street. Do you think you're going to get more or less than $1,600 in rent from the tenant you ultimately choose?
More, right? These people are all competing with each other, and there's clearly a ton of demand, so you can afford to hold out for the best offer. This might be well above your initial asking price. (In San Francisco at the height of the most recent tech boom, for example, there were anecdotal stories of vacant apartments going to the first prospective tenant to offer the landlord the entire year's rent up front in cash.)
What if you held the open house and nobody showed up? What if weeks went by and you couldn't find a tenant? You're sitting there, maintaining this apartment, paying the taxes on it—you'd sure like to have it generating some income for you. What can you do? Well, you can lower your asking price.
This simple thought experiment illustrates how one crucial statistic, the vacancy rate, affects the price of housing. In an environment in which there are a lot of vacant homes or apartments, prospective tenants or buyers are at an advantage. They can shop around and be choosy. Because landlords are in competition for tenants, they may be forced to undercut each other on rent or otherwise throw in extra amenities or perks.
On the other hand, in a market in which there's a scarcity of vacant homes or apartments, the power dynamic is reversed. The landlord (or seller) now holds all the cards, because the people who want to live there are now competing with each other to be the lucky one to land the spot. Thus, they will tend to bid up the rents. And other landlords or sellers with their eye on the market will adjust their asking prices accordingly, too.
In summary, when there is unusually low vacancy, the price of housing will tend to be bid up over time. When there is unusually high vacancy, the price of housing will tend to be bid down over time.
For clarification, the vacancy rate is not a predictor of the prevailing rent itself: too many other factors affect that, so it's not always true that higher-rent cities have lower vacancy or vice versa. What the evidence does support is that the vacancy rate in a given market tracks remarkably closely with whether rents are increasing or decreasing.
For example, here's a chart from the Minneapolis-St. Paul area, produced by MPR News, that shows the rental vacancy rate and average market rent between 1996 and 2018. The connection between the two lines does not immediately jump out, and even the caption seems to suggest there isn't one:
But let's take the exact same data and look at it a little differently. If we graph the vacancy rate against the year-over-year change in rents, we can see a striking trend:
In years in which there was high vacancy, rents increased very little or not at all. In years in which there was low vacancy, rents increased by as much as over 10%.
Here's similar data from Seattle, shared in 2015 by the Better Institutions blog (a project of Shane Phillips, author of The Affordable City, upcoming as of this writing). We can observe a similar trend: the rental vacancy rate appears inversely correlated with year-over-year rent increases.
The Goldilocks Answer
The vacancy rate is somewhat analogous to the unemployment rate, which affects the power dynamic between employers and employees similarly to how vacancy influences the power dynamic between tenants and landlords, or buyers and sellers of homes.
Just as there is always some unemployment (barring theoretical state intervention such as a jobs guarantee, I suppose) even in the strongest economy, there will—and should—always be some level of housing vacancy. If there were zero vacancy, housing markets wouldn't function well at all. Imagine being a New Yorker trying to move to Seattle for a job. With no available homes in Seattle, you'd have to find a Seattleite who's moving to New York at the same time, and swap with them.
We're looking for a Goldilocks solution. Too little vacancy and housing prices go through the roof. Too much vacancy, and you get the blight condition found in hollowed-out neighborhoods of some Rust Belt cities, where homes sit empty for lack of demand, and fall into disrepair because they aren't worth what it would cost to replace the roof or the siding.
Neither extreme is desirable. This implies we should seek an equilibrium "just right" vacancy rate, where prices aren't going to skyrocket or crater. What is that rate?
There's no clear answer, and it likely depends on many specific local factors. But here's a graph from the St. Louis Fed of U.S. rental vacancy rates, as recorded by the Census Bureau, since 1956. This suggests the long-term norm has hovered somewhere around 7% or 8%. Some scholars think the "natural" vacancy rate has been trending upward in some markets. And you'll see differences depending on how you measure it.
The Census Bureau reports rental vacancy and homeownership vacancy rates each year through its American Community Survey; you can get these at the city level or in some cases for even more fine-grained areas. The Census also reports the total number of occupied and vacant homes in an area. For example, here are the 2018 figures for the city of Los Angeles:
There are about 100,000 vacant homes in Los Angeles, which is 6.8% of the total number of homes. So why are both the Homeowner and Rental Vacancy Rates much lower than 6.8%?
The answer is that a vacant home on the market is different from a vacant home not on the market. Only when the home is actually available for rent or sale is it able to affect that renter / landlord power dynamic we began this article with. And vacant units may be unavailable for rent or sale for any number of reasons. They may be under renovation. They may be newly built and not sold or leased yet. They may be used part-time for a purpose other than the owner's primary residence: for example, an AirBnB or a vacation home.
(If you want to go deeper into how the Census calculates vacancy rates, check out this document full of definitions and formulas.)
What is true is that in the past decade, the infamously expensive markets in the Northeast and on the West Coast have seen low vacancies and climbing rents. And these two things are closely related. When the number of vacancies on the market rises enough—either because the supply of homes grows, demand falls, or both—you can expect to see rents start to fall.
This doesn't mean population will fall, or that growth will cease. Consider, for example, the case of New York City in 2020, after being hammered by the coronavirus. There's been no shortage of headlines about the decline of New York and the mass exodus of New Yorkers to the suburbs. Does this mean New York will see huge vacancy rates and a glut of empty apartments? Not necessarily.
It could also mean, as apartments are vacated, that rents decrease, and this entices a whole different crop of people to New York who would love to live there but not at what it previously would have cost them. It might also mean existing New Yorkers not being priced out of New York who otherwise would have been. It might mean people finally moving out of their parents' houses, or parting ways with that annoying roommate.
These things sort themselves out in complex and non-linear ways: the consequence of a big shift in a housing market is what Johnny Sanphillippo recently dubbed a Great Reshuffling.
Housing prices are the result of a complex push and pull between many factors. In this system, vacancies are a crucial piece of bottom-up feedback that tells us when something in the housing ecosystem is out of equilibrium.
In a way, paying attention to the vacancy rate allows us to sidestep the less answerable philosophical question of how many homes a place needs, or what constitutes a "shortage." How, after all, do you determine the "right" number of people who "should" have homes in a place like California? That's ultimately a subjective question that requires weighing multiple interests against each other. As I’ve argued before, it’s the wrong question, because it relies on the illusion that, at the end of the day, we (read: some version of “the public”, through some political process) actually get to choose how many neighbors we will have.
We don’t actually get to choose—or, rather, we must recognize that choices have consequences. And there are very real consequences to having too many or too few vacant homes for years on end. The human toll of displacement in places like California is painfully obvious. So is the toll of mass abandonment of homes in a place like Akron or Cleveland.
The vacancy rate doesn’t answer the question, “How big should my city be?” But it does help answer the question, “Is my city’s housing stock in rough balance with the number of people trying to live there?” What we want to do with that answer is up to us.
In this episode of Upzoned, co-hosts Abby Newsham and Chuck Marohn discuss how inflation and high housing costs can put the American Dream out of reach for many people, as well as potential responses.