From: Real Assets Advisor
By: Paul Fiorilla
Date: April 1, 2018
What has caused U.S. multifamily rents to decelerate so sharply over the past 18 to 24 months? The main driver appears to be the extent to which supply growth has put downward pressure on occupancy rates in individual metros.
Year-over-year rent growth has settled into the 2.5 percent range, after rising as high as 5.5 percent in January 2016. The downward trend has multiple causes, including diminishing affordability, increasing supply and slightly weaker job growth, present to one degree or another in each metro. To understand the decline in rent growth by metro between year-end 2016 and 2017, Yardi Matrix analyzed multiple factors, including changes in employment and the overall increase in supply. By far, the metric that tracked most closely with the change in rents was the occupancy rate.
Although occupancy rates are high by historical levels, they have fallen 60 basis points in each of the past two years. With supply growth expected to hit a cycle peak of 360,000 in 2018, it is a good bet rent growth will level off or continue to decelerate in most metros for another year or two. Beyond that, rent increases will depend on how well developers calibrate development with demand for rental units.
MULTIFAMILY’S STRONG CYCLE
Multifamily fundamentals have excelled during the long economic expansion that followed the housing-fueled global economic crisis. Demand for rentals soared while the supply pipeline was largely shut down in the wake of the recession. The occupancy rate of stabilized apartments climbed from 94.2 percent in first quarter 2011 to 96.1 percent in first quarter 2016, while rent growth rose from less than 1 percent to 5.5 percent. But the market then began to weaken, albeit slowly and gradually.
There are numerous reasons for the softening. For one thing, rents are becoming difficult to afford — particularly in the most expensive metros such as New York City, San Francisco and Los Angeles, but it is also a growing problem in metros that have had sharp increases in recent years, such as Denver; Portland, Ore.; San Jose; and Miami. Rent growth has exceeded wage increases, and rents are taking up a bigger share of personal income. With labor slack declining, growth in employment has slowed in some metros.
Another issue is supply growth, which has risen steadily in recent years, from barely over 100,000 units in 2010 to more than 300,000 units in 2016 and 2017. At the beginning of 2018, some 600,000 units were under construction, and new stock is projected to hit 360,000 units in 2018.
RENT DECELERATION AND DECLINING OCCUPANCY
To understand the cooling in rent growth, we looked at different metrics, including job growth and supply growth, and the changes in the occupancy rate seem to be most culpable. We plotted the change in rent growth between December 2016 and December 2017 in 30 top metros, with the change in occupancy rate during the same period. The results found metros where rents fell the most had sharp decreases in occupancy rates. The most glaring examples were Nashville, Portland and Seattle. The rate of rent growth dropped 410 basis points in Nashville and Portland and 280 basis points in Seattle. Each metro had substantial declines in occupancy rates during the year: 150 basis points in Nashville, 110 basis points in Seattle and 120 basis points in Portland.
On the other side of the equation, Denver (up 10 basis points) and Houston (flat) are the only metros in which the overall occupancy rate did not decrease. Only seven metros had a higher rate of rent growth in December 2017 than a year earlier. Houston is an outlier because apartment demand rose in the wake of Hurricane Harvey, which displaced some homeowners and took some apartments out of commission.
The deceleration in rents was less correlated with total supply increases. Sacramento has the highest rent growth and lowest supply; Nashville was an outlier in terms of supply growth, while rent increases stalled. In some metros, however — Seattle, Orlando and Denver among them — rents increased at a rate above the national average with above-trend supply growth. The results underscore that each metro has a unique set of drivers. The point remains, though, the change in occupancy is more telling regarding the direction of rent growth than other metrics.
CORRELATION FADES OVER TIME
The change in occupancy is closely correlated with rent deceleration over the past year, but the relationship breaks down when we look at longer time periods. In the three years through December 2017, rents rose 11.7 percent on a national basis, while supply increased 8.3 percent and occupancy was flat overall. There was very little correlation on a metro level, however. Over five years, the correlation breaks down even further. In the five years ended December 2017, U.S. multifamily rents increased by 21.0 percent, while occupancy rose 60 basis points and total stock increased by 12.8 percent. On a metro level, there is little correlation among changes in occupancy rates, rent growth and supply growth.
LESSONS FROM THE DATA
We can derive several lessons from the study. One is that, over time, a metro’s performance is based on economic performance. Metros that are a destination for people due to healthy economic growth, job creation, or even for lifestyle or climate will benefit from strong demand. Metros such as Seattle; San Jose; Denver; Charlotte, N.C.; and Miami have added more than 19 percent to multifamily stock over five years, with an increase to the occupancy rate and strong rent growth. Nashville and Portland have had strong rent growth over five years, despite above-trend deliveries and declining occupancy rates. Price counts as well. Rent growth is weakest in expensive Northeast metros that are facing issues of affordability and out-migration.
Another lesson is short-term trends should not be ignored. It is not a sure bet once the current spate of new projects is absorbed, robust rent growth will automatically pick up again. We expect supply growth will diminish after 2018, but recent data on multifamily starts shows deliveries might remain elevated into 2019 or beyond. With rent growth elevated so much in recent years, the capacity to raise rents in secondary markets might be reduced.
None of this is to sound alarmist. Apartment demand is expected to remain strong, and new supply is needed to house the growth in population, which is increasingly tilted toward renters as opposed to homeowners. But until the delivery pipeline tapers, rent growth is likely to remain weak to moderate in most metros.