When Will the Landlord Leverage End on Apartment Rentals?

Looking for a rental apartment/? Zillow offers five suggestions, noting that in a recent survey they took, more than a third of respondents said it was harder to find the rental they’re in now than it would be to get a new job. The advice: pay more up front, sign a longer lease, be flexible on move-in dates, be one of the first to look, and have strong references.

It probably sounds like good news for those enjoying strong demand and rents in multifamily, but ultimately may not be. What favors one side in negotiations at a given moment frequently leads to unstable markets that can turn things upside down in unexpected ways.

The progenitors of current conditions that make obtainment of an apartment seem akin to winning the lottery have been in the works for years. Housing stock has been underdeveloped. “While the total stock of US housing grew at an average annual rate of 1.7% from 1968 through 2000, the U.S. housing stock grew by an annual average rate of 1% in the last two decades, and only 0.7% in the last decade,” real estate economics consultancy Rosen Consulting Group and the National Association of Realtors noted last year.

But housing means more than single family houses. The National Multifamily Housing Council has reported that the sector needs to build an average of 328,000 new apartments per year at a variety of price points to keep up with demand. That’s happened only a few times since 1989.

Supply was limited coming and demographics in the US were shifting before the pandemic. The business shutdowns in combination with the need to work and study at home meant houses got snapped up at prices and at speeds that were unheard of. In the third quarter of 2019, median house prices were $318,400. In 2022 Q3 that number became $454,900: a three-year jump of 42.9%. That’s 14.3% a year. With mortgage rates currently topping 7%. Whose income keeps up with that/? Homebuilders are already bailing because people can’t afford to buy, reducing construction even more and pushing people who otherwise might have purchased into rentals which are also in critically short supply.

Advantageous markets can be profitable, but only for so long. For years, many in CRE invested at low financing rates and high leverage. As lending has have completely changed, the question is now whether new financing can be had from lenders, or if new rates and conditions make that impossible.

What’s kept multifamily operators in gravy has been just that, an advantageous market. Now market normalization is underway, according to Marcus & Millichap, and apartment demand is feeling economic pressure.

“Following the strongest first quarter on record for multifamily net absorption earlier this year, the metric has now dipped negative in consecutive three-month spans,” the firm said this month. “National vacancy rose from just 2.4 percent in March to 4.1 percent in September. For a historic context, this rate is about 120 basis points below the same month’s average between 2000-2019, but up by the same 120-basis-point margin from one year ago. This indicates a normalization is playing out, after a stretch of historically tight conditions. Fewer people are forming new households amid broad-based uncertainty, hindering rental demand. At the same time, new supply is being delivered at a blistering pace, creating a temporary imbalance.”

Demand drops while new supply is coming online, which means leverage is slipping away. Eventually there will be a rebalancing—and a reckoning. Especially if the Fed’s efforts to stem inflation result, as many think will happen, in a recession.

How do you get blood out of a stone? Or money out of someone who has lost their job? Expect people to move in together, stay with relatives, opt for cheaper properties where they can find them, and reduce demand. Or ask Zillow, which just laid off about 5% of its staff. Maybe it will have five suggestions for landlords.