Apartment Fundamentals Improve But Challenges Remain

In football terminology, apartment fundamentals have made a lot of first downs but not necessarily touchdowns for 2023, according to Carl Whitaker, Director of Research and Analysis, RealPage.

“So, because the ball is moving in the right direction, it’s a win,” Whitaker said, speaking last week at the Middleburg Housing Summit, hosted by Middleburg Communities.

“The industry has been able to weather the storm of economic uncertainty.” Apartment demand stabilized in 2023, following on the heels of a record-setting 2021 and a challenging 2022.

In 2022, there was the weakest demand since 2009, and in 2023 there’s been a solid, but not spectacular rebound in demand, Whitaker said.

“One of the key drivers to demand is improving consumer confidence, which typically precedes improving household formations,” he said. “Consumer sentiment is improving partially because inflation is cooling.”

Unlike what some national headlines suggest when assessing all rental housing, median rent-to-income suggests no affordability pressure for the market-rate segment.

“Resident screening is doing its job,” Whitaker said. “It’s putting the right residents in the right units.”

High interest rates have not necessarily led to an immediate positive impact for multifamily demand, Whitaker said. “It’s not generating renter demand, but it’s keeping residents in their apartments for longer.”

Whitaker disputed another common refrain that stagnating rent growth via cutting rents does not necessarily stimulate demand.

He added that absorption in 2022 did not falter due to residents “doubling up” en masse and improved consumer sentiment.

Meanwhile, occupancy has reverted to its lowest level since 2013 at 94.5% but the pace of occupancy contraction has slowed, and that could be promising for the 2024+ outlook. Rent growth has slowed, just barely holding in positive territory in the September stats. Loss to lease is hovering around 5%, so while rent roll inversion isn’t an immediate concern it should be monitored at a market (and especially property) level.

Though supply is weighing on some local submarket readings, there is a large share of submarkets achieving still-solid performance. The submarkets with negative YoY rent change 285 total are down 1.8% with average inventory growth of 3.5%. Submarkets with negative YoY rent change 285 total are up 4.2% with average inventory growth of 1.7%.

The relationship of supply and diminished rent growth at a submarket level is clear: Submarkets with less than 2.5% inventory growth are seeing the strongest rent growth on average (733 of 1,034 submarkets RealPage tracks) and submarkets with less than 7.5% inventory growth are seeing the weakest rent growth on average (55 of 1,034 submarkets RealPage tracks).

Yes, construction has approached a 50-year peak, but today’s construction surge isn’t the same as the 1970s boom. In fact, the quarter-over-quarter drop in starts in Q2 2023 (41%, or 50,000 units) is the largest such drop since RealPage began tracking starts in 2013.

Starts are falling today due to tangible changes in economic drivers. Financing is the leading cause of delay whereas during the pandemic it was due to supply chain issues.

Looking ahead, RealPage’s forecast for headwinds and subsequent downside is oversupply: Lots of new product will be delivered in the coming 12 to 24 months and if lease-ups struggle to fill units, the industry could see concessions spiral in those assets.

Job and wage growth could slow, creating localized pockets of distress. “But do other submarkets play a game of “follow the leader,” he asked.

There is remaining economic uncertainty, especially with interest rates. Whitaker wonders if revenue growth holds up in an environment where expenses are stubbornly elevated.

As for tailwinds and their subsequent upside, inflation is tapering off and is in line with wage growth easing, which will also help the ‘O’ part of NOI.

Job growth – though slowing – remains above expectations and economic distress seems to be “rotating through” individual sectors rather than all at once a la a recession.

With the “Survive ‘til ‘25” mantra, he said there’s some strong belief that once the supply pipeline dissipates demand will be enough to support strong rent growth.

Looking out three-plus years, Whitaker said supply will eventually ease and the strong demand-driven Sun Belt markets will return to the top of the leaderboard, such as Dallas-Fort-Worth, Central Florida, Central Texas, the Carolinas, and Nashville.

Some select Midwest/Rust Belt metros will see outperformance due to regionally strong economies’ limited supply, such as in Columbus, Indianapolis, and suburban Chicago.

Demand drivers seem okay in some markets, but regulatory risks could outweigh the upside potential in areas such as Boston, Denver, and Washington, D.C.

Coastal market performance is expected to remain bifurcated between the East Coast & West Coast, whereas Boston, New York/Northern NJ, and DC, are expected to outperform the Bay Area & Seattle with Los Angeles being a potential exception.