U.S. economy may be Nipping at Apartment Sector | Improving Single-Family Market

October 25, 2012 4:36 pm Published by

* Third-quarter vacancy posts smallest decline in two years

* Effective rent rises 0.9 percent, less than prior quarter

The U.S. apartment sector posted its smallest vacancy decline in nearly two years, raising the possibility that the strongest commercial real estate category may be succumbing to the sluggish economy, according to real estate research firm Reis Inc.

For nearly two years apartment landlords have been able to boost rents and fill their buildings as Americans, either burned by the housing bust or unable to get a mortgage, turned to renting instead of owning a home.

But rent growth ultimately depends upon significant job growth and rising incomes, and during the third quarter neither have come through.

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The national vacancy rate inched down to 4.6 percent in the third quarter, typically one of the stronger quarters, from 4.7, according to Reis’ preliminary figures released on Wednesday. The dip was the smallest since the recovery began in early 2010.

“I think the market is getting so tight at this point that further declines in vacancy not supported by strong economic growth are just not going to be possible,” Victor Calanog, Reis Head of Research & Economics, said. “We’re already in no man’s land now where vacancies are so low and yet the unemployment rate is above 8 percent. At some point economic gravity is going to kick in, and even this sector will feel the brunt of it.”

In another sign of cooling and discounting apartments that were given up, only 22,615 more units were leased in the third quarter, down from 31,014 units in the second quarter and 36,423 units in the first. It was the lowest net lease-up since the first quarter 2010.

 

The average asking rent in the third quarter rose 0.8 percent to $1,090 per month, Reis said. Reflecting landlords’ ability to offer fewer perks to lure tenets, such as months of free rent, the average effective rent rose 0.9 percent, to $1,041 per month.

Despite being marginally less than the prior quarters, the numbers still reflected strong rent growth, Reis said.

“Landlords appear to be shifting their revenue-maximizing strategy away from occupancy improvements to raising rents,” Calanog said.

Large apartment companies such as Equity Residential and AvalonBay Communities Inc already have shown they are willing to sacrifice a little occupancy for higher rents.

Of the 79 markets Reis follows, New York had the lowest vacancy rate at 2.1 percent, the same as in the second quarter. It also had the highest average rent – $2,990 per month, up 1.7 percent from the second quarter. It was the second-highest rent increase after San Jose, where rent increased 1.9 percent to $1,599 a month.

Reis expects the apartment sector to remain strong, with vacancy declining by the end of the year but not falling below 4 percent.

The sector faces some potential risks in the near future. One may be competition from single-family home buying, Reis said. Another could be a spike in construction next year in rental markets such as Seattle, Washington D.C. and suburban Maryland.

A third threat could show up in Boston or Chicago. Both cities have surpassed previous rent and occupancy peaks and may be nearing the point where landlords will no longer be able to raise rents if the median wage remains stagnant, Calanog said.

As signs emerge indicating that the U.S. housing market is recovering, there’s one question that Ric Campo, CEO of apartment REIT Camden Property Trust(NYSE: CPT), has been asked “a million times” lately: What does that mean for the flourishing multifamily sector?

Campo contends that there is room for both the single-family housing market and multifamily sector to succeed at the same time.

“I think an improved housing market is great for the multifamily sector. When you think about it, our economy is not hitting on all cylinders because housing has been down,” he said. “They have coexisted in the past, and both have done well.”

Favorable buying conditions and low interest rates apparently have prompted homebuyers to take advantage of the affordable housing stock. Home sales improved in August, and the national median sale price increased for the sixth straight month, according to a September report by the National Association of Realtors (NAR). New home construction also rose in August by 2.3 percent, according to figures released by HUD and the U.S. Census Bureau.

Rich Anderson, an analyst with BMO Capital Markets, said he thinks the housing recovery will impact multifamily REITs.

“Being in the rental business has been the name of the game lately, but the American dream has not been to rent,” Anderson said. “It will always be to own, so that issue in of itself is a negative” for the multifamily sector.

Andrew McCulloch, an analyst with Green Street Advisors, said he doesn’t foresee a scenario in which the housing recovery would wipe out the strength of the sector.

“After several false bottoms, it does appear that the single-family market is on the mend,” he said. “This likely means the tailwind that apartment operators have been enjoying from a weak housing market is fading. That said, we don’t expect the housing pendulum to swing back to home-buying in a way that would completely derail apartment fundamentals.”

Campo disputes the idea that housing market collapse represented a massive boon to the multifamily sector. Many of the 4 million people who left homeownership behind rented single-family housing, not apartments, Campo explained. As such, the sector only got an incremental demand bump from the housing crash.

Anderson did note that the housing recovery should strengthen the job market, which he said would be a benefit to the multifamily sector.

“We can’t live in a weak housing market forever,” Anderson said.

The supply-demand dynamic in the apartment market is also working in favor of apartment owners, according to Camden’s CEO. Campo explained that because multifamily REITs weren’t building new apartment developments during the recession, any new supply now is, in effect, catching up to meet demand. According to McCulloch, however, that process will eventually push down rents.

“An improving single-family market, along with the introduction of new supply, will almost assuredly cause rent growth to slow,” McCulloch said. “But a host of structural and demographic factors should keep demand for apartments healthy for several years.”

Source: REIT & Reuters

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