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Few Cracks Showing in the Apartment Sector

The equilibrium in the apartment sector will be challenged if developers keep adding new construction projects.

Average apartment rents are increasing across the country. And despite all the new units that have become available, renters keep showing up to leasing offices, keeping the average vacancy rate in the sector relatively low.

“Stabilization is a word that comes up over and over,” says Greg Willett, chief economist for RealPage and its subsidiary MPF Research.

The apartment sector continues to be relatively healthy. Rent growth and the average vacancy rate for apartments have only changed a little. Even though developers continue to build more units than expected, demand for rentals is also beating expectations. Researcher hope that developers will pull back on new construction, but say the market has not yet lost its stability.

Rent growth still strong

Apartment rents are growing at a rate of roughly 2.0 percent per year, according to research firms including CoStar. That’s below 5.0 percent growth in 2015, but it’s still reasonably strong.

The current data for rent growth includes a period of slow growth at the end of last year that worried some analysts. That period was offset by faster rent growth this spring.

“Strong demand that emerged once we hit prime leasing season in the second quarter eases the concerns,” says Willett. Apartment rents for new leases grew by 1.7 percent in just three months, according to preliminary figures for the second quarter from RealPage. That matches the rent increases posted during the same period a year ago. Spring is normally a strong season for leasing.

The average vacancy rate followed the same trajectory. “Nearly all the backtracking seen during the slow leasing period of late 2016 and early 2017 has been filled in once more,” says Willett. The average vacancy rate was 5.0 percent in the second quarter, down 20 basis points from the year before, according to MPF.

Occupancy over the last couple of decades has averaged slightly less than 95 percent, and annual rent growth has run right around the 3.0 percent mark. RealPage’s forecast of market performance over the next 18 to 24 months is virtually identical to that long-term norm.

Core weakness

However, some types of apartments are suffering more than others.

“The bell is tolling on the luxury side of the apartment market,” says John Affleck, research strategist with CoStar. “There is a ton of new supply of that kind of product.”

More affordable class-B apartments are performing much better than more expensive new class-A units. Today’s vacancies are highly concentrated in the new projects conducting initial lease-up,” says Willett.

The division is also becoming evident when it comes to urban vs. suburban markets. Suburban markets have seen less new construction, and are now experiencing higher rent growth and more attention from real estate investors.

Core real estate markets, where many new apartment buildings have opened, are experiencing less rent growth and higher vacancy rates. “With so many urban and in-town deals competing to lease up simultaneously, the close-in markets have weakened,” says Witten.

The equilibrium in the apartment sector will be challenged if developers keep adding new construction projects. Also, that new construction is based on the assumption that the U.S. economy will continue its growth.

“To the extent we’ve been surprised, it’s been that starts haven’t pulled back as rapidly, given the reduced appetite for construction loans from banks,” says Witten.

Developer are on track to open 100,000 units per quarter for the rest of 2017 and early 2018, according to MPF. That’s a rate of 400,000 per year. “We certainly hope to see some pullback in additional product entering the pipeline in the coming months,” says Willett.

TAGS: Leasing
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