Demand for apartment rentals rises unexpectedly as home sales plummet

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Apartments for rent in San Francisco.

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Growing demand and heavy occupancy in the domestic apartment market are “surprising” experts who say the continued strength is “unexpected.”

Just a year ago, as dozens of cranes swarmed major American cities, there were concerns that the rental apartment market was overheated and oversized.

According to the US census, apartment absorption, which is the rental rate for new homes, is now at its highest level in three years. Apartment building took off in 2012 and peaked in 20 years in 2017. It has remained high this year, despite warnings that demand would slow as more millennials age in their years of buying apartments. a house.

And as buyer demand has increased, sales have been thwarted by tight supply that has driven prices up in recent years, undermining affordability. When mortgage rates soared this year, even fewer people were able to afford a home.

“People underestimate how far away many tenants across the country are from home ownership, even in luxury apartment buildings,” said John Pawlowski, residential sector manager at Green Street Advisors . “The demand has been better than expected. The tenant base is stronger and the pricing power of this tenant base, again in the face of a high supply, has simply surprised us. “

The third quarter of this year marks the fourth consecutive quarter of positive operating “surprises” for apartments, according to a recent Green Street report, which noted that the asset values ​​of these apartments remain stronger than most. basic property types. Income from apartments was also better than expected.

This is because the rents remain high. In the fourth quarter of this year, both the national average to ask rent and effective rent (the latter takes landlord concessions) increased 4.9% and 4.6%, respectively, from the fourth quarter of 2017, according to Reis. The apartment vacancy rate has not changed, despite the number of new units completed.

“Apartment building started to accelerate in 2017 and remained high throughout 2018,” said Barbara Denham, senior economist at Reis. “This had raised concerns that the apartment market was becoming oversized. Yet the growth in apartment occupancy has practically kept pace with the growth in supply, as the demand for apartments has been robust throughout 2018. ”

Denham also points to the weakness of the housing market which is boosting demand for apartments.

“The housing market could continue to suffer given the recent stock market declines that have rocked the entire market. In addition, last year’s tax reform which doubled the standard deduction reduced the incentive to buy a home, which also helped the apartment market, ”Denham added.

Some markets are better than others

Of course, all real estate is local, and some markets are doing better than others. In Washington, DC, where apartment construction has been fairly robust, homeowners are slightly more cautious.

“Bozzuto has reason to be optimistic as we have seen an upward trend in rents and healthy absorption across our 72,000 unit portfolio over the past quarter,” said Toby Bozzuto, President and CEO of the Bozzuto group, which develops apartments in major cities. mainly in the North and the South-East.

“We are increasingly confident in our revenue forecast for 2019 and anticipate an increase in rents of 1 to 3% across the portfolio. We also attribute this strong rental demand to cracks in the market for housing for sale due to rising interest rates. that the continued irruption of tenants by choice, ”he added.

The shares of apartment REITs also rise with their companies’ profits, and that wasn’t the case just a year ago when investors thought the industry was oversized.

“REITs was one of the best performing industries in 2018,” said Pawlowski. “2017 was also a difficult year for REITs, so part of the outperformance of 2018 was due to them looking cheaper as the year approached compared to the substantial underperformance before 2018. . “

Green Street has a sectoral overweight call on residential REITs, including apartments, single-family rental REITs and manufactured housing.

“We are confident these types of properties will outperform and outperform most non-residential sectors by next year,” said Pawlowski.

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