The first half of 2016 has seen steady growth in the apartment sector. While demographic trends are still strongly favoring the multifamily industry, some markets and properties — particularly those on the higher end — are beginning to see a slowdown in rent growth. Let’s examine that, and a few other trends to keep an eye on as 2016 winds down.
Wage growth will start to catch up to rent growth
The labor market is reasonably strong at the moment. We saw 2.7 million non-farm jobs added in 2015. The unemployment rate dropped 60 bps to 5.0% last year. The Bureau of Labor Statistics projects similar job growth this year, which should lower unemployment to 4.8%.
While inflation adjusted wage growth has remained relatively stagnant since the mid-1990s, there are signs that a turnaround is on the horizon. Take, for instance, that weekly earnings increased 2.7% year-over-year as of the first quarter of 2016. Compare that to a gain of 1.1 percent in the Consumer Price Index during the same time frame. The end result is more money in the consumer’s pocket, which is a good thing for everyone.
Rent growth will slow down
One of the reasons why wage growth will start to catch up to rent growth is because rent growth is slowing down. This is due to a several of factors. First, the tremendous rent growth seen in recent years was never a sustainable phenomenon. Consider that median asking rents in the U.S. increased 20.3% from Q1 2009 to Q1 2016.
The recent boom of apartment units under construction should also slow down rent growth as developers offer concessions to stabilize their assets. Managers at existing apartment assets will slow their rent growth to remain competitive.
To put things in perspective on the construction front, at the end of 2015 there were roughly 543,000 apartment units under construction, up from 450,000 at the end of 2014. The 2015 number was the largest year-end figure since 1973, when there were 853,600 units being built.
Keep an eye on the suburbs
We all know that Millennials, who are now the largest demographic cohort in the U.S., love their urban rentals and the 24/7 lifestyles they offer. We also know that Millennials tend to get married, form households, and have children later than previous generations. The oldest Millennials are now in their early 30s.
Considering that the homeownership rate continues to drop (63.5% as of Q1 2016), when these Millennials do settle down and start to look for more space and better school districts, a larger portion will do so as renters. Suburban apartment properties — which tend to be older, more spacious, and more affordable than their urban counterparts — have not seen prices appreciate as much as Class A urban properties.
As recent research from JLL shows, institutional money sees value in suburban apartments. Expect to see the sales volume increase in primary and secondary suburban markets in 2016.
No up trend lasts forever
It is the nature of real estate and the general economy to progress through cycles. As of June, we are 83 months into an expansion coming out of the Great Recession. The largest expansion seen since WWII followed the early 2000s recession, and lasted 120 months. Simple math shows that unless we are currently in the longest expansion since 1945, GDP will turn flat or negative for two subsequent quarters within the next 3 years.
There is no shortage of pundits calling for a correction, whether it is in the equity markets or apartment sector. It is hard to argue that the pricing of well located, luxury apartment assets in gateway cities is rational, but cap rates continue to compress regardless.
Is there enough of an appetite for these highly amenitized urban properties? The increase of so-called life-style renters suggests there could be. The rate of construction suggests otherwise. Look to Brooklyn as an example. The borough, which is currently home to the majority of apartment units under construction in New York City, is forecast to see negative rent growth for the first time this cycle.
While the upper end of the market looks to be saturated in certain cities, Class B and C properties look to be a safer alterative. Sure, rents are lower, but investors can often find suburban opportunities at a significant discount to replacement cost.