Multifamily rent growth finally hit a wall in August, with U.S. average asking rents dropping $1 to $1,718, according to Yardi Matrix. The leveling comes after a 22% increase in U.S. asking rents since January 2021 in which the average grew by more than $300.
Deceleration in rent growth was expected this year, given that the growth over the last 18 months was far higher than any previous period in the market’s history. Rents—which increased by 14% nationally in 2021—had not grown by more than 5% in any full year over the last 20 years. Beyond the reversion to the mean, though, there are reasons to believe that rent growth will settle at more normal levels.
One immediate element is seasonality. Rent growth tends to be concentrated in the spring and summer months, when more people move. The winter/spring of 2021/22 proved to be an exception, as rents rose 5.1% between September 2021 and March 2022, but August’s performance is a sign that the trend will not be repeated this winter.
Seasonality, however, is a small part of the bigger deceleration picture. One bigger factor is that the migration set off by the pandemic is slowing down in some markets that were the biggest beneficiaries of the COVID-19-induced shutdowns that started in the spring of 2020.
Migration was spurred by different reasons. Some was related to the 22 million jobs lost, which left families looking for less expensive housing. The pandemic led to an outflow of households from high-cost gateway markets to Sun Belt metros, especially in Florida, Texas and Arizona. Indeed, in 2020, the top 10 metros for multifamily units absorbed—half of which were in Texas and Florida—accounted for nearly 40% of the 268,000 units absorbed nationally, per Matrix.
Some migration came from workers taking advantage of work-from-home to move away from an urban office setting, while others decided to seek more living space in suburbs and smaller metros. Multifamily absorption was negative in 2020 in gateway metros, led by move-outs from New York, San Francisco and San Jose.
The dynamic changed in the spring of 2021 as the economy improved and cities opened for business. Nationally, apartment absorption hit a record 568,000 during the year, prompting the extraordinary rent growth. Demand remained exceptionally strong in the Sun Belt, led by Dallas and Houston, but the most striking change was the recovery in gateway markets. Absorption as a percentage of stock was 4.4% in gateway markets in 2021, just a hair below the 4.5% level recorded in secondary markets/tech hubs, per Matrix.
This year, demand has returned to more “normal” levels, with 223,000 units absorbed through August, per Matrix. Gateway (1.7% of total stock absorbed year-to-date through August) and tech hub markets (1.8%) continue to see strong performance overall, and Dallas and Houston continue to lead the country in units absorbed. However, absorption has flattened or turned negative in some formerly hot markets.
In markets such as Atlanta, San Antonio, Phoenix and Las Vegas, occupancy rates are slipping as supply growth outpaces demand. The exodus from gateway markets continues, but at a lesser pace. Although office work has become more flexible, some companies are requiring employees to return, at least on a part-time basis. Meanwhile, the pandemic pushed forward the natural exit of households from urban areas due to the start of families or retirement, so some of that migration has slowed.
Other markets with waning absorption in 2022 include Sacramento and the Inland Empire, which had benefited from migration from more expensive nearby metros Los Angeles and San Francisco. After years of above-trend rent growth, these metros no longer offer the relative cost benefit they did a few years ago.
Weaker Household Formation
An under-reported part of the robust demand for housing in 2021 was the surge in household formation. The growth did not come because of booming population. Legal immigration remains weak—down by roughly 75% since 2016—and the domestic birth rate is on a long downward slide.
However, the rebound in jobs—more than 10 million have been created since January 2021—along with robust wage growth, strong household balance sheets and personal savings (fed by federal stimulus dollars and the rallies in the stock market and home prices) has given individuals the financial wherewithal to form their own households. Moody’s Analytics estimates that U.S. households have over $2 trillion more in savings than they did before the pandemic. The result is that individuals have the means to rent apartments or buy homes, forming independent households away from families or roommates.
This growth in households is likely to slow, curtailed as the economy cools. The Federal Reserve increased its benchmark interest rate by another 75 basis points this month to a range of 3.0% to 3.25%, and is expected to push rates to 4% in coming months to reduce demand and slow economic growth. The Fed’s actions are intended to put some people out of work and reduce wage growth, which serves to work against household formation.
It remains unclear whether or when the economy will go into recession, or if the Fed can achieve a “soft landing” before inflation gets back to its target rate near 2.0%. However it plays out, though, growth in household formation is a good bet to cool.
Rent costs have grown much faster than wages in recent years. Between January 2014 (when rent growth started to rise above the long-term average) and August 2022, the average U.S. multifamily rent increased 49%. During that time, wages and salaries of workers at private companies rose 29.1%, according to the employment cost index, a measure of wages and salaries produced by the Bureau of Labor Statistics. While renters have displayed remarkable ability to absorb rent increases, it is hard to conclude anything except that the rent growth at the levels seen in recent years is unsustainable.
Migration to the Sun Belt for less expensive housing is a long-term trend that increased substantially at the start of the pandemic. However, after years of robust rent growth, secondary markets are no longer the relative bargain they once were. To take but a few examples: Since January 2014, the average multifamily rent has growth 93% in both Phoenix and Sacramento, 80% in Tampa and 61% in Charlotte.
Outlook Still Strong
The outlook for multifamily remains strong. Even with the problems posed by inflation, energy costs and supply chains, the employment market is healthy by historical standards. The Fed’s rate increases will hurt some families but could even boost multifamily demand if single-family home sales drop and homeownership becomes out of reach, preventing first-time buyers from purchasing.
On a big picture level, rent growth is driven by the fact that there is more demand for housing than supply. Occupancy rates of stabilized properties are at 96.0%, per Matrix, and are near all-time highs in many markets. People need a place to live whatever the circumstances, and the nation has a shortage of housing that many analysts estimate to be in the millions of units.
That said, the market may be coming to an end of its extraordinary run of rent growth. Demand is slowing as migration and household formation slow to normal levels. Meanwhile, many metros where job and population grew in part due low costs are reaching the limits of affordability. Going forward, the likely scenario may be a flattening of growth through the winter, followed by years of moderate rent increases.