Review of all things Real Estate: Apartment demand turns negative for the first time since 2009

Bob Hillery

CR Properties

Net demand for apartments ended in negative territory for calendar year 2022. But, unlike the last time demand went negative in 2009, renter turnover was curiously low in 2022. The problem was that demand for new leases all but evaporated due to low consumer confidence and high inflation. After an historic wave of household formation and relocations in 2021, Americans chose to mostly stay put in 2022.

We’ve not witnessed this before, weak demand for all types of housing despite robust job growth and sizable wage gains. It wasn’t that apartment demand shot up in 2021 and plunged in 2022; the same pattern played out to varying degrees in other rentals and in for sale homes.

To dispel common myths about weak rental demand:

1. There’s no massive wave of move outs. Renter turnover throughout 2022 held at historically low levels, topped only by 2021. Turnover is gradually normalizing, but it’s still low.

2. There’s no big jump in unpaid rent. In November 2022 (the most recent available period), 95.7% of market rate apartment renters paid rent on time; an increase of 0.6 percentage points year over year.

3. There’s no indication renters are doubling up to any significant degree. That may occur later, but as reported by the publicly traded apartment REITs in their last report, it’s not a major factor yet.

4. There’s no “flight to affordability” meaning renters aren’t moving down from more expensive units or markets into more affordable units or markets. The drop in demand came across all price points and in all markets.

The root cause is simple: consumer confidence is low. According to the University of Michigan’s consumer sentiment index, confidence dropped even lower in 2022 than it did during the Great Financial Crisis. Human nature is that uncertainty has a freezing effect; when you’re uncertain, you’re much more likely to stay put.

The 2022 apartment demand numbers clearly demonstrate this. We typically see a significant seasonal bounce in demand after college graduations during the summer… but that didn’t happen in 2022. Employment data indicates that most found jobs, so why didn’t they show up in the housing market? It appears many got jobs but chose to live with family or friends given economic uncertainty and inflation, including elevated housing costs. My grandson chose to remain at home for a year after college graduation.

That would point to pent up demand for apartments in 2023, but first we need to see consumer confidence rebound which is iffy especially with more voices predicting a pending recession. But cooling inflation (including a string of rent cuts) could be a strong enough counter measure to unleash stronger apartment demand in 2023 than we saw in 2022. That appears likely to happen even if the Consumer Price Index doesn’t capture it right away due to a lagged methodology.

Rental market is shifting in favor of renters

New lease apartment rents fell in December for the fourth consecutive month amid soft demand, dropping another 0.4%. While rent cuts in the winter months are seasonally common, the cumulative rent drop of about 1.6% since September is deeper than normal. And further cuts appear likely in early 2023 especially in Class A apartments competing with the oncoming wave of newly built lease ups.

For calendar year 2022 overall, effective new lease asking rents increased 6.1% nationally. That number was inflated by large hikes earlier in the year but has dropped off precipitously since peaking at 15.7% in March. Further cooling will continue into 2023.

Bottom line is the rental market is rapidly shifting in favor of renters. National apartment vacancies jumped from a record seasonal low one year ago of 2.5% up to 5.0% in December 2022. Vacancies increased over the past year in all but two of the nation’s 150 largest metro areas.

Vacancies will almost certainly increase more in 2023 as new supply surges to the highest levels in four decades. A total of 971,356 apartment units were under construction at the end of 2022, with about 575,500 scheduled to complete in 2023. New starts continued at a brisk pace through 2022 too, which means lease up volumes will remain elevated well into 2024.

New supplies will especially impact the upper tier Class A market competing for upper income renters. The widening gap in rents between Class B/C and newly built lease-ups suggests that middle and lower tier apartments will be somewhat insulated from supply pressures. That means it’ll be tougher for lease ups to lure renters out of Class B apartments with concessions than it had been in prior cycles.

The bottom line; there is good news for renters but not so good news for investors and landlords.