Multifamily sector to '09: Good riddance

Victor Calanog, director of research, Reis Inc.

As published in Scotsman Guide's Commercial Edition, August 2010.

Despite seeing growth in the gross domestic product and some economic stabilization, 2009 ended on a sour note for the apartment sector. But although we’ve seen record-high rent losses, this year could be a little more positive.

Apartment vacancies climbed to 8 percent by year’s end, a 130-basis-point increase from the fourth quarter of ’08. This is the highest vacancy level on record in nearly 30 years of Reis’ record-keeping and a 250-basis-point increase since the sector’s cyclical low of 5.5 percent in the third quarter of ’06. New properties also came online at about 60-percent vacant for the quarter.

Net absorption was positive at just less than 15,600 units. The 34,000 newly completed apartment units opening in the quarter contributed to this.

Rents suffered, too, with effective rents decreasing by a record 2.9 percent in ’09 — more than triple the deterioration in the ’02 downturn. Effective rents dropped 0.7 percent in the fourth quarter of ’09, their fifth-straight quarter of loss.

The drop in asking rents poses greater worry. It demonstrates that multifamily landlords were forced to lower their initial asking prices before any concession negotiations occurred. Asking rents decreased by 0.7 percent in the fourth quarter of ’09, the largest quarterly decline since Reis began publishing quarterly performance data in 1999. The 2.3-percent asking-rent decrease between ’08 and ’09 also is the biggest we’ve seen.

A driving factor in the rent slide was the more than 130,000 units that came online in ’09. This level of new construction mirrors the more than 128,000 units coming online in ’03, a year with a stronger economy. It also hints at increased competition between new and existing properties for attracting and retaining tenants.

Additional supply exists as “shadow inventory,” or unsold multifamily housing that puts pressure on market rent rates. This pressure can be significant in some areas with high property-conversion rates and may hurt rent growth there.

That said, other supply indicators show that the multifamily sector’s future may not be so gloomy. Although substantial new supply entered the market in ’09, far less construction activity is expected in the pipeline in the next several years. The economy has demonstrated some slow growth, and the University of Michigan’s Consumer Sentiment Survey has started to rebound after hitting a low point in late ’08.

More important for the apartment sector is sustained job creation. This year’s employment data has been encouraging, though not consistently strong. Assuming employment situations continue to improve and household formation takes hold, apartments probably will begin to see some rent growth in the near future — though any sizable upturn still may be a few quarters off.

We do not foresee vacancies turning the corner as quickly, however, and we expect vacancy rates to climb slightly before the end of the year because of typical weakness in the winter.  

Victor Calanog, director of research at Reis Inc., writes a monthly column on property types for Scotsman Guide. As head of Reis’ core economics team, he is responsible for data models, forecasting, valuation and portfolio services for clients in commercial real estate. Reach him at victor.calanog@reis.com. Brad Doremus, analyst for Reis’ economics department, contributed to this article.