The national vacancy rate remained unchanged at 4.1 percent during the second quarter, a potentially worrisome result for those who fret about the near-term future of the apartment sector. As we explain in this column, this is not unexpected, and a moderation in the brisk pace of improvement in fundamentals has been built into our forecasts for some time.
Supply growth quickened, with more than 34,000 units coming on-line this quarter versus approximately 27,000 in the first quarter. Net absorption, however, continued to outpace supply growth, clocking in at more than 35,000 units. While supply growth is expected to accelerate in the latter half of the year, there is little reason to expect demand for apartment rentals to slacken significantly. Job growth has been robust, with an average of 229,857 jobs created per month in 2014. There are, however, some MSAs where job creation and household formation have not kept up with additions to inventory.
Healthy growth
Asking and effective rents grew by 0.8 percent and 0.9 percent, respectively, in the second quarter, faster than during the prior period, but in line with seasonal strength during the spring and summer months. On a year-over-year basis, asking rents grew by 3.2 percent and effective rents grew by 3.4 percent. Rent growth for the first half of 2014 is roughly comparable to the first half of 2013, suggesting that the ability of landlords to raise rents may have reached some equilibrium rate that is slower than its strongest rate, recorded in 2012. Asking and effective rent growths have also been approximately equal, or within 10 basis points difference since the latter half of 2012, implying that landlords may have little leeway left to boost effective rent growth by reducing concessions. The recovery has been so broad and has progressed for so long (four years at this point), that we appear to be approaching a new point in the business cycle.
Not a downturn
We must be careful when we discuss topics like “new points in the business cycle” for the apartment sector. If the robust recovery that apartment investors, lenders and owners have enjoyed since early 2010 is over, the next few years appear to herald nothing approaching a “downturn” or “contraction,” but more of a state when fundamentals revert to historical averages.
The long-term national vacancy rate for the apartment sector stands at 5.4 percent, and Reis forecasts suggest a gradual rise in vacancies over the next five years. Rent growth will stabilize as well, at or around 3 percent. This means some markets will have occupancies deteriorating—from 97 percent to 94 percent, for example. Hardly cause for worry, but a reality to be planned for nonetheless, especially if future projections were built on much rosier assumptions.
Net absorption was positive in all 82 primary markets in the second quarter; similarly, effective rents rose in all 82 markets, in line with late last year when most, if not all, markets boasted rising effective rents. Still, with rent levels exceeding historic highs, it should be expected that the ability of landlords to extract higher rents may become constrained in the coming quarters. Such constraints may be lifted somewhat if job growth remains strong and median incomes begin growing at a faster pace.
Local highlights
New Haven remained the tightest market in the country, coming in with a 2.2 percent vacancy rate. Interestingly, a number of unusual suspects had some of the strongest vacancy rate compression this quarter. Markets like Columbia, Tucson, Omaha, Las Vegas, Richmond, and Lexington were among those with the largest declines in vacancies this quarter.
Several of the markets normally near the top of the rankings, such as the California markets, were further down the list, and some registered no vacancy declines this quarter. This indicates that although the recovery in the apartment sector was already widespread, markets that had been lagging during the recovery are now starting to gain ground while markets that led the recovery are losing a bit of steam, especially as construction ramps up. With supply growth accelerating in many major markets, the tide is already turning a bit for vacancy. Although 17 markets now register a vacancy rate lower than 3.0 percent, a post-recession high, there were only 45 markets that registered a vacancy decline. That is down significantly from what we have observed in recent quarters. While it could be an isolated event, the supply pipeline intimates that we should see fewer markets registering vacancy compression going forward.
New York remained the most expensive market in the country, with effective rents at over $3,100 per month. Although increased supply will dampen rent growth in a number of markets, rent growth should remain positive barring a recession.
Near-term outlook
Even though the economy got off to a rough start in the first quarter, the labor market appears to be strengthening. This will sustain demand for apartments, and absorption should remain fairly strong for the balance of the year.
However, construction continues to ramp up and new completions should be greater in the latter half of the year than during the first half. The market is expected to deliver between 180,000 to 200,000 new units this year, well above the long-term historical average. Therefore we continue to anticipate national vacancy will not fall on a calendar-year basis. Quarterly vacancy increases could emerge as soon as the third or fourth quarter of 2014.
Despite all this, vacancy remains incredibly tight at near 4 percent, a level that is sufficient to generate rent growth in excess of inflation. Even if vacancy begins to rise (as it already has, in certain markets), it should not be characterized as a downturn.
