Demand for apartments plummeted in the national apartment market in the third quarter, coming off what had been several quarters of strong run-up in demand and rent growth for the national multifamily market.
In fact, apartment demand turned negative last quarter, the first Q3 in at least 30 years that such a phenomenon occurred, according to RealPage Inc. The summer months are typically strong for the for-sale and rental housing markets, making the Q3 drop in demand this year particularly significant.
Net demand was -82,095 units in Q3 among the markets tracked nationally by RealPage, bringing year-to-date net demand to -47,143 units. Negative demand means more renters moved out of than into apartments during a specified period.
Jay Parsons, head of economics and industry principals for RealPage, in a statement accompanying the report said soft leasing numbers and weak home sales point to low consumer confidence. People tend to go into wait-and-see mode during periods of uncertainty, he also said.
It’s possible, too, record rental-rate growth across the U.S. observed in the past 18 months, up until the end of this summer, has more renters doubling up to split the rent.
There’s a record number of apartments under construction across the U.S., prompting questions of whether the sudden slowdown in apartment demand will affect that pipeline, as well as future investment decisions by capital groups and developers.
Carl Whitaker, director of research and analysis at RealPage, said in an email that a performance slowdown will almost certainly cause investor groups to reassess their view on the marketplace but it’ll take something more drastic than a one- or two-quarter period of moderation for groups to significantly adjust their approach to acquisitions and dispositions.
“Multifamily’s share of total (commercial real estate) investment grew steadily even in the pre-pandemic cycle, and the past two or so years have only further solidified apartments as a highly coveted space for investor groups,” he added.
There are some 917,000 apartments under construction, by RealPage’s count — the most on record since the company began tracking the market in the early 1990s.
Whitaker said what’s most likely to influence a construction slowdown are external economic factors, such as rising interest rates and supply chain challenges. Even with the performance slowdown and record amount of construction, he said it would take a prolonged and significant pullback to influence development appetite measurably.
One area of the market where at least some investors could slow development and investment as they tighten the screws on deals: real estate markets that boomed during the pandemic but are hitting the brakes hard.
Boise, Idaho, may be the poster child for such a market, with home values at $323,897 in March 2020, peaking at $515,378 in March 2022, which has since fallen to $502,547 in August, according to Zillow Group Inc. (NYSE: ZG). The typical observed market rental rate in Boise went from $1,333 in March 2020 to $1,886 in August 2022, according to Zillow.
The housing market has cooled very rapidly in Boise in recent months, although rental rates have yet to decline. They grew only 0.2% between July and August, though.
Sean Robertson, originations and underwriting director at New York-based Churchill Real Estate, said his company looked at tertiary markets that boomed in the wake of remote work during the onset of the pandemic. Churchill typically focuses on workforce-housing deals, or properties that can rent at or below 140% of the area median income.
But, ultimately, those pandemic boom markets didn’t make sense for investment — and less so now.
“Those markets were very difficult to comp,” he said. “A lot of developers were going in, overpaying for land, looking to be the market leader as far as amenity packages, finishes … (I)t hasn’t really been battle-tested yet.”
Like many others in multifamily, Churchill has been keen to finance deals in established Sun Belt markets, such as Austin, Texas, and Phoenix. With the cost of capital higher now, and companies like Churchill taking a harder look at which deals to move forward on, high-growth markets in the Southeast and Southwest are places it still feels good about, Robertson said.
But Sun Belt cities are becoming more suburban in nature, following migration trends and where more affordable projects can be pursued. Places like Katy or McKinney in Texas — about 30 miles from Houston and Dallas, respectively — are some of the places Churchill recently closed deals on.
It’s also targeting affordable metros on a relative basis, such as the Inland Empire in southern California, and markets that’ve undergone an industrial boom in the past few years.
When a deal in the Lehigh Valley of Pennsylvania first crossed his desk, Robertson said, it was a “no” initially. But after checking out the area, one of the most prolific warehouse markets in the U.S. that services much of the Northeast, his team’s thinking changed.
“There was not much supply of Class A or even B-plus apartments,” he said. “The housing stock was very old but you saw every industrial REIT sign up, massive (buildings) out there employing thousands of people. They need a place to live.”
Other investors that bet on small cities and towns that grew rapidly in light of the pandemic still see potential for some of those nontraditional markets — if there’s a sustainable growth story.
Chicago-based Pangea Mortgage Capital closes multifamily loans across the U.S., particularly for acquisitions and rehab deals. It’s a subsidiary of Pangea Properties, which owns about 13,000 apartments nationally.
Some of the apartment deals Pangea closed on recently were in places like Moscow, Idaho; Bend and Eugene, Oregon; Kennewick, Washington; and San Luis Obispo, California.
“There’s been a flight, I think, in the post-pandemic world to some of these non-urban areas, somewhere where there’s a work-life balance,” said Michael Bachenheimer, director and head of West Coast originations at Pangea Mortgage Capital. “There’s a whole argument to be made that the five-day workweek, where you’re in an office all five days, is slowly eroding.”
It’s particularly relevant for the tech sector, with those companies pulling back on their office plans as more of their employees are working remotely permanently. Some tech workers who once lived in the pricey Bay Area or Seattle have moved to places like Eugene, Oregon.
Tertiary markets tend are generally less competitive and offer better value plays and more yield, Bachenheimer said, but certain markets work for specific reasons.
Moscow, Idaho, for example, is home to the University of Idaho, which provides continued housing demand from the university as well as their suppliers.
Tertiary markets — perhaps, especially, ones on the fringe of larger metropolitan areas — may continue to be popular with apartment investors and developers, as affordability pushes people farther out or to new markets. And while the permanence of remote work is still debated, if a greater number of people have more choice in where they live, that can spur demand in new cities or towns.
When examining deals now, Bachenheimer said, there are no areas off the table, but because of the Federal Reserve’ position to continue to raise interest rates, Pangea is more closely examining the exit underwriting.
“A lot of deals, while they look great today, they don’t look good two to three years from now,” he continued. “We’re cutting leverage on the front end.”