Apartment Rentals are Evolving to High Levels

A recent analysis report issued by Morningstar Credit Ratings sheds insights about developments and trends in the multi-family (mostly apartments) segment of residential housing. The highlighted information focuses on:

• Growth shifting to secondary markets and the suburbs.
• The effect of the Tax Cuts and Jobs Act of 2017 becoming clearer.
• Rising oil prices impacting specific markets.
  

  Market Shifts

Apartment demand rose to its highest level in 25 years during 2017 according to Trepp, LLC. This corresponded with the overall growth of the U.S. economy. As a result, apartment loans have been the best performers in the commercial mortgage-backed securities (CMBS) sector. The loan delinquency rate (as a percent of property type) registered only 0.36% in March 2018. It has been among the highest performing subsectors in residential real estate.

Through 2016, gateway cities, such as Los Angeles, New York, San Francisco, and Boston showed the best performance and most new growth activity. As these cities have become built-out, a shift to secondary cities and suburbs is occurring. Gateway cities were able to sustain rent increases and higher costs of construction because of the growth in employment for high paying jobs in science, technology, engineering, and mathematics (STEM jobs).

Now those STEM jobs are shifting to less expensive secondary markets such as Charlotte, North Carolina; Salt Lake City; Denver; and Austin. For the next few years, rental demand in these markets is expected to exceed the gateway cities. Meaning most of the forecast growth will occur outside the major markets. Coastal areas will also do well, with cities in California and Florida making up half the list.

Potentially negative impacts in these secondary markets are increasing vacancy rates if growth exceeds demand, aging and decreasing populations, lower than expected economic growth factors, and violent crime rates. Also, U.S. Census Bureau data from between July 2016 and July 2017 shows a suburbanization trend developing. This could develop into more homeownership as millennials start to settle down to raise families. However, potential homeownership increases could be offset by changes in tax laws.

Tax Cuts and Jobs Act of 2017

This legislation is very likely to influence multifamily properties during and beyond 2018. The federal increase in the standard deduction (to $24,000 from $12,700 for joint filers and to $12,000 from $6,350 for single filers) could discourage homeownership as the mortgage interest deduction becomes less of a financial incentive. An April 2018 report by the U.S. Congress Joint Committee on Taxation estimates that only about 13.8 million taxpayers will claim the mortgage-interest deduction in 2018, down from 32.3 million in 2017.

New state and local tax deduction limitations show the possibility of further eroding the level of homeownership because of less affordability. This can be expected to increase the percentage of people choosing to be renters. The markets expected to be most impacted by limitations on state and local taxes are New York, Connecticut, California, New Jersey, and the District of Columbia.

Rising Oil Prices

Demand for oil has led to higher prices since a low point in 2016. The effect on multifamily housing is likely to be negative in this cycle because the industry depends less on human labor. The result will be a lower spike in demand for rental housing as less of the labor force relocates to oil industry-dependent regions and cities. This is expected to be especially true near physical rig locations, refineries, exploration, and production sites. This is supported by rental market statistics in the Houston metro area.

The report is a snapshot in time. Currently, rental market opportunities appear best in smaller secondary cities and suburbs for both rent growth and demand. However, long-term factors to consider include demographic shifts, changing government policy, and the economy at large.

To view the full Morningstar report, click here.

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Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 12 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. With the Pacific Ocean a couple of miles in the opposite direction.