The gravitational forces of rising supply, economic uncertainty, and the return of seasonality have all pulled the apartment market back down to Earth.
While apartment owners would normally not celebrate a softening in demand, this is exactly what the Fed needs to see in order to tame inflation, which will be great for the economy overall, as well as apartment owner borrowing costs and cap rates.
The major publicly-traded apartment REITs just finished reporting their 3Q22 and preliminary October results, and confirmed what we noted last month: rent growth is quickly decelerating. The Fed has to be pleased with the latest round of results from America’s largest residential operators.
While rent growth has slowed, the apartment executives remain bullish on 2023 because they see both the financial strength of their renters and the numerous headwinds facing their competition: the for-sale housing market. While many analysts expect job losses next year, including the Fed who is forecasting unemployment to rise to 4.4%, most believe the losses will be mild due to today’s labor shortage.
Here are the performance highlights that apartment REIT executives shared over the last few weeks.
New lease rent growth decelerated sharply in October
By October, all REITs reported low- to mid-single-digit new lease rent growth (the best proxy for current demand), a deceleration from recent double-digit growth. While a slowdown is expected this time of the year due to seasonality, that sharp of a decline indicates the apartment market is slowing more than normal. Annual new lease rent growth slowed to 5% in October, from 13% in 3Q22.
- Essex Property Trust: 3% in October, down from 10% in 3Q22.
- Equity Residential: 5% in October, down from 13% in 3Q22.
- UDR, Inc.: 5% in October, down from 13% in 3Q22.
- Camden Property Trust: 5% in October, down from 12% in 3Q22.
- Mid-America Apartment Communities: 6% in October, down from 14% in 3Q22.
Renewal rate growth eased but remains high
REITs focused on pushing renewal rents to minimize the difference between in-place rents and market rate rents (known as loss to lease). As a result, renewal rents increased at a similar pace to new leases in the third quarter and outpaced new lease rent growth in October.
Turnover increased in 3Q22
Loss to lease shrunk from 9%–15% in 2Q22 to 4%–7% in 3Q22, which means that the REITs were successful in retaining residents even with significantly higher lease rates. However, annualized turnover shot up as a result of these aggressive renewal offers. Here are some of the sharpest increases across the 6 REITs we track:
- Equity Residential: 55% (up 10% QOQ)
- UDR, Inc.: 59% (up 9% QOQ)
- AvalonBay Communities: 55% (up 8% QOQ)
Occupancy fell slightly
Weighted average total occupancy fell to 96.2% in 3Q22, from a record high of 96.6% one year prior. Mid-America Apartment Communities, with a portfolio located in Sunbelt markets, was the only REIT that reported an increase in occupancy from 2Q22.
Transaction market at a standstill
Apartment sales have almost come to a full stop as buyers wait on the sidelines, expecting either prices or borrowing rates to drop further. Per the REIT CEOs, asset values have already declined 10%–20% this year, pushing cap rates up 75–100 basis points.
- Equity Residential: “There’s so little going on in any market. Just sharing anecdotally, a large national broker told us that [in] a large southeastern apartment market, they didn’t have a single listing at this time, so that’s unprecedented.”
- Camden Property Trust: “We will not be selling or buying properties for the balance of the year. Apartment transactions remain quiet as participants’ cost of capital continues to rise and price discovery continues.”
Key metrics are declining a little too fast to be just normal seasonal softening. And with layoffs becoming more widespread, we are watching the apartment market for signs of distress.
The good news is the embedded growth built up from extreme rent hikes this year puts the REITs in a good position moving into the new year. The real test will come in the second half of 2023, when a wave of apartment completions is scheduled to hit.
*The six apartment REITs we track in our report include AvalonBay Communities (AVB), Camden Property Trust (CPT), Essex Property Trust (ESS), Equity Residential (EQR), Mid-America Apartment Communities (MAA), and UDR, Inc. (UDR).
Note: AVB does not report new lease or renewal rent growth. October results as of October 26–28, 2022.