Apartment rents are finally slackening after an incredible run. Here’s how to play it

An apartment for rent sign seen on the Upper East Side of Manhattan.

Adam Jeffrey | CNBC

Apartment rent growth appears to have peaked after a terrific run in 2021, and that could boost some of the real estate stocks that were early darlings of the pandemic.

Nationally, rents rose just 0.8% between June and July, a third of the growth seen in the same period a year ago, according to RealPage. On an annual basis, rents in July rose 12.2%, compared to a 13.8% year-over-year growth in June.

The cooling comes amid a decline in accessibility. Rent growth has outpaced income growth for the past 20 years, but the coronavirus pandemic has widened that divide, especially in the more expensive coastal markets.

Landlords slashed rents dramatically in 2020 as tenants fled urban areas, only to return in 2021 and even more sharply this year. New tenants are younger and generally have lower incomes, forcing landlords to settle for higher rates.

Additionally, landlords offered incentives in 2020 to bring tenants in, such as free months or adjusted lease terms. Removing some of these incentives in 2021 means tougher growth comparisons from 2021 to 2022 as the baseline stabilizes.

Additionally, a massive amount of new offerings are flooding the market, with around 420,000 new apartments set to be completed this year, according to RentCafe. The last time completions topped 400,000 was in 1972. Much of this new inventory is in New York City, as well as the Sunbelt region.

This change creates an attractive opportunity for investors in apartment REITs, which soared in the first two years of the pandemic but have recently fallen – largely due to rising interest rates rather than fundamentals. REITs in general are high yielding, so they tend to be a low interest game for investors.

But not all apartment REITs are created equal: Expensive coastal markets could see further rate cuts, while the Sunbelt, which was cheaper to start with and still sees strong demand, could see higher rents.

“The Sunbelt never had the Covid discounts,” said Piper Sandler chief executive Alexander Goldfarb.

Rent as a percentage of income has seen an increase in the Sunbelt, Goldfarb said, suggesting the potential for long-term equalization between regions.

“Everyone says people are just willing to pay in the city, but what we’ve seen is that Sunbelt rents have gone up faster and rent as a percentage of income – that number has gone up standardized between the Sunbelt and the coasts. Sunbelt residents were willing to pay more. The coasts stagnated,” he said.

Accordingly, Goldfarb said he was bullish on REITs that are more concentrated in the Sunbelt, such as Camden Estate Trust and Central American apartment communities. The same is not true, he said, for coastal REITs like Avalon Bay, Residential Equity and UDR, Inc.. He likes too Essex Land Trustbecause although it is largely a West Coast REIT, its properties are mostly in the suburbs.

In addition to apartments, rents for single-family homes are also softening. Rents rose 13.4% year-over-year in June, according to CoreLogic – a lower annual growth rate than in May.

However, strong rental demand for single and multi-family dwellings is unlikely to decline too much, given that home sales are falling so dramatically. With mortgage rates still significantly higher than they were at the start of the year and house prices still high, some consumers have no choice but to rent.

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