While it is clear that the multi-family sector has generally recovered from the pandemic, a new report from Fitch Ratings indicates that a full recovery in urban areas to 2019 levels could take longer than previous recoveries.
Occupancy rates and rents are improving and concessions are slackening, but urban apartments still follow those in the suburbs, according to Fitch. Usually, rents in cities bounce back in a year or two, but patchy reopenings can delay their recovery.
The rating agency says major trends in the tenant cohort and emigration will delay the full restoration of previous cash flows for urban landlords. Population growth in the 35-55 cohort means space will be at a premium, which favors suburban apartments. Fitch notes that these tenants could also choose single-family homes to buy and rent, although rising interest rates may hamper home purchases.
While suburban occupancy rates sit at 2019 levels, they are several hundred basis points lower than pre-pandemic levels in many coastal urban markets, according to Fitch. When the moratoriums on evictions expire, occupancy rates could come under pressure, especially in some coastal urban markets.
The rent table is better for suburban apartments. From the second quarter of 2021, their rents could exceed 2019 levels. While urban rents have recovered half of their declines following the pandemic, they are still 5 to 15% lower than the peaks of 2019.
Other reports also show a prolonged urban recovery. Yardi projects that it will take more than five years in New York to meet first quarter 2020 rent levels. While there are strong projections for rents in West Coast subways, it will take some time for rent growth to reach pre-pandemic levels. Yardi projects whose rents will exceed February 2020 levels in 2025 in San Francisco and San Jose and in 2023 in Los Angeles and Seattle.
Another factor is that investors are flocking to the solar belt markets, lowering cap rates and putting pressure on yields. REITs, which migrated to urban coastal markets in the last cycle, are also increasing their presence in the solar belt, according to Fitch. It indicates that debt and asset sales at low capitalization rates are the cheapest sources of funding for these REITs.
REITs “will increase exposure to the Sunbelt and suburban market, recycling older, more capital-intensive properties for new assets with better growth prospects,” according to Fitch. “Diversification will reduce portfolio volatility and returns could improve with a decline in investment, but a further rise in urban assets is possible as rents recover.”
However, these solar belt markets are more prone to a new offering. Fitch notes that lending standards limited new developments in 2008 and 2009, but there is no evidence that this is happening this time around. However, construction costs can hamper new starts.
Fitch notes that housing starts yields could fall by 50 basis points, pushing yields 5-10% below the pre-pandemic underwriting. However, the growth in rents could offset the pressure on costs.
The good news for apartment owners across the country is that multifamily fundamentals have largely recovered the recession caused by the pandemic, in particular compared to other sectors of the CRE.
ApartmentList’s national rental index rose 2.3% from April to May, the third consecutive month of record rental growth since the company began tracking monthly rents in 2017. Rent growth year over year is now 5.4% nationally, although “significant regional variation” exists.
ApartmentList paints a slightly brighter picture of urban recovery. Prices have started to rebound in cities like San Francisco, where rents have fallen the fastest during the most difficult days of the pandemic. Rents in San Francisco are still 17% lower than they were in March 2020, but prices have also risen 13% in the past four months alone.
Nine of the ten cities that posted the largest year-over-year rent declines during the pandemic have now experienced four straight months of rental growth. Four of those cities – San Jose, Washington, DC, Boston and Minneapolis – have posted rent increases for five consecutive months. If the trend continues in Boston, where prices have increased an average of 3.4% per month this year, rents will likely exceed March 2020 levels this summer.