I had the opportunity to attend the October 15th MultiFamily NW breakfast meeting at the Multnomah Athletic Club. Greg Frick, partner and owner of HFO Investment Real Estate, asked the question all of us in the room secretly have been asking ourselves in recent weeks: “When will the party end for apartments?” In other words, when will the apartment market transition back to a renter’s market?
As we all know the apartment market in terms of rent growth and value appreciation has been on a significant upward trend for the past few years. Currently apartment vacancy in the Portland metro area is estimated at 3.7%! But at some point in time we all know that there will be a transition from a strong landlord market to a newly emerging renter’s market. But when will that happen and what factors could trigger it?
Both Greg Frick and Jerry Johnson of Johnson Economics addressed this issue in their presentations. Between the two of them, they came up with four indicators for us to watch that will be telltale signs of an emerging renter’s market.
1. Rising Interest Rates – Some of us have been predicting rising interest rates for years and for years we’ve been wrong. Dead wrong! But for the very first time in recent memory we could actually be on the cusp of rising interest rates and here’s why: The Quantitative Easing program enacted by The Federal Reserve ends next month.
As you may recall, quantitative easing is a policy that has The Fed buying U.S. Treasuries with the expressed purpose of keeping interest rates artificially low. Ending quantitative easing will once again allow market forces to determine Treasury yields not The Federal Reserve. If interest rates slowly increase, this rise in rates will eventually impact capitalization rates for all types of commercial real estate. A rise in cap rates will at some point cause investors to slowly back away from investing in apartments.
2. New Apartment Construction – At the present time there are 25,000 new apartment units under construction or planned in the Portland metro area. Historically, the apartment market absorbs about 3,000 annually to stay in equilibrium. But there is such a pent up demand in the Portland market that new units coming on line will not result in a precipitous increase in the apartment vacancy rate. Mr. Johnson assured us that no disaster is coming, no Texas overbuilding is in the works. That said, the vacancy rate is anticipated to rise slowly over time.
3. Lack of Wage growth – Over the past year local wage growth has been growing at a healthy clip between 2.5% to 3.0%. If this trend continues then renters will have the ability to absorb the sizeable rent increases that landlords are asking for and getting. But what happens if wage growth stagnates or even declines? What happens then to rent growth? It’s fair to say that renters that are on the financial edge will be forced to move back in with their parents or at the very least will have to find a roommate to better absorb the cost. If this happens begin to see a rise in vacancy rates especially in one-bedroom units.
4. Rise in Home Ownership – When will higher rental rates trigger a flight to home ownership? The rent vs own question is always an important consideration for renters. At some point it just makes economic sense to own a home rather than renting.
ersonally, I think this time around things are much different. Millennials, people 18 to 33 years old, are a different breed of renter than those who came before them. They are more experience oriented and less materially driven. They would prefer to rent in a highly sought after urban neighborhood rather than owning a house or condo in a mundane suburban location. They also saw all of the homeowners who lost their houses to foreclosure during the Great Recession. So there will be significant resistance from them to follow down the path to home ownership.
So when can we expect the apartment market to turn? Good question. Mr. Johnson said that historically when vacancy rises beyond the 5 to 6 percent range, rental rates begin to stagnate, concessions begin being offered, resulting in the beginning stages of a renter’s market. Mr. Johnson believes that will occur in late 2016. I have no reason not to agree with his assessment.
That gives us two years to prepare for the coming downturn. So how do we prepare? 1) Raise rents while the market is still good; 2) Refinance your properties now while interest rates are low but don’t over leverage them. Those owners who got in the most trouble during the Great Recession were those who had leveraged their properties to the max. Avoid that temptation. And finally, 3) Lock in long term interest rates, preferably 7 or 10 years. You want to avoid the triple whammy of stagnant rent growth, higher vacancy rates and higher interest rates. That’s a recipe for disaster.