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Mid-Priced Apartments Thrive Despite Challenging Market Conditions
Rent growth has been rapidly decelerating since the end of 2021, with year-over-year rent growth dropping from around 11% to 2.5% in the first quarter of this year. In this shifting market, the four- and five-star properties that drove rent growth during the pandemic have fallen behind. Coming out ahead are three-star properties. What sets these properties apart?
In a recent presentation at this year’s NAA Apartmentalize conference, Jay Lybik, national director of multifamily analytics for CoStar Group, offered his analysis of why mid-priced apartments are on track to drive rent growth.
Rent growth dropping with supply on the rise
After double-digit numbers in 2021, current year-over-year rent growth overall has dropped to 1.7 percent year-over-year, as of June 9.
Why is rent growth so weak? Low absorption, driven by high supply, is to blame.
“After the record-setting absorption we saw in 2021 of 700,000 units,” Lybik said, “we haven’t cracked 100,000 units of absorption in a quarter.”
The first quarter of 2023 saw only 43,000 units of absorption, or about half of what is typically for a pre-pandemic first quarter absorption total, Lybik said. At the same time, a record of 486,000 units, the highest total since the 1980s, is forecast to be delivered this year.
And these factors aren’t distributed evenly across price points. Within these properties under construction, the top end of the market is significantly overrepresented. About 75 percent of all units under construction today fall into the four- and five-class rating, which also constitute the most expensive units to rent. These factors lay the groundwork for three-star properties to regain their previous momentum.
How rent growth compares by price point
Pre-pandemic, it was the three-star class rating that saw the greatest rent growth. Four- and five-star properties jumped ahead during the pandemic as the rent growth leader but began retreating by 2022. Since then, the three-star price point has reemerged, with 3.2% rent growth, compared to the 1.6% of four- and five-star properties.
“It’s now the clear leader in the terms of rent growth,” Lybik said.
Compared to in years past, owners and operators of four- and five-star properties today have fewer options at their disposal to mitigate the rise in vacancies and subsequent decline in rent growth. Previously, when facing oversupply, these high-end communities would offer concessions to entice residents of three-star properties to move up. But given the large divide in rent costs between these property classes today, this strategy has grown increasingly challenging.
To illustrate this, Lybik calculated the increase in yearly housing costs that a three-star renter would face when moving into a four- or five-star property. He then determined how many months of free rent would be needed to bridge that gap — as much as three and a half months in the Miami market — and also looked at the additional income needed for this resident to qualify for the new unit. In the case of Miami, this was over $30,000 in additional income a year to qualify.
“In the 1980s or 1990s, when the majority of new construction was garden-style apartments and the difference between a new garden-style apartment and an existing garden-style apartment wasn’t very much,” Lybik said, “it was much easier to bridge that gap.”
The price difference between the top end of the market and the middle market is about $600 a month, Lybik said. This translates to $2,100 in extra income a month to qualify for that four- or five-year property.
Although vacancy has also been increasing for three-star apartments, rates are much lower for the three-star properties than in the four- and five-star space, Lybik said.
The outlook for three-star rent growth
To demonstrate the continued strength of three-star rent growth, Lybik offered several current and historical snapshots.
Within the Austin, Nashville, and Tampa markets, three markets on track to see record supply deliveries this year, three-star apartments are not only outperforming overall but “really killing the top end of the market,” Lybik said, as four- and -five-star fail meet their absorption goals.
Looking historically before the pandemic, three-star properties led five-year rent growth averages. Even during the pandemic, when four- and five-star properties shot ahead as rent growth leaders in 2021, it was three-star properties that showed the most rent growth for the 2020–2022 period overall.
And shifting to 2023 and 2024 forecasts, the three-star class is expected to continue to have the greatest rent growth.
“Even though sometimes we like to think that the brand-new, shiny properties are where the rent growth is,” Lybik said, “in reality it’s the middle of the market that’s got the best rent growth and is going to continue to have the best rent growth.”
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