Are Mid-Priced Apartments on the Road to Recovery?

The latest multifamily data from the third quarter of 2023 showed a market on the verge of stabilization. With the slowest increase in vacancy since that metric began to rise in late 2021, it appears the turbulence in the market is receding — good news for apartment owners and operators facing tough market conditions for the last six quarters.

But a closer look at the data reveals a more complicated picture. When broken down by price point, most of this positive trend is thanks to the middle of the market, while high-end properties continue to bear the brunt of oversupply.

Apartments by price point

Before diving into the data, let’s establish some definitions. Three-star apartments refer to mid-quality apartments according to the CoStar national building rating system. In this system, star ratings range from one to five, with one representing the lowest quality and five the highest.

Three-star apartments, which fall in the middle, are typically older buildings and have more limited amenities than luxury apartments, the category classified as four- and five-star buildings. Within the three-star category, buildings may also be smaller, such as garden-style apartments rather than high-rise buildings. This class is also referred to as mid-priced apartments, since building quality is correlated to relative price point in the local market.

At the top end, four- and five-star apartment buildings are typically newer construction, in addition to their upscale amenities and high price point.

The good news for mid-priced apartments

In the third quarter of the year, overall rent growth has decelerated to just under 1 percent, at 0.8 percent. This national average contrasts with 1.4 percent for three-star apartments.

Vacancy, too, shows a bright picture for the middle of the market. At 6.5 percent, the vacancy rate for mid-priced apartments is 3 percentage points lower than for luxury apartments, which are seeing 9.5 percent vacancy as of the latest Q3 numbers from CoStar.

Luxury apartments lag behind

The picture for four- and five-star apartments is less bright, at least in the near term. Rent growth dropped into negative territory in the third quarter for the second straight quarter, reaching negative 0.4 percent.

At 9.5 percent, the vacancy rate for four- and five-star properties is the highest for all building types, notably above the 6.5 percent for the three-star class.

Why are four- and five-star apartments struggling?

Two key factors are driving the challenges facing high-end properties in the current market.

On the supply side, the record highs in current and projected supply have flooded the market, driving down asking rent. With almost 1 million units under construction, 560,000 units are expected to be delivered by year’s end.

But at the same time, economic uncertainty and high inflation have weakened demand among renters. Google reports that year-over-year demand for multifamily apartments is down 5.7 percent.

Furthermore, where in the past, falling rents for luxury units traditionally incentivized renters from lower price points to move up, this trend is no longer typical. Rent costs today diverge so greatly by price point that most renters currently in a three-star unit would find it difficult to meet income requirements for a four- or five-star apartment, even factoring in concessions and the recent drop in rent.

Relief ahead

Even as the storm clouds hanging over the multifamily market begin to fade, the timeline for relief varies drastically by price point.

Within the three-star class, recovery could be on the way, but for four- and five-star properties, challenges will remain through the end of the year and into 2024. The vacancy rate for this class is projected to approach double digits by the fourth quarter, according to CoStar data, and it will take several more quarters before supply and demand fall into a healthier balance.