Rent Inflation Highest at the Lower End
Good article on CNBC this morning which underscores a trend that we at PGP have been thinking about for the past year or so: almost ALL of the new inventory coming online in the multi-family space is aimed solidly at the high end of the market.
This makes sense - it is more profitable for everyone involved to build the $150,000+ per door buildings.
However, there is strong demographic growth amongst the working class, sub-$60,000 household income bracket. And there is little or no new supply in that category.
Therefore, a well-managed portfolio of Class B and C+ properties should out-perform over time - at least on a cash-on-cash distribution basis. Plus, there is much less sensitivity to overall cap-rate risk that the higher end deals are exposed to. Cap rates at the high end can move from 5.5% back to 6.5% without really impacting a Class B deal which was purchased at an 8.5% cap rate.
From the article:
"Rent inflation is consistently higher for lower-cost housing units than it is for higher-cost units," Jonathan McCarthy and Richard Peach, researchers at the Federal Reserve Bank of New York's research and statistics group, said in a recent blog posting….
More new units at the high end likely keeps the vacancy rates there higher, while less competition between tenants for units helps to dampen price inflation in that segment, the researchers said. So even though the actual rent may be higher, it's likely it won't have as large a percentage rise as lower-cost apartments.
This is because at the lower end of rents, supply increases are more likely to come from units that were previously offered at higher rent being pushed down to the next bracket, the researchers said. Those units are still more likely to have higher rents than the housing already in the lower end, pushing up price inflation for that segment, they said. Call it the "trickle-down" effect on rent.
Indeed, during 2011-13, rent inflation in the lowest quintile was nearly 16 percent, but in the highest quintile, inflation was a negative 0.4 percent, the research shows.
Rents and occupancies are currently hovering at historic highs as supply isn't keeping up with demand. While apartment construction has seen strong growth over the past three years, construction of multifamily homes such as apartment buildings fell to next to nothing amid the housing bust, so new units are meeting with pent-up demand.
Permit authorizations for multifamily, or apartment building, construction dropped nearly 15 percent in September from August and are now 1 percent below September 2014, according to the U.S. Census. The vast majority of new supply has been in pricier areas, in particular major urban cores, which has not helped renters in the suburbs or in smaller cities that are in dire need of more affordable rental housing.