New Supply Erodes Class A Apartment Rent Premium
Good analysis of a trend that Prudent Growth has been talking about for some time now: the growth in rents in the Class B category is stronger and more sustainable than the rate of growth in the Class A category. And the trend of Class B outperforming Class A is starting to get noticed.
Why is this important? Investors looking for high returns combined with low risk need to be focused on rent growth - and the growth is simply better in the Class B segment. Nearly all of the new inventory supply over the past 5 years has been in Class A, while the growing populations of new immigrants, middle class workers, and retired fixed-income residents is driving the demand for affordable rentals to record levels. There is simply not enough new supply of these units coming online.
We certainly have seen better than 5% rent growth - and in come cases better than 10% - at our communities. Some of that is simple math - a $30 per month increase on a $600 apartment is 5% - whereas a 5% increase at a $1,700 apartment is a much larger $85. The cost and inconvenience of moving is not usually worth it for a small $20 or $30 increase, whereas tenants looking at a $75 to $100 increase may be more motivated to look around - especially with all the new building going on in that category!
But it also takes great management, attention to details, quick and courteous repairs and maintenance, and intelligent asset improvements. When properties are well managed and cared for, residents are happier, turnover is lower, and rents can be increased along with the quality of living.
From the article:
Class A units have always been priced at a premium to Class B, and over time, that premium has slowly grown. Recently, however, a divergence from the norm has occurred.
According to historical data from MPF Research’s top 50 markets, Class A units have commanded an average rent premium of 37.2% (or $340) over Class B apartments going back to 2001. That delta peaked in 4th quarter 2014 at 49.4%, when the average Class A unit was priced nearly $500 more than the average Class B apartment. Since then, the delta between Class A and B rents has started to decline. Annual rent growth among Class B units has outpaced Class A apartments for the past seven consecutive quarters. And that trend is likely to continue into 2017 when new supply levels are expected to peak.
Going forward, MPF Research expects a supply-induced slowdown in Class A rent growth in the short term as new apartment deliveries continue to mount. Currently, the average Class A-to-B rent premium is about $520. But the impending surge of new multifamily product coming online, combined with continued strength in Class B units, will likely continue to narrow that premium.