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Apartment Rent Concessions are 'Back With a Vengeance'

Short-term Headache, or Sign of Real Trouble? Most Investors Have Slower Leasing Priced Into Their Financing. Some See Apartments as Hedge for Next Recession
May 25, 2018
It’s the age-old developer’s trade-off.

In a market saturated with new apartments, building owners have a decision to make. You can either tolerate higher vacancy rates and hope they don’t last too long. Or, you can offer a month or two of free rent to get renters in units. Either way, in the long run, you’re hoping to have enough tenants to pay the rents you’ve based your whole project on.

Today, nine years into the multifamily market’s dramatic recovery and rise, developers in some of the most popular rental markets are confronting that choice more and more.

And more often than not, they’re offering concessions.

New residents get a month or two of free rent, or perhaps free parking. Existing tenants who renew their leases could see a little benefit, too - a free month, an apartment upgrade or no rent increase.

"There was a refreshing and short period of time when concessions went out of the market," said Lynn Bora, vice president of operations at Winn Companies, which owns or manages nearly 100,000 apartments across the country.

"Now, concessions are back with a vengeance."

Bora said there’s an urgency for property managers and owners to stabilize the properties and meet their underwritten occupancy levels. And, the thinking goes, a tenant who moves in with a little free rent upfront is likely to stay there. As the place fills up, rent increases could be just around the corner.

Generally, the rise in apartment concessions is confined to the top end of the market - all those expensive new high rises in downtown Chicago, LoDo in Denver, DUMBO in Brooklyn and the Boston Seaport District.

But anywhere that has seen a wave of multifamily development in the last few years is experiencing concessions, said market players.

Nashville, for instance, has increased its supply of apartments by 30 percent during this economic cycle. Developers are offering not only one or two months free for lease-signers in new buildings - they’re reducing rents, according to CoStar research. And in some of the most-saturated submarkets, more supply is on the way.

The multifamily sector’s long run as a real estate favorite has spawned a generation of apartment optimists.

Homeownership rates in the U.S. are at historic lows and are unlikely to ever return to their historical levels, say the optimists. A new preference for urban living among both the millennial generation and aging empty nesters adds to apartment demand, goes the thinking. New development is peaking, and reduced rents and concessions will burn off in a year or two, they say.

The wind remains at the sector’s back.

Kyle Dupree is a senior vice president of asset management at LaSalle Investment Management in Chicago. He focusses on multifamily investments and is mainly in the optimist camp.

"Even with all this supply, we’re not seeing absorption drop off," said Dupree.

And CoStar data shows that apartment vacancy rates remain modest, even in markets like Nashville, which for some has been this cycle’s poster child for over-development.

"We’re not seeing occupancy drop into the 80s (percent range,)" Dupree added.

In markets with oversupply, rent growth may not be there, he said, and there may be rent concessions, but, “the (leasing) risks are priced into the building (for investors),” he said.

Bora at Winn Companies also points out that concessions have not forced them to reduce their asking rents in the long term.

The risk in the rise in concessions is that in many markets, developers may have financed their projects based on achieving rents that may no longer be realistic. That is, a property that has to give away 16 percent of its projected annual rent just to get a new tenant in the door is priced all wrong.

An owner may have the cash flow and reserves to ride out the lease-up period until the property stabilizes. But owners without the financial resources to keep meeting debt payments will be facing loan defaults and other troubles on the horizon.

CoStar research suggests that softening fundamentals in the apartment sector aren’t in fact due solely to over-building.

The stellar rise in apartment rent growth in the last few years was likely an anomaly and rates are expected to return to a more normal growth pace. According to CoStar data, rent growth has slowed to slightly more than 2 percent annually nationwide from an average of more than 5 percent a few years ago.

"The data clearly shows that rent growth has slowed from the highs of 2015," says John Affleck, CoStar’s director of analytics. "But 2015 was a rare year, when demand for housing, thanks to a healthy economy, far exceeded housing construction. Since then, developers have responded, and rent growth has fallen to long-term trends. But what we’re seeing is not a hard landing - it’s a return to normal."

While owners can deal with slower rent growth, the bigger risk looming out there is if a recession may be on the way. The resulting loss in jobs, the end of robust new household formation, all would hurt the rental sector.

Then again, points out LaSalle's Dupree, apartments may take on a new shine when the economy slows -- or crashes -- again.

"What we saw in the last recession is that multifamily is a great hedge," he said. The rental sector recovers quicker and sometimes benefits from conditions that make home ownership more expensive in a downturn.

"It’s a little bit more elastic than the other assets classes, and a little quicker to react to markets, which can help maintain cash flow in a downturn," he added.

John Doherty, Multifamily Reporter  CoStar Group   

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