By Dawn Wotapka
Strong growth of rents and occupancy levels of rental apartments have pushed some building values to record levels as Americans shift away from home ownership.
While concerns about the economy are cooling the market for most other types of commercial real estate, apartment rents and occupancies continue to be boosted by demand from millions of people who are victims of foreclosure or are unwilling or unable to buy their own homes.
At the end of the third quarter, 5.6% of the nation’s apartments were vacant, down from 5.9% in the second quarter, and the lowest level since 2006, according to Reis Inc., a real-estate data service.
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Rents are up even in some cities that have been hard hit by high unemployment and the housing crash, like Orlando, Fla., Detroit and Phoenix. Effective rents, which include landlord discounts in some markets, rose to $1,004 a month in the third quarter, up 2.3% from a year earlier, according to Reis. Of the 82 major markets that Reis tracks, only Las Vegas saw rents decline compared with a year earlier.
Forecasters say rent increases could slow or stop if the economy weakens further. But for now, these trends are producing outsized returns for real-estate companies, compared with other commercial-property classes.
Values of apartment buildings in the best locations—with modern amenities like resort-style swimming pools and outdoor movie viewing areas—went into record territory in the third quarter, according to an index compiled by Green Street Advisors. The previous record had been set in the second quarter of 2007.
Investors who bought apartment buildings just a few years ago are selling for big profits. Regency Club, a 372-unit complex in Jackson, N.J., with two swimming pools and tennis courts, sold for $44 million in August, compared with $39.9 million in early 2009, according to Marcus & Millichap.
At the same time, though, the rise in rents is squeezing large swathes of the middle class by increasing living costs just as wage increases are anemic and unemployment high.
Glen Guile, a 40-year-old information technology and marketing employee for an auto-parts company in Raleigh, N.C., says he’s looking on Craigslist, an online classified-ad service, for a roommate because he just heard his $629 rent for a one-bedroom apartment could be increased another $30 to $40 a month. He’s already working a second job at a Costco store. “I don’t get a day off. I work seven days a week,” he said.
But thanks to rising rents and occupancies, some analysts predict that real-estate companies will have the highest growth in property net income this year and next year since 2006.
Associated Estates Realty Corp. kicked off the earnings season for apartment-building companies Monday by reporting a 12.5% year-over-year increase in funds from operations, a common metric used by real-estate companies to measure performance. When looking at apartments owned for a year or more, rents for Associated’s 12,000-unit portfolio were up 4.6% compared with the third quarter of 2010.
“Some people try to make the argument that what’s going on in the job market affects apartment demand,” said Jeffrey Friedman, Associated’s chief executive. “We don’t believe that.”
The apartment sector has been insulated from high unemployment because it continues to inhabit a sweet spot in the economy created by demographic factors and the anemic home sales market. The U.S. is expected to see 1.5 million rental household formations in 2011, a record year, according to Green Street.
The main reason for the rental increase is a faster-than-expected decline in the home ownership rate, according to Green Street. The nation’s rate came in at 66% in the second quarter, down from 66.4% in the first quarter and 66.9% in the second quarter a year ago, according to the Census Bureau.
Some industry watchers say the rate could fall to as low as 60%. Each 1% decline in the home-ownership rate represents the movement of one million households to rentals.
If a current tenant balks about a lease renewal including higher rent, Mr. Friedman says he isn’t overly concerned. “There’s someone coming right behind them who can afford it,” he said.
To be sure, the economics of apartment investments aren’t detached from the concerns about financial problems in Europe and the possibility of a double-dip recession in the U.S. As a result, landlords have started to temper rent growth in some areas, including Denver, Atlanta and the Baltimore area, according to Green Street.
If another recession hits and unemployment rises, millions of renters could likely double up or move home with their parents, putting a crimp in demand. “People just aren’t going to write bigger and bigger rent checks into infinity,” warns Andrew McCulloch a Green Street analyst.
The high rents are also being supported by a lack of new supply. Developers have scrambled to launch new projects, but most of them won’t start hitting the market until late 2012. Roughly 8,200 new apartments hit the market in the third quarter, the second lowest number since Reis began tracking data in 1999.