When demand exceeds supply, prices rise. That's one of the fundamental principles of economics. But it may not apply in the apartment market during the near term.
The outlook for rent recovery in much of the nation doesn't look very promising, even after employment growth levels regain momentum and begin to yield apartment demand in excess of completions.
Low-interest mortgages, which make home purchases attractive, place a ceiling on rent growth potential. They have significantly reduced the premium to buy versus to rent in numerous cities, including Houston, Seattle, and Charlotte, N.C.
If apartment owners raise rents in these locales, it could further accelerate home sales rates that, in many cases, are already moving at a breakneck pace.
Understanding this phenomenon requires an analysis of local trends. National statistics don't tell the story; they show that the premium to buy versus to rent remains essentially where it was in 2000. But that's mainly because the national numbers have been held up by dramatic increases in the purchase premium for a handful of cities – mainly in California, the Northeast, and the Mid-Atlantic. Mild increases in effective rents in these areas over the course of the past three years have not come close to equaling the sizable jumps in homeownership costs.
In about half of the nation's 50 largest metros the difference between the cost of homeownership and typical apartment rents has narrowed. While the monthly cost of principal and interest on the median-priced home still tops the average apartment rent virtually everywhere, that premium to buy has eased by 10 percentage points to 20 percentage points across 13 cities.
In contrast, the Real Estate Center at Texas A&M University reports that single-family home sales in Houston climbed by an average of 3.9 percent annually in 2001 and 2002, topping 56,500 units last year. Early results from 2003 place the metro on track to set another home sales record.
The median home price in Houston now registers at $129,200, according to the National Association of Realtors. Assuming a down payment of 5 percent and a 30-year fixed-rate mortgage at 5.4 percent, the typical home requires just $779 per month to cover its principal and interest payment. This monthly cash outlay tops Houston's average apartment rent of $667 by just $112, a little under 17 percent. During the past three years in Houston, the premium to buy a typical home versus to rent has decreased by almost 11 percentage points from nearly 28 percent.
A home buyer obviously also must pay for taxes, insurance, and maintenance costs – items that significantly push up the total monthly cash outlay for homeownership. Still, even those additional expenses leave purchase of the typical existing home well within reach for most renters in more expensive, top-tier apartments.
Houston's average rent for an apartment built since 1990 averages $870, though it can cost $1,000 or more within closer-in neighborhoods. That leaves an upper-end renter a considerable cushion to cover the typical homeownership expenses incurred beyond the principal and interest requirements.
Potential competition from for-sale product also raises some concern about the rent growth prospects across Atlanta; Orlando, Fla.; Philadelphia; Pittsburgh; San Antonio; and West Palm Beach, Fla. In these cities, cost differences between buying and renting may not have shown significant movement recently, but there never was much of a purchase premium to begin with.
The bottom line for most of the trouble spot cities is that today's effective rents really should be considered true market rates. Any discounts now thought of as concessions probably will be around for quite some time. Until interest rates rise significantly, there simply isn't room for rents to go up without spurring large numbers of additional renters into making home purchase decisions.
On the other hand, Albuquerque, Baltimore, Philadelphia, and Pittsburgh have comparatively strong occupancy rates and only limited additional product in the pipeline. For these cities, competition from the for-sale market may cap rent growth potential for the most expensive apartments, but more affordable product likely could perform well.
Furthermore, while rent escalation prospects do not appear favorable in a significant number of markets, overall revenue growth still could be realized through improved occupancy.
Trends in the for-sale sector seem unlikely to have much impact on rent growth potential across several markets that experienced sizable rent declines recently. This group includes Boston, Chicago, Denver, Minneapolis, the San Francisco Bay area, and Austin, Texas. In these locales, any fundamental correction needed between home sale prices and apartment rents appears to have already occurred. That doesn't mean that additional rent reductions won't be seen, but rent shifts should reflect the traditional supply/demand relationship rather than the influence of the for-sale option.
Also look for the trends in supply and demand to shape future rent growth patterns in areas like Northern New Jersey, most of South Florida, Southern California, and metro Washington – areas that have ranked among the nation's better performers in recent times. All of these markets have plenty of room for rents to rise without prompting a sizable outflow of apartment renters into for-sale housing.
As always, metro-level analysis provides only a broad perspective as to likely trends for individual apartment communities, as neighborhood-level conditions have far more impact on a specific project's performance. Individual property characteristics likewise are important, and can produce revenue results far different from the patterns seen across the metro as a whole.
Greg Willett is vice president of research products for Dallas-based M/PF Research Inc. Raymond Torto is principal and managing director of Boston-based Torto Wheaton Research.
According to the "M/PF-TWR Multi-Housing Outlook," a market conditions forecasting product from M/PF Research and Torto Wheaton Research, only one-fifth of the country's 59 largest apartment markets are likely to experience revenue growth of at least 3 percent from mid-2003 through the end of 2004 (First-Tier Markets). Another one-fifth should see revenues inch up slightly or hold stable (Second-Tier Markets). In three-fifths of the markets revenues are expected to decline further (Third- and Fourth-Tier Markets).
Los Angeles
Honolulu
El Paso, Texas
Fort Lauderdale, Fla.
Greenville, S.C.
Norfolk, Va.
Northern New Jersey
San Diego
New York
Birmingham, Ala.
Boston
Detroit
Revenue Growth Projected Through 2004: Above 3 percent
Most of the top tier markets expected to perform best through the coming year already have occupancy rates above the national norm; they have little additional product under construction; and they should lose comparatively few renters to single-family home purchase, as the for-sale sector is priced out of reach for many households. Revenue growth is projected to be above 3 percent through 2004. The few exceptions to this profile, such as El Paso, Texas, and Greenville, S.C., have rents so low that revenue growth of 3 percent or more results from adding just a handful of dollars to property balance sheets.
Notable Market: Los Angeles. As the only market anticipated to post double-digit revenue growth through the end of 2004, it offers the nation's best outlook. Affordable neighborhoods appear likely to perform particularly well, with demand propped up by immigration. The key factor needed to meet its favorable overall expectations is success across a sizable wave of new, upscale product coming on stream downtown. While these projects are among the nation's most impressive communities under construction, several are in locations that will require a very big dose of urban pioneer spirit.
Orange County, Calif.
Albuquerque, N.M.
Louisville, Ky.
Raleigh, N.C.
Riverside, Calif.
Tucson, Ariz.
Memphis, Tenn.
Portland, Ore.
St. Louis
Tampa, Fla.
Miami
Charlotte, N.C.
San Antonio
Revenue Growth Projected Through 2004: Under 3 percent
The typical market in the second tier of performers already has a competitive leasing environment. But an improving job picture should produce enough demand to roughly meet moderate ongoing construction and allow rent concessions to ebb a little. Thus, revenues should inch upward – they are projected to rise less than 3 percent through 2004.
Notable Markets: Riverside, Calif. and Miami. These two metros don't fit the prototype for second-tier performers. While they held up much better than most during the past couple of years, the near-term outlook is not as strong because of increased construction activity, particularly in Miami.
Richmond, Va.
Dallas
Greensboro, N.C.
Baltimore
Tulsa, Okla.
Washington
Fort Worth, Texas
Jacksonville, Fla.
Philadelphia
Revenue Loss Projected Through 2004: Under 3 percent
It's a mixed bag of cities in the third tier. While some have comparatively low vacancy rates now, others contain some of the nation's largest stockpiles of vacant units. What separates third-tier markets from those ranking a little better is a slightly more aggressive pace of construction that will make rent concessions harder to reduce, thus revenue projections predict losses at less than 3 percent.
Notable Market: Washington. The nation's capital has been leading the country in employment growth. Its occupancy rate is well above the U.S. average, and a sizable difference between rental rates and homeownership costs leaves room for pricing increases. You might be expected it to rank higher than the third-tier group. However, momentum will be hard to sustain because the market is challenging for the national lead in ongoing construction.
West Palm Beach, Fla.
Houston
Kansas City, Mo.
Dayton, Ohio
Phoenix
Denver
Pittsburgh
Atlanta
Oklahoma City
Cincinnati
Sacramento, Calif.
Seattle
San Francisco
Orlando, Fla.
Indianapolis
Cleveland
Minneapolis
Austin, Texas
Salt Lake City
Oakland, Calif.
Columbus, Ohio
San Jose, Calif.
Revenue Loss Projected Through 2004: Above 3 percent
The group is heavy on Midwest cities, where manufacturing's key role in the employment base always translates to comparatively big job losses during times of national economic turmoil. Also present are many markets with sizable job concentrations in the struggling high-tech industries.
Notable Markets: Austin, Texas and Houston. Austin and Houston could see big movement in the upcoming year. Austin's poor showing primarily reflects the large amount of product still under construction as of mid-2003. However, almost all of that future stock is nearing completion, and this year's starts have been minimal. Furthermore, after sizable cuts in rents, there is a much bigger difference between rental costs and home purchase expense in Austin than elsewhere in Texas. On the other hand, Houston, which barely misses the cut off to qualify as a third-tier market, could see its position relative to other metros deteriorate quickly. A dramatic surge in construction starts will equate to a flood of completions throughout 2004 and into early 2005.
* Markets are listed from strongest to weakest.