CHICAGO, IL - Origin Investments’ proprietary suite of machine learning models, Origin Multilytics, is forecasting that for the 12-month period from February 2023 to January 2024, year-over-year Class A apartment rent growth nationally will be negative by as much as 2% (-2%), the fourth largest rent decline in U.S. history, behind only World War I, the Great Depression, and the Great Financial Crisis. Negative rent growth also will occur in various regions, and in key gateway and secondary markets across the U.S.
According to Origin, the primary factors influencing negative rent growth include delivery of new units at a pace not seen since the 1970s and an increase in the affordability ratio to a level not seen since at least the 1970s. The implication of negative rent growth will be seen in lower net operating income (NOI) which will reinforce the discrepancy that exists between buyer and seller expectations thereby muting capital market activity.
Mutilytics is forecasting that after one year of negative rent growth, rents will again turn positive for the foreseeable future, based in part on the traditional strength of multifamily fundamentals. The median annual rent growth rate between January 1947 and January 2023 is 3.5% according to the St. Louis Fed. Further, between June of 2021 and October of 2022 the median annual growth rate was 15.06%, according to the Zillow Observed Rent Index.
“One year of negative rent growth doesn’t mean the sky is falling,” said David Scherer, co-CEO, Origin Investments. We’ve seen double-digit rent growth over the last two years and we’ve known, given historical trends, that this wasn’t normal or sustainable. What we’ll be seeing in 2023 is a logical correction.”
The rarity of annual negative rent growth, according to Origin, further underscores the historical strength of the sector.
“We are as bullish on the long-term viability of multifamily investment and development as we ever have been,” Scherer added. “We know that bouts of negative rent growth traditionally are followed by a strong correction. Yet it’s imperative for investors to go in with their eyes wide open.”
According to Multilytics data, the trajectory of rent growth has been flashing red for some time. Rents moderated during fourth quarter 2022, were flat in January, and will soften further through July before reaching year-over-year negative levels by January 2024.
On a regional basis, Multilytics forecasts that by January 2024 rent growth will be negative by as much as 2% (-2%) in the West and Southeast regions and in key gateway markets. Rent growth in the Northeast and Southwest regions is forecasted to be negative by as much as 1% (-1%). The worst case scenario for the Midwest region is no rent growth.
The rent growth forecast ranges for markets in which Origin invests in and/or develops multifamily assets includes Austin, -1% to -3%; Denver, -1% to -3%; Nashville, -3% to -5%; Phoenix, -3% to -5; and Tampa Bay, -4% to -6%.
In addressing the negative rent growth that is forecasted in markets where Origin invests and develops, Scherer said, “As long-term investors, we analyze a broad spectrum of variables, not just rent growth projections, when committing to a market. Population and income growth also matter and lead us to believe that positive rent growth will come back quickly, as it has historically.”
Greatest Influencers of Rent Growth Are Supply and Affordability
According to Phil Schuholz, assistant vice president, Origin Investments, the two factors most influencing the Origin Multilytics forecast of negative rent growth are supply and affordability.
- Supply: The delivery of new units and complexes across the country is unprecedented. According to RealPage, 426,000 units were delivered in 2022. Berkadia estimates 565,000 units will be delivered in 2023. Looking ahead to 2024, as many as 1,000,000 units may be delivered. The development of new multifamily units is at a level that is largely unmatched since the 1970s.
The unprecedented volume of new development was not unexpected. The boom experienced in the multifamily sector has been fueled by strong demand in growth markets across the U.S., and an extreme shortage of housing units that today totals +/- four million units. The impetus for the boom also can be traced back approximately three years when the Federal Funds rate went to 0%, making it much easier to get the financial backing for new projects. Rising interest rates have put development activity in check, which according to Multilytics will be a factor in a return to positive rent growth moving forward.
- Affordability: According to the Multilytics data, the affordability ratio (percentage of gross income paid for rent) nationally has been steadily increasing and reached 31.67% in 2022, the highest level recorded since at least the 1970s. For the previous five years the rent affordability ratio averaged 29.3%. It was as low as 25.31%, in the midst of a three-year period when the ratio was in the 25% range, in 2010.
“The affordability ratio is out of equilibrium,” said Schuholz. “It should be 30% or less, otherwise it puts a lot of pressure on household budgets. It’s not as simple as just paying more in rent.”
One scenario that is likely to gain momentum, he noted, is renters leasing two-bedroom units and taking on roommates. With that scenario, however, owners looking to compete both with new deliveries and added supply of one-bedroom units will be forced to make those units more attractive by offering increased concessions and/or lowering rents.
Lower Rents Equal Lower NOI and Valuations and Reduced Activity Levels
The logical outcome of negative rent growth in 2023 is downward pressure on property net operating income (NOI) levels. Further, when combined with likely increases in debt service obligations and other rising expenses (i.e., insurance premiums, employment costs, and maintenance costs) due to inflation, NOI likely will decrease further.
Accordingly, the implications for owners and investors likely will mean a pricing correction that may be nominal for certain assets, but as much as 5% to 15% for others, according to Scherer. This could mean trouble for some financially distressed owners who will find it necessary to sell and/or recapitalize assets, and opportunities for well-capitalized investors and fund managers.
“As investors and fund managers, now is not the time to put your head in the sand,” Scherer said. “This is an environment that we see creating acquisition opportunities. But success requires a long-term outlook, and we believe that information, along with informed decision-making, leads to better investment outcomes.”
About the Report
Origin Investments has produced the Origin Multilytics Rent Forecast, a report that provides a one-year outlook for Class A multifamily rents nationally, regionally and, more comprehensively, in a variety of markets where it owns, develops and manages multifamily communities. Multilytics’ proprietary suite of machine learning models, which provides the data for the report, can forecast rents down to the property level.