Apartment Construction Remains Strong, Rent Prices Dropping

Recent reports suggest that a combination of the Federal Reserve’s interest rate hikes and tightening credit conditions are affecting the multifamily home market, with a surge in U.S. rental home construction.

The Commerce Department announced in late July 2023 that groundbreaking on homes with five or more units — generally considered apartments — decreased over 11% to 482,000 starts in June from 545,000 starts in May. It’s likely a direct result of the aggressive rate hikes adding significant costs to financing large-scale construction projects. Permits issued for new multifamily projects also hit their lowest rate in June since 2020.

Yet slowdown aside, government data shows:

In short, the country’s apartment building boom has begun easing the pressure of a rental housing shortage that has plagued home-seekers and driven rental costs soaring since 2020 and earlier. It’s possible, as some experts think that this boom may finally pressure rent prices to drop. 

By the Numbers: The Multifamily Market

The Fed policymakers have been watching these numbers for months, and signs indicate that while the monthly consumer price index (CPI) figures haven’t yet registered recent trends, the 500 basis points worth of interest rates may finally be cooling the market.

One economist likens the current situation to a “tale of two economies,” where first-time single home buyers are hampered by high borrowing costs, and robust construction on multifamily units suggests the market will soon see more available units for rent.

Tenants are more than ready for rental relief. Even though declines in various goods and services pulled the CPI down to its lowest annual increase (3%) in more than two years, rent prices soared over 8% YOY in June, driving 70% of upward pressure on inflation. And recent data suggests rent’s inflationary pressure is finally easing.

For example, in June, Zillow reported a 4.1% annual rent increase — about equal to historic averages pre-pandemic and significantly lower than the record-hitting 16.2% increase in February 2022. The midwestern and northeastern markets are still experiencing the highest annual rent growth, although San Jose, CA, leads the pack with the highest typical monthly rent ($3,411), followed by the NYC metro area ($3,405). 

The annual growth rate of the CPI’s Rent of Primary Residence category dropped from 8.80% in April to 8.66% in May, and the current monthly growth rate sits at about 0.5% (5.7% annualized). 

Another real estate analytics company confirmed that the growing availability of rental stock could influence a downward trend in prices if it keeps outpacing demand for new leases. The company reported a 10-basis-point increase in the national vacancy rate to 6.8% in June.

Booming Apartment Construction

While climbing interest rates have significantly increased the borrowing cost, multifamily construction remains robust. According to RentCafe, NYC Metro leads the race with 33,000 new rentals predicted to be available by the end of 2023. Developers plan to open 460,860 rentals by December 31, and deliveries will remain high through 2025.

Other reports show slightly different, but still high, numbers. Census data show nearly 1 million new apartment units — the highest number under construction since the 1970s — are under construction, with 520,000 expected to hit the market this year and 460,000 anticipated for 2024.

Considering ongoing materials and workforce shortages, how is this fast pace possible? RentCafe’s report suggests that the strong job market has enabled younger workers to move out of their parents’ homes into their own apartments. Work-from-home and hybrid policies also encouraged renters to upgrade to larger spaces to accommodate home offices. 

Twenty high-growth metros — which comprise over 40% of the renter demographic — hold nearly two-thirds of new multifamily units built during the past three years. Yet many of those rentals (nearly 90%) are high-end and unaffordable for those needing housing because they target upper-middle and high-income renters.

Take Philadelphia, for example. Within one week, three developers completed construction, broke ground for, or continued working on several multifamily high-rise apartments — all luxury and high-income properties. The city’s Center City District has seen incredible growth, with over 75% of new housing units in 2022 within the “Greater Center City” and adjacent zip codes. Of the nearly 6,000 completed homes, over 90% were multiunit buildings

Developers and property managers credit young adults who’ve moved to the city driving this building explosion. Many people also relocated to the City of Brotherly Love from Washington, D.C., New York, and Boston. Also influencing demand and propelling apartment construction? A change to the city’s housing policy.

Many projects under construction got their permits before the city halved its 10-year property-tax abatement for renovations and new construction. Increased costs and changes to this abatement have impacted some projects, making them harder to “pencil” — that is, ensuring a building’s sale or rental income covers construction/renovation costs, yielding a reasonable ROI to the developer.

Higher interest rates have pushed more people to stay in rentals rather than incur a mortgage, and builders have an easier time recovering their expenses with multiunit buildings than single-family homes. Also challenging for builders? Obtaining necessary licensing, permits, and approvals, so it’s more cost-effective to build multifamily homes with 50 or 100 units than a single residence. 

Are you a commercial real estate investor or looking for a specific property to meet your company’s needs? We invite you to talk to the professionals at CREA United: an organization of CRE professionals from 92 firms representing all disciplines within the CRE industry, from brokers to subcontractors, financial services to security systems, interior designers to architects, movers to IT, and more.

Related Articles