Multifamily as an asset class has performed well since the onset of COVID, especially Class B and C properties.
As of the end of Q2, occupancy and rents were more or less flat.
This is staggering when you consider employment was down 11.5 million jobs and the Q2 GDP declined by an annualized 32.9%.
Let’s unpack the story, starting with occupancy.
The strong occupancy is easier to explain than resilient rents. Most impactful has been the many forms of eviction moratoriums. Residents who would typically be evicted for non-payment or skip to avoid eviction, are hunkering down and remaining in place while building up large delinquent balances. At a typical Class B/C community, you could expect 1-3 evictions per month.
Resident retention has also been abnormally high as many landlords have been less aggressive with their renewal increases and many residents have opted not to move during the pandemic due to health concerns. We typically see retention rates of ~50%, but many of the Atlas properties have had retention rates of 60%+ since the onset of the pandemic.
Lastly, the pandemic occurred during the strongest part of the leasing season (spring and summer). This wasn’t a typical leasing season, but I suspect leasing velocity was stronger than it would have been in the winter under the same circumstances.
The combination of fewer evictions, higher retention, and the strong leasing season have led to solid occupancies at Class B/C properties. This could change as the eviction moratoriums burn off.
The story around rents is more complex.
What we’re experiencing in the economy and the level of government support is completely unprecedented, so it’s difficult to look at history to inform the future.
From Q1 to Q2 2020, GDP was down 9.5%, Employment 12%, and Consumer Spending 10.5%, yet rents held firm.
GDP and employment are typically correlated to rent growth and signal a major decline in the near future. Historically, GDP/employment leads YoY rent by 2 quarters and if the relationship were to hold true, we would expect average rent to decline ~10%. That’s not going to happen.
We had such a steep drop off during Q2, but ever since, we have been experiencing a Nike Swoosh-shaped recovery. Rents are disconnected from GDP and employment.
The explanation for the break in correlation is due to household income and savings, which was aided by significant government support. Median household income grew slightly in Q2 and disposable personal income increased by 9.6% from Q1 to Q2 2020. People who lost their job, but retained similar income were able to pay their rent.
Despite the increase in unemployment, the decrease in total compensation was offset by the additional stimulus. That explains why rents have held firm, but what do we anticipate moving forward?
Here are the factors that play into future rent.
- The recovery is continuing but at a slowing pace. Many previously furloughed workers are being laid off permanently. Rents down.
- As of September, the unemployment rate was 7.9%. We’ve regained 11.4M of the 22M jobs lost in March and April. The unemployment rate is now in line with previous recessions and well above the 3.5% unemployment rate we had in February.
- Since the government has been unable to pass additional stimulus, median household income is declining. Rents down.
- The Coronavirus is still not under control and the timing of a vaccine is unknown. Rents down.
- Eviction moratoriums are being lifted and occupancies will decline. Rents down.
- There is an ongoing affordability crisis that should lead to sustained demand for Class B/C communities. Rents up.
- Class B/C communities will be the beneficiaries of downward mobility, with Class A tenants moving to more affordable properties. Rents up.
- 5 million home loans (or 7.01%) are in forbearance. Per a recent WSJ article, many of these owners have equity in their homes but can’t afford their mortgage. This may lead to forced selling and could be a boon for the rental market. Rents up.
Forecasting rents is challenging and there are many factors at play that impact how Class B/C communities will perform moving forward. However, barring any major unforeseen shocks to the market, I expect Class B/C rents to hold firm and grow over the long-run.
What do you think?