What Can Price Class Performance Tell Us About Multifamily Affordability?

The third quarter brought into fresh perspective the extent to which 2022 has not resembled 2021 for the multifamily industry. The surge in apartment demand that fueled occupancy and rent growth upward and drove lease concessions from the market did not survive the turn of the calendar. Leftover unusually high average occupancy to open the year helped to propel rent growth through the summer even as demand remained tepid, but steam finally ran out in the third quarter.

A common topic of discussion in the industry has been how much affordability issues have contributed to reduced demand in recent months and many analysts have been dubious of the connection. A look at price class performance can be helpful here.

As usual, all numbers will refer to conventional units of at least 50 units. Details on ALN methodology relating to price class designations can be found here.

Class A

One indication that price pressure may be having an impact of apartment demand is that net absorption has remained most resilient at the top of the market. If affordability concerns were negatively impacting net absorption, we would expect that the effect would be smaller in the premium space – especially with the cost of a major substitute good (home ownership) going up.

Class A net absorption through September of this year was 48% lower than last year. That was a substantial shortfall, but it was also the smallest of the four price classes. Just less than 80,000 net units absorbed in Class A units in the first nine months of the year was less than any recent year except for 2020. Class A properties also held up best in the third quarter specifically, with about one-third of year-to-date net absorbed units coming in the third quarter.

This subset of properties is also the group to deal most with the competition from new units entering the market. Lackluster demand combined with this year’s new supply resulted in an average occupancy decline of 0.7% through September to just over 88%. Even after trending slightly downward all year, Class A average occupancy entered the fourth quarter almost 400 basis points higher than in the months leading into the COVID pandemic in early 2020.

Class A average effective rent growth has led the price classes this year, although, not by the margin that might be anticipated. A 9% gain through September was lower than last year’s 11% jump but considerably higher than in any other recent year. The average Class A unit finished the month leasing for approximately $2,325 for new residents. The availably of lease concessions remained low relative to historical norms and fell further in the third quarter.

Class B

Class B properties have in many ways been a blend of Class A and the workforce housing tiers. On the one hand, net absorption through the first three quarters has been nearly 75% lower than last year but remained in positive territory as did Class A absorption. On the other hand, this year’s absorption total in the period was less than half that from any year in the 2017 through 2019 period – an ignominious feat avoided only by Class A.

About 43,000 net absorbed units was not enough to offset new supply for this group. While new Class B properties are less common than Class A, there are new properties that come online outside the most expensive submarkets of a market and find themselves categorized as Class B based on a unit mix-weighted average effective rent per square foot ranking in the metro. National Class B average occupancy fell by 1.3% in the first nine months of 2022 to close September at just over 92%.  While not as substantial a difference as with Class A, average occupancy finished the third quarter almost 200 basis points higher than in early 2020.

Year-to-date average effective rent growth of about 8.5% brought the average Class B unit to about $1,920 per month for new leases to end the period. This gain followed an 11% increase in the same portion of last year but was at least double the appreciation from any year in the 2017-2020 period. As with Class A, lease concession availability remains low and has declined on a year-to-date basis. However, the third quarter did see an 8% increase in discount availability and the fourth quarter will likely see another increase.

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Classes C and D

The picture has been quite different for the bottom two price tiers. Both have suffered a net loss of leased units so far in 2022, both have seen lease concession availability increase this year as well as in the third quarter in particular, and both have still experienced unusually high rent growth.

More than 13,000 net leased units have been shed for Class C properties in the first nine months of the year, and roughly another 21,000 net leased units have been lost in Class D properties. In other words, about 34,000 fewer units were leased at the end of September than to open the year for the workforce housing segment. Class D has already been in negative territory at mid-year, but the third quarter was an especially tough one for Class C. Slightly positive net absorption through June gave way to a net loss of about 19,000 leased units from July through September.

A 1.4% decline in Class C average occupancy and a 1.2% decline for Class D were the result of this negative net absorption. Unlike the top two price tiers, after the third quarter decline, Class C and Class D average occupancy has already returned to the pre-pandemic level. This will remove one tailwind that was still aiding rent growth earlier in the year.

Rent growth so far this year has been the metric to most resemble Class A and Class B performance. An 8% gain for Class C and a 6% gain for Class D were each lower than in the same period last year but obviously also well above the rent growth from prior years. The average Class C unit closed the period leasing for around $1,615 per month for new leases with the Class D average finishing at about $1,270 per month.

Takeaways

It has been clear since early 2022 than a paradigm shift had occurred for apartment demand. There are myriad reasons for the change. One that does not get enough attention is the unusually high number of 25-to-34-year-olds previously living with parents that created their own households in 2021. This was a temporary boost that was unlikely to be repeated in 2022. However, affordability must be part of the conversation.

Basic economic principles would tell us that as price increases, demand decreases – even for relatively inelastic goods like housing. National average effective rent for new leases has increased by 25% since the start of 2021, with some markets well above that. The fact that single-family pricing and availability have also been challenging likely helps multifamily demand to some extent, but that impact will be most concentrated at the top of the market.

Outside of the premium sector, household consolidation also plays a role. Purchasing a home may not be an option as a response to higher rents and finding a substantially cheaper unit may also not be feasible – but adding roommates and splitting costs or moving back to a relative’s home is always an option.

If affordability were impacting apartment demand, we might expect to see demand declining less for premium properties with higher income residents and declining more for properties with higher rates of residents with less disposable income. This dynamic is precisely what has played out over the last nine months.

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