Gray Report Market Summary and Highlights: Week of July 21, 2022

Every week, The Gray Report publishes a video and podcast that covers the latest news, research, and reports from the multifamily industry, commercial real estate markets, and the economy. Below are some of the notes associated with our weekly video, podcast, and newsletter as well as the links to the sources that we discuss. These notes may be rougher and more conversational compared to other blog posts and publications from Gray Capital, but they provide additional insight into our ongoing discussion of the most important news and research for apartment investors.

RealPage: “Market-Rate Apartment Renters Spending 23% of Income Toward Rent” https://www.realpage.com/analytics/market-rate-apartment-renters-spending-23-percent/

• Sometimes I ask myself, “are we really teetering?” … Are we really teetering towards a place where people are spending more and more of their income on rent?
• RealPage would say that we’ve got a long way to go.
• The opener is a nice name check on the eviction tsunami that is—wait, are we still… is the tsunami coming? Did I miss something?
• So, yeah, the eviction tsunami did not arrive, despite the oceans of ink spent predicting it.
  • Rather than distinct policy decisions, RealPage argues that there is a “more significant driver keeping rental distress – and evictions – low: The vast majority of renters were able (and willing) to pay the rent.”
• Near-term, rents have gone up compared to rents, but we’re not teetering: Wages went up 15.6% in the past year, but rents for new leases went up by 21.9%. That seems like a tough figure to swallow but:
  • 57% of renters were renewals which don’t see as fast of a rent increase as new leases
  • Also, the actual rent-to-income ratio for market rate apartments only increased by about 2%, from 21.3 to 23.2, in the past three years from 2019 to today. Decreasing, but not teetering.
  • Most significantly, this past year marks the ends of an EIGHT YEAR trend of declining rent to income ratios
  • We are now approaching the same rent to income ratio as
    • Here’s a nice quote for some context:
    • “Median signed rents (actuals, not asking rents) were increasing slightly below income growth from 2016 to 2019, so rent-to-income ratios inched back to as low as 21.3% in 2019. As housing demand and renter incomes soared, actual monthly rents jumped 11.5% in 2021 and 9.3% so far in 2022, up to $1,510. Those increases reversed the pattern of descending rent-to-income ratios. The median rent-to-income ratio in 2022 to date measured 23.2%, matching the level seen back in 2011”
• According to the official government definition, renters are cost-burdened when they are paying more than 30% of their income on rent.
  • According to RealPage, the most cost-burdened segment were renter of class C properties who had a rent-to-income ratio of about 25%.
  • 25% is less than 30%.
  • This isn’t a mic-drop moment, and it’s a little mean and simple to think that that’s it here. The thing is, “cost-burdened” is pretty much an arbitrary definition. The thing that’s driving rent increases is the demand from the market, not some number-crunching target to get people to rent at 30% of their income level.
  • These numbers are not applicable to affordable housing, which is a different group, and I am very much NOT denying that there are low-income renters that are extremely cost-burdened. But the middle-of-the-road renter of market rate apartments is quite far away from being cost-burdened.

Redfin: “Rental Market Tracker: Asking Rents Rise 14% in June, the Smallest Increase Since October” https://www.redfin.com/news/redfin-rental-report-june-2022/

• Another week, another multifamily rent report, except that this one came out last week. I’m including it this week because I’ve noticed that a large amount of general news publications, when they dip their toes into reporting on rent growth, it’s more likely than not that they are going to cite the Redfin report.
• Am I disappointed that Redfin no longer has a side-by-side of average monthly mortgage costs vs. average monthly rent? 
  • A little bit. I mean, they’re not charging for this report, but I do miss that extra information.
  • It probably helps the overworked Gannett news service writer finish an article about the “dangers of rising rents” when there is no side-by-side comparison with monthly mortgage costs to needless complicate the issue.
• Rents “inched up in June” for a .7% month-over-month increase, that, if extended to all 12 months of the year, would come to 8.4% annual rent growth, which is well above the historical average rent growth. The year-over-year rent growth was measured at 14% in June.
  • Yardi Matrix measured a 13.4% year-over-year increase and called it “rolling along.” I like rolling along. It makes me feel like I’m going much faster. I’d much rather be rolling along than inching along.
  • Apartment List measured a 14.1% year-over-year increase and described rents as “holding steady.” Still better than “inched up.”
  • I think a lot about audience, but Redfin and Apartment List characterized rent growth a little differently, and they serve a similar audience of prospective renters. 
  • At least the numbers, in this case, match up fairly well, with all three of these monthly rent reports coming within 1% of each other.
• As long as you’re not expecting 15%  annual rent growth from the next two years, I think 14% is high, elevated rent. It could even go down and remain quite elevated compared to the historical average of 3-4% rent growth. 
• When it comes to specific markets, I like mentioning the Midwest, and Cincinnati is the leader in year over year rent growth.

Apartment List: “More Than 2 Million Households Dissolved (then Reappeared) During the Pandemic” https://www.apartmentlist.com/research/more-than-two-million-households-dissolved-during-pandemic

• This report on household formation covers the pandemic-related dip in household formation with some additional contextual information that really pulled me in.
  • Yes, you could read the headline and be off on your merry way, but the details behind this sudden drop and equally-sudden recovery could help explain household formation trends more generally
• One of their main points was that this shift in household formation was largely due to single-person households.
  • Single-person households were in the negative from March till October of 2020, but ever since then, this group has grown, more than making up for the drop in 2020.
  • Who are these single-person households? “It’s the young people,” says Apartment List: Gen Z renters experienced the most dramatic swings, dropping more in mid-year 2020, and rapidly growing ever since, at a rate that far outpaces other age groups
  • I have to give it Apartment List here because it’s rare to see such a simplified and easy-to-understand story that’s backed up so nicely with data.
    • Apartment List argues that these Gen Z renters went back home for a little while during the pandemic, and after October of 2020, they started going back to renting their own apartments.
    • This makes sense to me on an individual level, and you can see the increase in nuclear family households right as single-person households were going down, and then once single-person households went up, nuclear family households decreased. They went back to live with their parents, then they went back to live on their own.
    • The starkest evidence of this is how many people were living with a parent or living with a child in 2020, then in January of 2021, it flips, and there are more people living on their own.
    • Gen Z renters already have a baseline of growth as a renter population of an ascending demographic group, which accelerated the rebound after October of 2020.
  • So people went back to live with their parents, but what about other options? Did they group up as roommates? Nope. No they did not.
    • This is understandable in the pandemic sense if you think that, well, you’d rather hole up and be sick around your family, which is a nice heartwarming sentiment.

National Association of Home Builders: “Builder Confidence Plunges as Affordability Woes Mount” https://eyeonhousing.org/2022/07/builder-confidence-plunges-as-affordability-woes-mount/

• The recent drop is only matched by the drop that coincided with the beginning of the pandemic, but where that drop bounced back very quickly, I think that this drop will take more time to recover.
• “Affordability is the greatest challenge facing the housing market. Production bottlenecks, rising home building costs and high inflation are causing many builders to halt construction because the cost of land, construction and financing exceeds the appraised value of the home. In another sign of a softening market, 13% of builders in the HMI survey reported reducing home prices in the past month to bolster sales and/or limit cancellations.”
• Inflation is a term used to describe a general increase in the prices of all goods, … too much money chasing too few goods … but it’s not just a few goods, it’s a description of a widescale economic condition
• Arguably, supply chain issues and commodity price increases weren’t exactly inflation. For inflation, it’s like “prices are rising because prices are rising.” For the supply chain the past two years, you could point to specific labor force and logistical issues that were specific to certain commodities. I mean, lumber was really expensive, then it went down.
• What this report is suggesting is that there is an inflationary force that is coming up on top of the materials and labor shortages. And that’s making them feel less confident about building more homes.
• We’re not getting out of the housing supply shortage any time soon. This could be a sign that existing developments could be delayed, as well.

Marcus & Millichap: “Inflation Research Brief” https://www.marcusmillichap.com/research/research-brief/2022/07/research-brief-july-inflation

& “Implications of Rising Inflation for CRE” https://www.marcusmillichap.com/research/videos/implications-of-rising-inflation-for-cre

• Before I watched and read these two pieces, I tried to solve the problem myself, and I kept thinking about interest rate hikes. John Chang adds recession risks and reduced capital inflow into some CRE markets.
• Recession risks, to me, are the big one, but as we’ve said before, CRE and multifamily in particular can provide somewhat of a sanctuary if you find the right investment.
• Likewise, I doubt that multifamily investment will decrease as significantly as investment in other property types, and we could see capital moving from less inflation-resistant property types like industrial, office, and retail and moving into multifamily.

MarketWatch: “The Fed’s next interest rate hike ‘might be the biggest in decades.’ So we asked 6 real estate pros: What might that do to mortgage rates?” https://www.marketwatch.com/picks/the-feds-next-interest-rate-hike-might-be-the-biggest-in-decades-so-we-asked-6-real-estate-pros-what-might-that-do-to-mortgage-rates-01658191514

• Hat tip to Gray Capital Financial Controller David Brown for this article!
• The mindset behind this quote helps to explain a lot of the market reactions and how they seem to act almost inexplicably happy after news of a rate hike. (NEWS FLASH! YOU ARE SUPPOSED TO NOT LIKE RATE HIKES).
  • Really though, there’s a sense of acknowledgement of the inflation problem and a desire to resolve it quickly and start getting back to normal again:
  • “more rate hikes now means fewer rate hikes later which means the timetable for peak interest rates gets moved up and the eventual decline in rates due to a weak economy also happens sooner, he notes. “But all of this depends on, and even assumes, that inflation peaks very soon. If not, all bets are off,” says McBride.”

Mortgage rates are connected to, but not really determined by the Federal funds rate. And it is perhaps this indirect relationship and gap that is why McBride also notes the same kind of emotionality or volatility that often comes in the wake of a rate hike, predicting that mortgage rates could rise above 6% for a little bit after a rate hike announcement before settling down “shortly thereafter.”

• Another thing that’s clear from this article is that the talk is not about 75 basis points any more. A full 1%—100 basis points—increase in the federal funds rate is now a reasonable expectation. I’d say 75 basis points is reasonable as well, but it’s an interest time when a 1% rate hike is a reasonable expectation.