Another Strong Year in the Books
While the end of the year brought a partial Government shutdown (now the longest in history), and volatile markets trying to make some sense of the profusion of political noise, 2018 proved to be another strong and steady one for multifamily. As this cycle’s development tapers out over the next few years, the industry is expecting to see stable occupancy – especially in the Class B/C sector – and continued rent growth, albeit at a slower pace.
Rent Growth & Vacancy
While overall vacancy has hit a cycle-high of 4.8%, it has remained at that level for two consecutive quarters, according to data from Reis. A Q3 year-over-year rent growth of 4.48% is 13bps slower than the 4.61% measured in Q2 2018, but 20bps faster than what was achieved year-over-year as of Q3 2017.
Reis projects continued rent growth to round out 2018, when asking rents should average close to $1,436. Vacancy is expected to increase to 5.1%, driven by an uptick in completions compared to 2017. More on construction in a bit.
A Tale of Two Asset Classes
When we separate out Class A and Class B/C projects, we see a quarter-over-quarter vacancy decrease of 10bps in Class A product, while Class B/C displayed a 10bps increase. Still, at 3.6%, the Class B/C vacancy level remains significantly lower than the 6.2% found in Class A assets. Interestingly enough, year-over-year rent growth in the Class B/C space has surpassed that of Class A this quarter – this is only the second time this has occured during the cycle.
Higher vacancy in the Class A space is a function of unit deliveries rather than a lack of potential renters. There were 49,500 Class A completions in Q3 2018, about 4,500 less than the prior quarter. Tight vacancy in the Class B/C space is partly due to an almost non-existent construction pipeline, with just 18,000 units delivered from 2014 to present. Compare that to 918,000 units in the Class A space.
The Continued economic expansion is supporting an extended apartment cycle. December saw 312,000 jobs added to the economy, significantly higher than the average of 229,000 added each month over the past year. The December unemployment rate clocked in at 3.8%, 10 bps higher than the cyclical low.
While the end of 2018 pressed pause on the upward trend of interest rates, the 10-Year Treasury is currently hovering around 2.7%, up from the 2.4% seen at the end of 2017. More interestingly, the 2-Year Treasury has steadily climbed from 1.40% to 2.48% over the past year. The spread between the 10-Year and 2-Year is now below 20 bps, and will likely invert over the next few quarters.