Inflation and Interest Rates Continue to Make Apartments Attractive
The Federal Reserve raised interest rates by 25 basis points at the July meeting, resulting in a 22-year high for the Fed Funds rate. That’s not good news if you want to buy a house or need to sell an interest rate-sensitive asset. Although the Fed is increasing the short-term interest rate, as of today, the rate of a 30-year fixed mortgage is 7.125%. Subsequent increases in the Fed Funds rate are going to continue to put upward pressure on mortgage rates, which will continue to exacerbate the growing unaffordability of single-family homes. This dynamic makes renting an attractive alternative until interest rates return to lower levels.
While the change in interest rates impacts housing today, the result of inflationary increases in construction costs coupled with lower demand for new construction (both single-family homes and luxury apartments) will reduce the overall supply and drive up future costs. This slowing in supply can be seen in the recent Census Bureau report on new building permits for private housing. Year-to-date through July, permits for new housing are down 13% compared to the same period last year. Similarly, construction starts have dropped 7% year-to-date. Though 2021 and 2022 saw the onset of a housing boom, particularly for apartment construction, developers are putting the brakes on new projects.
This doesn’t mean that markets will not experience a near-term supply shock. According to RealPage, markets like Austin or Nashville as of Q2 2023 have 15.6% and 16.3%, respectively, of their total apartment inventory under construction. Those units will get built, they will get rented, apartment vacancy will increase, and rents will decline. However, these markets will continue to grow and will need additional apartment units to satisfy growing demand once the initial flood of units is absorbed. With construction of additional new apartment units delayed because of the current interest rate and economic environment, a strain on rents will occur and cause them to increase more than the norm.
Unfortunately, there will be nowhere for the renter to turn. Currently, single-family inventory is low with 646,698 active listings across the country as of July. That compares to pre-Covid inventory in July 2019 of 1,239,298. The combination of inflationary increases in price throughout the pandemic and now the doubling, if not tripling, of mortgage rates has prevented people from moving out of their homes. The alternative is not worth it to them. Again, this bodes well for the apartment market. As single-family home inventory languishes, pricing remains relatively high (though down from the peak), and mortgage rates don’t appear ready to subside, renting is a welcome alternative. Both renting apartments and single-family homes will benefit from this trend. The advantages of having a long-term outlook include capturing the near-term drop in apartment values due to increased interest rates and near-term supply challenges as well as the long-term rent growth from a future lack of supply for apartments set to remain in demand.
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