Five months into the pandemic, fissures are beginning to form in the foundation of the multifamily market. Through the spring leasing season, liquidity from enhanced unemployment insurance benefits and a yearning for stability in uncertain times were enough to maintain occupancy near pre-coronavirus levels and to provide something of a buttress for rents. As spring turned to summer, however, winds seemed to change direction, tenant patience began to fray and property performance waned.
West Coast cities with high technology exposure were the first to exhibit material revenue attrition. Reduced employment and income prospects led many renters to reconsider the efficacy of paying the highest rents in the country. Many tenants chose instead to relocate to more affordable areas when leases expired (as many do during the spring leasing season) or simply vacated and broke existing leases. Rents in the San Francisco Bay Area have declined by about 4 percent since the beginning of the year, and as much as 9 percent over the last 12 months.
More affordable markets, including Portland, also experienced softening, but to a lesser degree. While fleeing tenants apparently generated a “renter’s market” in San Francisco, absorption in a sample of 919 Portland properties surveyed by Yardi remained solidly positive in April, May and June, when tenants leased a net of more than 1,200 vacant units. Metro occupancy, including properties in lease-up or undergoing renovation, decreased only 17 basis points from 94.54 percent in March to 94.37 percent in June.
Although occupancy in the broad market remained healthy, demand for recent construction space appeared softer and the pace of lease-up slower. For example, unit-weighted average occupancy among 34 apartments completed in 2019 and 2020 declined from 77.26 percent in March to 64.57 percent in June. A portion of the decline was attributable to actual vacating tenants; indeed, 10 of 23 new assets reporting occupancy in March and June recorded net tenant losses over the period. An equal part was derived from weaker pre-leasing and lower at-completion occupancy — the average fill rate of properties receiving final certificates of occupancy in 2020 was 39 percent upon completion, down from 43 percent among those completed in 2019.
Signs of market stress were more evident in rent trends in the Portland metro. Year-on-year rent growth of properties stabilized at least 12 months averaged 3.23 percent during the winter quarter, but average rent declined $6.43 (-0.45 percent) from March to June, sending the annual comparison into negative territory (-0.44 percent) for the first time in this six-year series.
Annual rent trends in the Class A sector have been soft since 2017, only exceeding 2.5 percent in three months since December 2016. Yet conditions deteriorated further this year. Average Class A rents fell nearly 2 percent from December to June, with the largest losses (-2.2 percent) observed among properties completed since 2017.
Submarkets with higher concentrations of new Class A product incurred the largest rent decreases. Northeast Portland, where 30 percent of units delivered since 2017 are sited, posted a 1.40 percent average annual rent decrease in June, while Northwest Portland, which received 32 percent of new metro supply, experienced a 3.26 percent decline.
Neighborhoods in the city center affected by weeks of civil unrest as well as COVID-19 and supply pressure were hardest hit. Rents in all properties in the Downtown neighborhood plunged 6.65 percent over the 12 months ended in June — the largest setback in the metro area — while neighborhood stabilized Class A rents declined 9.03 percent. A decrease of more than 4 percent also was observed in Portland’s urban gem, the Pearl District, although the Class A segment in this case posted only a 3.52 percent decline.
In the early days of the pandemic, investors managed to look past recent turbulence and continued to accumulate Portland properties at aggressive prices. In May, two workforce housing properties were acquired at cap rates in the high-4 percent area, and an unfinished luxury Pearl District mid-rise was purchased in June at a pro forma yield estimated to be less than 4 percent at current rents.
The gap between seller price expectations and investor confidence grew wider over the summer, however, as potential buyers paused to assess the impact on market performance of the economy, supply, recently introduced rent control provisions and social unrest. No sales were recorded between June 30 and July 24 (down from nearly $200 million in the same period in 2019), although at least a dozen investment quality properties were on offer.
The RED Capital Research team does not expect the hiatus to last long. Like Seattle, underlying market fundamentals remain strong. Tenant preferences may shift toward the suburbs for a time, but homeownership remains a daunting prospect for most renter households, and a large-scale exodus from the urban apartment rental lifestyle to suburban homeownership is unlikely. We expect typical unlevered multifamily investor returns to reach the high-7 percent area over a five-year hold, slightly lower than before the pandemic but still among the first quartile of America’s 50 largest markets. Rent control — which caps rent growth on properties at least 15 years old — will largely affect the appeal of value-add acquisitions and may discourage property renovations but should not negatively impact the market’s overall investment appeal.
— By Daniel J. Hogan, ORIX Real Estate Capital’s Managing Director for Research. RED Mortgage Capital, a division of ORIX Real Estate Capital LLC, is a content partner of REBusinessOnline. The views expressed herein are those of the author and do not necessarily reflect the views for RED Capital Group or of the author’s colleagues at RED. For further analysis from RED Capital Group, click here.
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