Those Humble Suburban Garden Apartments Deliver the Strongest Rent Growth

Article originally posted on CoStar on June 9, 2023

Over nearly a decade, mid-priced apartments have quietly solidified their position as a resilient force in multifamily real estate to be increasingly sought-after by renters because of their highly inelastic demand.

Meanwhile, an oversupply of higher-end apartments hasn’t become competitive to those three-star multifamily properties because of a large spread in rents between the two classes. As a result, mid-priced properties are poised to keep their spot as the front-runners in the multifamily rental market.

Rent growth is getting attention this week as industry professionals meet at the National Apartment Association’s Apartmentalize conference in Atlanta, where investors and owners are discussing returns of different types of multifamily properties. One interesting set of return data involves these mid-priced rentals.

From 2015 to three-star buildings consistently achieved the highest average rent growth with an annual average of 3.6% and a remarkably low average vacancy rate of 5.6%. These mid-quality properties outperformed rent growth in higher-rated four- and five-star properties by 100 basis points, surpassing the national average growth rate of 3.1%.

Even during the challenging pandemic years of 2020 to 2022, rent growth in three-star apartments kept beating higher-end properties, recording a rent growth of 5.9% on average compared to 5.3% across four- and five-star assets. And this came even as the higher-rated units hit record rent growth during 2021.

As rent deceleration began in 2022, four- and five-star properties experienced steeper rent slowdowns, while three-star buildings swiftly regained their rent growth lead, a position they have maintained ever since.

Renter demand for three-star units remains resilient as it is relatively unresponsive to rent growth since many renters in this income bracket face financial constraints and fewer options. A recent study revealed that 41% of renters earning between $30,000 and $75,000 annually experience a moderate housing cost burden. Moving to a less expensive two-star property often means sacrificing amenities and accepting lower-quality finishes, making it an unattractive trade-off for many renters.

Conversely, the dream of homeownership remains out of reach for a significant number of three-star renters, as the inability to save for a downpayment and cover closing costs presents a major obstacle. Consequently, renting becomes the primary housing option for these individuals and families.

Contrary to conventional expectations, the oversupply of high-end properties does not create bargain opportunities for three-star renters. Despite the anticipated increase in new unit completions, expected to be the highest since the mid-1980s, and a higher national vacancy rate for apartments that grew by 200 basis points in the past two years, rents have not seen a significant decline. While effective rents are falling in the high-end market because of concessions offered at new projects, the situation today is different from the past.

In the 1980s and 1990s, the small difference in rent between existing three-star properties and new developments allowed concessions to bridge the gap. However, the current gap between rent for new four- and five-star developments and three-star properties has increased to an average of $600 a month nationally, meaning new developments would have to offer an average of three months of free rent or more just to match the current rent paid by existing three-star residents. Furthermore, the average three-star resident would need $22,000 in additional income to qualify for higher-end buildings, further limiting their options.

The future performance of three-star buildings in the multifamily rental market appears promising. Mid-priced renters are caught in a situation where homeownership is financially out of reach, and downsizing into smaller rental units is unappealing, leaving them with limited alternatives for housing. Projections indicate that from 2023 to 2024, three-star properties are expected to experience an average rent growth of 2.1%, surpassing the 1.4% in rent growth forecasted for four- and five-star buildings.

One of the reasons for this success is the insulation provided by the significant disparity in rents between newly developed four- and five-star properties and existing three-star buildings. The rent gap largely shields three-star apartments from the effects of an oversupply in four- and five-star units, allowing three-star rent growth to outpace the higher-end market segment.