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Rental Supply Surging, But Landlords Still Have Leverage

14 January 2015 in Trading Ideas

The average landlord might tell you that the residential rental market is beginning to cool off. But that doesn’t necessarily mean it’s all downhill from here.

As a CNBC.com article pointed out last week, higher rents are still being collected: Average rents rose 3.5% in 2014, their highest growth rate since 2007. With rents setting new records, and an improving labor market resulting in faster wage acceleration, CNBC.com noted that landlords will have leverage to raise prices, at least in the short term.1

“It is surprising, and an outlier, to have a strengthening fourth quarter when everyone is going home for the holidays,” Alexander Goldfarb, an analyst with Sandler O’Neill, told CNBC.com. “Rent (price) growth in 2014 surprised everyone.”

The strong rental market has also been a boon for the stocks of real estate investment trusts focused on developing, leasing, or operating rental properties.

In the past 12 months, the Renter Nation motif has gained 39.6%. In that same time frame, the S&P 500 has increased 13.8%.

In the past month, the motif has risen 6.4%; the S&P 500 is up 1.4%.

However, such a hot market is bringing more supply on board in the wake of a construction boom in rental housing, which has some analysts projecting the market may pinch the ability of landlords to raise rents.

After apartment vacancies rose for the first time in five years this past summer, the second half of the year saw little change as vacancies remained flat in the fourth quarter, though still near historical lows.

Last year saw the largest increase in apartment construction activity since 2001, CNBC.com said, with 161,518 new units delivered, according to real estate analytics firm Reis. Cities like Houston, Austin and Washington, DC, are seeing an apartment boom, which could start to ease rising rents.

But developers aren’t standing pat. With too many cranes working in major urban markets, many have set their sights on the suburbs, where a building boom never happened — and where potential returns may be far higher.

Both Avalon Bay and Essex Property Trust (a combined 30.6% weighting in the Renter Nation motif) are starting to focus their investment dollars on the suburban markets, CNBC.com said. Further, the report said Essex, which is concentrated on the West Coast, is especially well-positioned.

“Housing is unaffordable in San Francisco, so Essex has been capitalizing on the fact that rent growth has been tremendous,” Goldfarb said. “In their development projects, the yields have been way above what they expected.”

According to CNBC.com, demographics still favor renting, with the enormous millennial generation now getting jobs at a faster clip and household formation still skewed away from owning, especially with housing prices still rising and lending still historically tight.

And, unlike the single-family housing market, multifamily never experienced a surge. In fact, CNBC.com said, in 2009 and 2010, developers were building so few new units that when factoring in apartments that became obsolete, the nation actually saw a net loss of apartments.

The possibility that rental supply still needs time to catch up to demand could be beneficial for rental housing developers and their investors.

1Diana Olick, “Will too many apartments pinch the rental market?”, cnbc.com, Jan 6, 2015, http://www.cnbc.com/id/102314102#., (accessed Jan. 11, 2015).