Rental Collapse Getting Worse. (Investors Panic)
The US Rental Market will Crash in 2023. Resulting in a massive Real Estate Investor Firesale that could be on par with the 2008 Subprime Crisis.
The #1 Story in the US Housing Market right now is not the decline in Home Prices. Rather - it's a complete collapse of the Rental Market. Apartment leasing demand has dropped to 30-Year Lows. Rents are declining. And Real Estate Investors are starting to panic.
Because these Investors have purchased A LOT of Homes over the last several years in the US Housing Market. According to data from Redfin, Investors have purchased 20% of all Homes Sold in 2021-22. In some cities, like Phoenix, they purchased over 30%. And in some neighborhoods it was north of 60%.
The profitability of these purchases was tied to the performance of the US Rental Market. Despite buying at record low Cap Rates, Investors were confident they could make their newly purchased properties profitable by jacking up the rent on their tenants.
And that thesis worked for a while. Rents across America surged in 2021 and early 2022. They went up by +42% in Tampa. +34% in Phoenix. And +29% in Dallas. Investors were riding high thinking they stumbled upon a pot of gold and many predicted rents would go up forever.
But then everything changed.
Beginning of the Rental Crash
The first warning came on July 27th when RealPage, the apartment software company, reported that leasing traffic at their apartment buildings "moderated" significantly in the Summer of 2022.
Lower leasing demand? That was a head scratcher for many investors. Especially since the conventional narrative was that higher mortgage rates would increase the demand for rentals.
But the bad news was just getting started. Next came a more dramatic report. In early October, RealPage revealed that Q3 2022 was the worst in 30 Years for apartment leasing demand. Check the graph below.
Quite literally - the renters left the building. A combination of sky-high rents, two years of inflation, and record low consumer sentiment resulted in renters consolidating households at a record pace. If someone was living alone, they found a roommate. Many young adults moved back in with parents.
The result was a sharp increase in rental vacancy rates. And declining rents. The most recent report from RealPage shows that October 2022 registered the 3rd biggest rental decline in the past decade.
Real Estate is a Bad Investment
This decline in rents is solidifying a fear that has been building in back of Real Estate Investor minds for the last 6 Months:
That buying Real Estate is a Bad Investment.
After all, Home / Apartment Values are declining, meaning that investors are losing on capital appreciation. At the same time, interest rates are going up, meaning that investors have to pay more to their lenders. And now Rents are declining too, which will further squeeze profit margins.
Put simply: the economics of buying real estate make no sense right now. In fact, the opportunity cost of owning real estate is negative because a Wall Street Landlord can earn more profit simply by buying a 6-Month US Treasury.
That's right. Due to Fed Rate Hikes, the yield on a risk-free, highly liquid, short-term US Government Treasury is higher than the Cap Rate (aka Investor Profit) to own and operate the average Rental Property in America.
This situation will inevitably coax many real estate investors, particularly Big Wall Street Investors, to invest in government bonds rather than real estate. Thereby resulting in a big drop in home purchase demand, a shift that is already starting to take place as Core Logic reported a big drop off in investor buying in Q2 2022.
As Home Prices decline further, Cap Rates will start to rise. Which could potentially entice Investors back into the market. But this where declining Rents complicates matters. If Rents continue to decline, then Cap Rates could remain flat even as Prices Decline. Which would cement Real Estate as a Bad Investment going forward.
But some Wall Street Investors remain optimistic. Despite Real Estate being a bad investment right now, I'm hearing these investors say things like "Rental Demand will bounce back in Spring 2023. At that point we'll buy some properties at a 15-20% discount, lock in a higher Cap Rate, and ride the wave of increasing rents once again. We have plenty of capital to deploy."
And that optimistic attitude explains why we haven't seen a complete, 2008-style firesale yet from Investors. They still think their business model of buying single-family homes, supported by a slew of false narratives regarding inflation and a housing shortage, is a good one. And they will continue thinking that until they lose so much money that they are forced to sell.
Record-Breaking Apartment Construction
One potential "nail in the coffin" that could force these Investors to sell is the record-breaking Apartment Construction that is occurring right now. According to the US Census Bureau, there are 909,000 Multifamily Units actively under construction in America. That is a 50% increase over pre-pandemic levels and the highest level in over 50 Years.
Meanwhile, there have been only 352k Apartment Completions over the last 12 Months. Indicating an unprecedented "backlog" of 550k Apartment Units that should have already been delivered, but haven't been due to construction delays. A majority of these units are set to hit the market in 2023, which promises to be the biggest dump of Rental Inventory ever.
A reality which will likely lead to further Rent Declines in 2023, especially among higher-end/luxury properties. And especially in Housing Markets like San Antonio, Boise, Philadelphia, Austin, and Phoenix, which have the biggest backlogs of Apartment Construction.
And Let's Not Forget about that Recession
1) Declining Prices - check
2) Declining Rents - check
3) Record Low Cap Rates - check
4) Rising Interest Rates - check
5) Record High Supply Glut - check
Are there any other headwinds we can throw on top of the pile for Real Estate Investors? Yes, actually. And this one is perhaps the biggest headwind of all: Recession.
This Recession is already showing up clearly in industries such as Housing and Tech. But it's still been fairly contained and the job losses have been mild, evidenced by a near-record low unemployment rate of 3.7%. However, at some point, likely sometime in the first half of 2023, the Recession will spread. And when it does the job losses will double and maybe even triple.
When that happens, it will create a whole new host of issues for the US Rental Market. Apartment Demand is likely to decline further, creating more downside for rents. I think we could see double-digit (>10%) Rent Declines in certain markets. If that happens many Wall Street Investors will lose their optimistic attitude. Many will get margin called and forced to liquidate. Which will ultimately make the decline in Home Prices even worse.
Looking on the Bright Side
But I want to end this article with an optimistic take.
And that's there should be lots of buying opportunities for homebuyers and real estate investors who exercise patience and diligence during this Housing Meltdown. As existing Investors get wiped out, that opens the door for new ones to buy in at a cheaper price.
I also think there's going to be a lot variation between cities. Some metros are way more exposed to the Rental Downturn and potential Investor Firesale. These are markets to avoid today, but to start targeting in 1-2 Years time as the dust from the Crash begins to settle.
There are also some metros - primarily the ones with a low share of investor buying and apartment development - that will be relatively immune to this downturn. And that could be a decent place to buy today if an investor is intent on deploying capital right now.
If you want more information on these markets and my predictions for the US Rental Market, check out this livestream I just did for my YouTube Channel Members. I spent 40 Minutes covering data from the November 2022 Reventure Newsletter, taking requests from Channel Members on different cities, and revealing some new interactive data points on Rental Vacancy Rates.
During my time off from YouTube I will continue providing YouTube Channel Members with livestreams once every two weeks. Along with access to interactive graphs and exclusive data. You can join and become a Channel Member at this link.