Rental Housing Is Suddenly Headed Toward a Hard Landing

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COMMENTARY

For most of the past year, investment risk in the housing market has been focused on the sales segment. That was largely because the spike in home prices during the pandemic led to a “what goes up must come down” mentality, coupled with lingering memories of the housing bust of the late 2000s. But the data we got over the past few months suggest that it is the rental portion of the housing market that is gearing up for a hard downturn.

Falling rents in 2023 should be the base case at this point, with the only question now being how far down will they go? And while tenants will enjoy this opportunity, the concern is that it will destroy the pipeline of new supply for years to come.

The upside risks in the rental market are surprising because the turnaround has been so sudden. Renters are still reeling from years of big profits. The first downward movements appeared just three months ago, as weak demand for apartments in the third quarter led to the return of seasonality in rental prices.

It has gotten steadily worse since then. According to Apartment List, rents fell nationally every month in the fourth quarter. Rents falling in the fourth quarter are in line with the pre-pandemic seasonal rate, but the magnitude of the decline is larger than what we saw between 2017 and 2019. Rents fell nationally by an average of 0.9% per month in the fourth quarter , against the 2017-19 average which was half that. In a typical year rents rise by about 3%, so that suggests rents fell by 3% in the final three months of 2022 on a seasonally adjusted annual basis.

Why has the rental market become so weak? As rental housing economist Jay Parsons points out, new rental demand fell in the second half of the year and was negative for the entire year for the first time since 2009.

During the pandemic, there was an explosion in the number of one-person households, and they mostly moved into apartments, in many cases replacing the people who contributed so much to home buying demand during the same time. As we saw in e-commerce and streaming services, the rental market attracted demand from the future. And it took until the second half of 2022 for that demand to dry up, leading to fewer lease signings, increased vacancies and lower rents.

Ominously for the rental market, it is not clear that developers and investors are prepared for a period of softness. The national housing vacancy rate rose to 5.9% in December, its highest level since April 2021, and has risen by 0.2% month over month recently, according to Apartment List. At that rate, the vacancy rate would be at its pre-pandemic level by April.

All this is happening while there are more apartment units under construction than there have been in more than 50 years, which will throw even more supply into the market. Even before accounting for the possibility of job losses and a recession in 2023, this increased supply will create more jobs.

There are several important pieces to this puzzle that go beyond another industry going from a pandemic boom to a post-pandemic bust. The first is that the rental industry did not go through the near-death experience that the for-sale housing market did in the late 2000s. Until the 2008 recession, the industry focused on building detached homes for sale instead of apartments, so if there was any shortage of apartments at that time. Homeowners who lost their homes needed somewhere to live, so they rented, which supported the rental market.

And then the entry into the workforce of millions of new members of the millennial generation was better for renting than the demand for ownership at that time. So while homebuilders, who tend to be more nationally focused, became more conservative in the 2010s, multifamily developers, who are more local and regional, aimed to build as many apartments as they could for meet the demand of the new millennia.

But as Bill McBride of Calculated Risk has pointed out, millennials are now at the age where they’re more likely to want to buy homes than rent them. The demographics of the country in the 2020s are leaning towards ownership, not renting. So as the housing market recovers from this soft patch, we should expect the sales market to rebound more strongly than the rental market.

The hope is that the rental market adjustment we get in 2023 is orderly — renters get a break in rents, investors take some losses, the market rebalances and life goes on in 2024. The risk is something more chaotic: capital dries up, multifamily developers go bankrupt and new construction sinks, leading to years of suppressed construction in the years to come. The time to raise the alarm is now – this situation is ugly and will get worse before it gets better.

More from Bloomberg Opinion:

• Housing market doesn’t need much to bring buyers back: Conor Sen

• Are you expecting house prices to fall? Bad Strategy: Alexis Leondis

• Renters are finally getting a break from rising prices: Conor Sen

This column does not necessarily reflect the opinion of the editorial board or of Bloomberg LP and its owners.

Conor Sen is a columnist for Bloomberg Opinion. He is the founder of Peachtree Creek Investments and may have a stake in the areas he writes about.

More stories like this are available at bloomberg.com/opinion