Apartment REITs Face Growing Supply, Plateauing Rents

By Stuart Eisenberg, Partner & RE Practice Leader, BDO USA LLP

New apartment construction is currently at a 42-year high, according to Bloomberg, leading to potential excess supply in certain high-end rental markets. Millennials and others still largely favor renting vs. ownership, with homeownership rates hitting historic lows this month. Despite the continued preference for rentals, supply is growing rapidly and may outpace demand as a result of the post-recession construction boom. June marked the biggest 12-month spike in the cost of shelter in almost a decade. This trend is not likely to stick around; in fact, economists predict an approaching plateau in rents.

Market conditions are raising red flags for many REITs. In particular, the two largest publicly traded multifamily REITs have repeatedly cut their revenue forecasts this year. Given the growing supply of apartments, some landlords have offered lease-signing concessions, such as periods of free rent or other incentives to retain and attract tenants to certain major markets.

Despite short-term revenue losses for apartment REITs, the rental market has remained relatively healthy overall. Annual effective rent has continued to grow, although it has slowed in recent quarters. According to data from Axiometrics, annual effective rent growth was 3.7 percent in the second quarter of 2016, a decrease from 4.1 percent in the first quarter and 5.1 percent in 2015.

There are several strategies apartment REITs can employ to ease the potential revenue squeeze. First, REITs may consider diversifying their portfolios and expanding to markets offering greater opportunity for rent growth. Excess apartment supply is largely concentrated in major cities and real estate hubs with high population densities, such as New York City and San Francisco. While dense urban centers are traditionally profitable, REITs may have more success supplementing existing properties in bigger markets with investments in secondary and tertiary markets—including Dallas, San Antonio and the Carolinas—to find new volume and grow revenue.

Additionally, REITs can look for opportunities to increase revenues with service and amenity upgrades to existing properties, which will help draw in new tenants, command higher rents and differentiate properties in crowded markets. REITs can also take steps to maximize cash flow efficiencies by minimizing the costs of utilities with high-efficiency appliances and automating certain management or maintenance processes. While REITs will need to make cuts to offset the lack of future revenue growth, they should make strategic decisions that do not sacrifice a property’s quality. For example, landlords should be hesitant to resort to deferring maintenance, and instead look to other solutions for minimizing costs.

In the coming months, supply will continue to increase, as current apartment construction projects are finalized and come to market. However, the market will likely experience a slowdown in new construction until demand catches up with supply. A successful strategy for apartment REITs will address short-term conditions in the market and also keep an eye toward possible developments in the sector and shifting economic fundamentals.