Falling rents in 2023 should be the baseline scenario at this point, and the only question now is how much will they fall? And while tenants will be thrilled by the opportunity, they worry it will destroy a string of new deliveries for years to come.
The rising risk in the rental market is surprising because the turnaround was so sudden. Tenants are still looking forward to many years of rapid growth. The first signs of a slowdown appeared just three months ago, after weak demand for housing in the third quarter led to a return to seasonality in rental prices.
It’s gotten worse since then. According to the Housing List, rents fell nationwide on a monthly basis in the fourth quarter. Rents falling in the fourth quarter are in line with the pre-pandemic seasonal norm, but the scale of the decline is larger than in 2017-2019. Rents fell nationwide by an average of 0.9% per month in the fourth quarter, compared to the 2017-19 average, which was half that. In a typical year, rents increase by around 3%, suggesting that rents fell by 3% in the last three months of 2022 on a seasonally adjusted annual basis.
Why has the rental market become so weak? As housing economist Jay Parsons points out, new rental demand surged in the second half of the year and was negative for the full year for the first time since 2009.
The pandemic has seen an explosion in the number of one-person households that have largely moved into housing, in many cases replacing those who contributed so much to housing demand at the same time. As we have seen with e-commerce and streaming services, the rental market has attracted demand from the future. It took until the second half of 2022 to exhaust this demand, which led to a lower number of signed leases, an increase in vacancy rates and a decrease in rents.
To the disadvantage of the rental market, it is not clear whether developers and investors are prepared for a period of stagnation. The country’s home vacancy rate rose to 5.9% in December, the highest level since April 2021, and has recently increased by 0.2% per month, according to the housing list. At this rate, the vacancy rate by April would reach the pre-pandemic level.
All this happens when there are more apartments under construction than in over 50 years, which will result in even more supply on the market. Even before considering the possibility of job losses and a recession in 2023, this increased supply will create more job vacancies.
There are some important pieces to the puzzle that go beyond just another industry going from pandemic boom to post-pandemic collapse. First, the rental industry has not gone through a near-death situation like the housing for sale market in the late 2000s. Until the 2008 recession, the industry was focused on building single-family homes for sale, not apartments, so if anything, housing was in short supply at the 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 young millennials at the time was better in terms of renting than demand for ownership. So while home builders, who tend to focus more on the country, became more conservative in the 2010s, multi-family developers, who tend to be more local and regional, aimed to build as many apartments as possible to meet the demand of young millennials.
But as Bill McBride of Calculated Risk has pointed out, millennials are now at an age where they are more likely to want to buy homes than rent them. The country’s demographics in the 2020s lean towards ownership rather than renting. So, as the real estate market recovers from this weak period, we should expect a stronger improvement in the for sale market than in the rental market.
We hope the rental market correction we get in 2023 is orderly – tenants move away from rents, investors take some losses, the market rebalances and life goes on in 2024. The risks are more chaotic: capital dries up, multi-family developers they go bankrupt and new construction declines, leading to years of stifled construction in the years to come. It’s time to raise the alarm – this situation is ugly and will only get worse before it gets better.
More from Bloomberg’s opinion:
• It doesn’t take much for the housing market to bring buyers back: Conor Sen
• Are you waiting for house prices to fall? Bad strategy: Alexis Leondis
• Tenants finally take a break from price hikes: Conor Sen
This column does not necessarily reflect the opinion of the editors or Bloomberg LP and its owners.
Conor Sen is a Bloomberg Opinion columnist. He is the founder of Peachtree Creek Investments and may have interests in the areas he writes about.
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