Higher for longer interest rates have been “killing off” the real estate market, especially commercial real estate, according to Lawrence Yun, chief economist of the National Association of Realtors. Yun, speaking at the recent National Association of Realtors Real Estate Forecast Summit, anticipates four to six interest rate cuts in 2024 and 2025, which will in turn improve conditions in the commercial real estate market.
Higher interest rates have caused transaction activity in commercial real estate to collapse by 60% over the past two years, well below 2019 transaction volume, Yun says. Potential buyers have a more difficult path to borrow money, plus the lack of recent transactions makes it harder for buyers and sellers to agree on a price.
Among the commercial property sectors, cap rates on apartments continue to be well below normal, which is just above 7%, Yun said. Apartment prices continue to hold up and cap rates are below 6% for that sector, compared with cap rates above 8.5% for offices and above 7% for industrial properties.
Yun anticipates that while rent growth for apartments is slower today, he believes growth will be significantly higher in two to three years because of continued high demand.
Jobs Driving Demand for Commercial Real Estate
With the exception of offices, the five million net new jobs created since February 2020 are driving higher net leasing across all property sectors including apartments, Yun said.
States with the highest job growth (from 7% to 11.5% between March 2020 and December 2023) include: Arizona, South Dakota, North Carolina, Montana, Texas, Florida, Utah, Nevada, and Utah. Just three states (Hawaii, Vermont and Rhode Island) and the District of Columbia lost jobs in that same period.
Multifamily Rent Tracking
Prior to the pandemic’s disruption of multifamily trends, annual rent growth was typically 2.5% to 3.5%, said Igor Popov, chief economist of Apartment List.
“Today, the apartment market is relatively cool, with muted growth that declined one percent year-over-year from February 2023 to February 2024,” Popov said. “But rents are still up 18% now compared to February 2020, just prior to the pandemic, even though they’re down 6% from the pandemic peak in August 2022.”
That 18% increase in rents since February 2020 may seem high, but it compares to a 44% increase in home prices in that same period, Popov said.
Housing cost data, which is based on rent for primary residences, is included in the Consumer Price Index and has been driving much of the headline inflation, Popov said. However, here’s a disconnect between government and private rent data, with the Bureau of Labor Statistics (BLS) showing 6% rent growth year over year in February 2024, compared to a decline in rent growth of 1% in Apartment List’s data for that same period. Popov explained that the BLS data is a lagging indicator based on what renters currently pay rather than new leases, and that rent growth peaked about six quarters ago.
While no one in the multifamily industry wants to see slower rent growth, much less negative rent growth, rent data contributes to Fed policies on interest rates. A decline in rent growth is good news for measuring inflation, which bodes well for several interest rate cuts by the Federal Reserve in the coming year or two, Popov said.
Regional Variations in Rent Growth
The 10 metro areas where rent growth declined year-over-year include Austin, Atlanta, Jacksonville, Raleigh, Portland (Oregon), Orlando, Nashville, Phoenix, San Antonio and San Franscisco, according to Apartment List. Popov pointed out that many of these metro areas are in the Sunbelt, where there’s significant population growth and job growth. The reason rents are falling in those locations is added supply, not a lack of demand. He anticipates those markets to stabilize as new supply is absorbed.
The 10 metro areas where rent growth accelerated year-over-year include Grand Rapids, Milwaukee, Hartford, Providence, Louisville, Washington, D.C., Virginia Beach, Kansas City (Missouri), Chicago and Pittsburgh. Many of these markets offer more affordable rentals along with population and job growth.
One pattern that continues even as the pandemic fades is the gap between rent growth in suburban locations (up 21% since pre-Covid) and city core locations (up 14% in that same period). Popov believes the higher rent growth in suburban locations is partly demographics, with millennials now growing their families and looking for more space at an affordable price, along with a general preference for less density that lingers since the pandemic.