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Grading the Apartment Recoveries in the Nation’s Gateway Markets

Grading the Apartment Recoveries in the Nation’s Gateway Markets

After an initial slowdown at the height of the lockdowns in 2nd quarter 2020, the U.S. apartment market rebounded quickly and then took off, recording record rent growth and big demand. But not every market enjoyed the same trajectory. The nation’s more urban, denser coastal markets took the biggest blows and have taken more time to regain momentum. Coastal gateway markets were also the “golden children” of the last two cycles, with investors buying heavily on the pre-pandemic thesis that these cities offered lesser volatility and endless liquidity.

Where are the big coastal metros on the road to recovery? We rank the apartment sector in nine key gateway markets based on how hard they were hit and the length of their expected recovery.

Boston

Boston set itself apart by holding onto stronger resident retention than other gateway markets throughout the pandemic, keeping occupancy in solid shape. That – plus some solid employment gains of late – positioned Boston for a quicker rebound on pricing. As of May, true new lease rent growth measured a very solid 8.2% – tops among coastal markets but still about 3 percentage points below the U.S. average. Rents in renewal leases were also up 2.6%, second best among coastal markets. Boston was also the only coastal metro to outperform the U.S average on year-over-year change in resident retention – the share of expiring leases that are renewed – in May. Boston’s retention rate came down 2.5 percentage points in the past year, a full point better than the U.S. average. Still, the overall retention rate in Boston is high at 60.8% in May. Rent roll revenues, however, are still down 2.9% year-over-year due to much weaker pricing booked in previous months.

Encouragingly, even the harder-hit urban core is producing solid rent growth again, while suburbs continue to perform well. Top-performing submarkets are suburban spots, including Essex County, Rockingham/Strafford Counties and Plymouth County. On the capital markets side, deal flow here has held fairly steady while cap rates have compressed.

Washington, DC

The DC metro ranks above some of its peers based on the strength of its large suburban apartment market and a more stable job base buoyed by federal employers. But the urban-suburban apartment performance split here is among the biggest in the country, perhaps due to political challenges in the District as well as stricter lockdowns last year.

Rent roll revenues were down 5.3% in the District as of May compared to just 0.8% in the suburbs. True rent change remained negative as of May in the District for both new leases (-3.8%) and renewals (-0.9%), while the suburbs produced solid growth. Resident retention in the District was still exceptionally low in May at just 37.3% compared to 54.5% in the suburbs. Occupancy came in at 93.2% in the District and 95.6% in the suburbs. Top-performing submarkets are very much Class B and C hotbeds like Fredericksburg/Stafford, Woodbridge/Dale City, Frederick and Manassas. The split also plays out in capital markets. Deal flow plummeted in the District while declining only modestly elsewhere in the metro.

Northern New Jersey

The popular narrative was that Northern New Jersey benefitted from some urban flight out of New York City, and there’s some data to support that view. For example, incomes for new renters signing leases in the Newark-Jersey City metro jumped significantly, which likely traces to relocating, upper-income, work-from-anywhere households. Rent cuts here never got as deep as they did in New York, and while retention rates and occupancy did drop off, the declines haven’t been as severe. Investors are following the renters, and they’ve driven up sales volumes in Jersey’s suburban submarkets – while urban spots like Hoboken/North Hudson and Jersey City see declines.

Northern New Jersey led coastal markets with a resident retention rate of 63.4% in May. Retention is always ultra high here, and it’s off only 3 percentage points year-over-year, a change not far from the national average – bearing in mind last year’s rate was unnaturally high due to lockdowns. Pricing momentum is also returning here faster than other gateway markets, with true rent growth around 3.5% for both new leases and renewals in May. On rent roll revenue, the Newark-Jersey City metro area remained down 2.5% year-over-year. Top-performing submarkets are, as expected, more suburban, including Somerset/Hunterdon Counties and Monmouth County.

Seattle

Seattle’s story is a bit complicated. On the plus side, the employment hole here is smaller than other gateway markets at -5.4%. And rent growth momentum returned quickly here, with true new lease growth of 6.0% year-over-year in May, second only to Boston among coastal metros. The macro story appears largely intact, particularly with the Seattle metro’s large employers – Boeing aside – performing well through the pandemic. And while Seattle’s urban core has had its challenges, the metro benefits from attractive, desirable suburbs with strong employment anchors – giving locals a viable alternative to hopping on the Sun Belt bandwagon. To that point, suburban incomes for new lease signers have improved significantly over the last year. And while Seattle’s suburbs perhaps haven’t performed to expectations on rent and revenue, they’ve held up significantly better than the urban core. Curiously, though, sales volumes remain more depressed in Seattle’s suburbs compared others. Only one submarket had positive rent roll revenue change in May – Everett at 1.1%.

As for the city of Seattle itself, the story isn’t great. Messy city regulations on rental housing plus ultra-high new supply levels and pandemic effects combine to make it slow going in the urban core. True new lease rent change got as deep as -28.6% year-over-year before flattening in May. Local regulations on renewal pricing have prevented a similar bounce-back in renewal rents, which were down 3.2% in May. Despite the renewal caps, retention plummeted as low as 27.9% in October and came in at a still-low 41.3% in May. Overall urban occupancy remained well below long-term norms, at 93.4%. Seattle’s urban core will certainly improve going forward, but local politics plus employment trends such as Amazon focusing on adding jobs elsewhere could provide long-term headwinds.

Los Angeles

Los Angeles differs from other gateway markets in that COVID-19 may have accelerated some significant headwinds, suggesting the road ahead may be choppier than you might expect. On the positive side, rents are trending back into positive territory again. True rent growth reached 3.4% on new leases and 1.4% on renewals in May, while rent roll revenues remained down 4.6% year-over-year. But the big concern here is around LA’s ability to retain upper-income renters. The media narrative of households leaving the state is overplayed but has some truth to it, and apartment retention and employment stats back it up. Resident retention plummeted as much as 17.5 percentage points across metro Los Angeles, and while it’s improved somewhat since then, overall retention remained unusually low by local standards at 47.1% in May. Declines are massive in downtown LA, but more surprisingly, retention is below normal in the suburbs, counter to the national pattern. Higher turnover isn’t a necessarily bad thing in a high-demand market, but it raises questions in a more challenged, high-cost metro like LA, where COVID-era job losses far surpassed the national averages. In fact, Los Angeles’ pandemic-era jobs hole was the deepest among gateway markets at -10.3%. Consequently, apartment deal flow has slowed throughout the metro – most dramatically in downtown LA – as investors either wait it out or shift their capital further inland.

Another negative distinction is that even outside of downtown LA, the bleeding got pretty deep in LA’s upper-tier submarkets highly valued by investors – including Santa Monica, Brentwood/Westwood/Beverly Hills, Sherman Oaks/North Hollywood, Palms/Mar Vista and Mid-Wilshire. The top-performing submarkets through the pandemic were more blue-collar spots like South LA, Southeast LA, North San Gabriel Valley, Long Beach and Antelope Valley.

Oakland

The East Bay certainly came out a net winner over pricier and denser San Francisco, but it didn’t come away unscathed. Unlike San Francisco and San Jose, the Oakland metro did post positive true rent growth on both new leases (2.7%) and renewals (1.1%) in May. But rent roll revenues in the East Bay were still down 3.4% year-over-year due to weaker performances previously. In other words, Oakland’s apartment market really only looks good relative to its neighbors. Among submarkets, Contra Costa County is the one clear standout – particularly the Concord/Martinez area.

Curiously, the East Bay is struggling with retention more than any coastal metro with the exception of San Jose. Retention plunged 17.5 percentage points year-over-year to 47.7%. However, occupancy never fell below 95.1%. That means high turnover traced not to net move-outs, but to musical chairs – bargain-hunter renters moving for better deals or better locations. That problem was created by poor operational strategy on pricing – slashing new lease rents while keeping renewal rents fairly flat, thereby incentivizing renters to go shop around. The challenges spread to the sales market, too, as deal volumes in the East Bay slowed roughly in line with its neighbors to the west.

New York

In fall 2020, apartment conditions were ugly in New York, which we define as the city plus a few suburban counties on the New York side of the state border. True lease-over-lease rents dropped as much as 20.2% for new leases. Retention rates plummeted 29.3 percentage points. Occupancy rates were dropping and would have fallen more if not for renters who left the metro but were unable to sublease their units. The Manhattan numbers were even worse. But since spring hit, New York has begun clawing back. New lease-over-lease rent growth returned to positive territory for the first time at 2.7%, lead volumes accelerated and occupancy ticked upward.

The gains are material and encouraging, but let’s be clear: This one has a long way to go. Local reports suggest a welcome return-to-normal feeling in the city, but on the residential leasing side, brokers and investors often conflate recovery with momentum. That may sound like semantics, but it’s an important distinction. Yes, the worst is in the rearview mirror. Renewal rents were still falling as of May, as operators scramble to address inverted rents, where new leases cheaper than renewals, thereby incentivizing move-outs. Rent roll revenues were still down 6.0% year-over-year, and in Manhattan, revenues were down further at 9.2%. New York has historically been the king liquid market but lost its crown last year, with deal volumes substantially below pre-pandemic levels as buyers and sellers wait each other out. One long-term headwind resulting from the pandemic will likely be policy risk, particularly around evictions and applicant screening, as policymakers pass the buck for their decades-long values to adequately support affordable housing creation.

San Jose

On the surface, San Jose looks like it should be less impacted than San Francisco. Pandemic-era job losses measured far fewer. And Silicon Valley isn’t as dense as its neighbor to the north. But the San Jose metro still felt the pains from the work-from-anywhere landscape plus declines in H-1B foreign worker program. Overall, rent roll revenues were down 11.0% as of May. San Jose and San Francisco were the only two large metros nationally still posting negative true rent change for new leases in May, with San Jose ranking worst at -6.0%. Renewals were also down, at -4.2%.

One nagging sign of trouble: Silicon Valley is struggling to retain renters, with May’s retention rate of 44.1% registering a remarkable 22.3 percentage points below last year’s rate. Much of this is apartment operators’ own doing by relying way too heavily on rental concessions to lure in renters. A nation-leading 42.6% of stabilized, available units were offering discounts in May, with an average six weeks free. There’s some evidence to show the heavy discounts are doing little to stimulate new demand, as occupancy rates have fallen 2 to 3 percentage points while the average income for new lease signers remains near pre-pandemic levels. Heavy concession utilization creates a cannibalization environment that directly leads to weaker cashflow. Renters who can afford to pay their rents are deal hopping between apartments, lowering the value of rent rolls in the process.

San Francisco

San Francisco historically was Exhibit A or B in the definition of “core markets” among institutional investors. But its highly volatile performances never aligned with the true definition of “core.” COVID-19 highlighted that pattern once again. Rent roll revenues plunged a national-worst 14.3% year-over-year through May 2021 after absorbing wildly discounted rents over the last 14 months. Apartments within the city limits endured a painful 13 consecutive months of double-digit executed rent cuts. Lease-over-lease rent change “improved” to -8.3% in May. At the same time, renewal rents were still down 5.7% in the city. Unfortunately, the suburbs of San Mateo County and Marin County didn’t perform a lot better – collectively producing only moderately better results. Retention also remains unusually low for the metro area at 47.5%, down 8.5 percentage points.

Among coastal metros, only Los Angeles remains in a deeper jobs deficit from the pandemic, with San Francisco at -10.2%. That number, of course, largely excludes workers who retained their jobs while relocating to other parts of the country. We’ve heard from plenty of wannabe bargain buyers, but most sellers aren’t ready to sell at discounted prices. As a result, sales volumes are falling fast. According to Real Capital Analytics, a total of 191 apartment deals traded in 2019. Only 64 sold in the year-ending March 2021.