When is a market full and why does it matter?
The general rule of thumb for single-family housing states that when inventory of unsold homes dips below a three-month supply, the market shifts from a buyer’s market to a seller’s market. This makes sense because it’s simple economics. Can we apply this same line of thinking to the apartment market? Common sense tells us that strong rent growth is positively correlated with high occupancy. With that in mind, we decided to explore whether there is a similar relationship between apartment market performance metrics to determine a point at which pricing power shifts from renters to operators. The results indicate that there is an “operator advantage rate,” the average occupancy rate that has historically accompanied rental rate increases in excess of 3.0% in a given market. (We’ve adapted this idea from research done by UBS, which called it the “landlord rate.” But since the apartment industry doesn’t like the word “landlord,” we’ll avoid using it.) But what does this figure tells us, specifically, and why does it matter?
Using 20 years of MPF Research data, the chart below illustrates the occupancy rate that characterized a full market. After calculating the rate, we then compared how responsive rent growth was during times above and below the rate. Looking at the results nationally, regionally and by market size, some interesting results emerged.
The most significant insight lies within the regions containing coastal markets. The discrepancy between average rent growth above and below the operator advantage rate was significantly larger in 2nd quarter 2014 than in other areas of the U.S. Furthermore, since net operating income growth is a function of rent growth, this insight provides strategic implications for buying and selling real estate. For example, the West region remained hot both in terms of occupancy and oversized rent hikes — and this trend is expected to continue. On the other hand, caution is warranted in the Northeast. The Northeast region has experienced modest employment expansion, including structural changes around the finance sector. As a result, the Northeast was operating below the operator advantage rate in 2nd quarter 2014, and in turn, rent growth remained lackluster. The largest spread between the occupancy rate in 2nd quarter 2014 and the operator advantage rate was observed in the 50 smaller markets (+1.0 point). However, as investors contemplate moving up the risk spectrum, it is important to note the rent growth achieved during the good times may not justify the risk associated with initiating a new position in a tertiary market.
Looking ahead, we will conduct this analysis at the metro level and begin exploring the historical spread over time between the current occupancy rate and the operator advantage rate. Through the use of Revenue Forecaster, an advanced statistical approach to forecasting, MPF Research can identify inflection points at the metro and submarket levels to suggest whether it is time to get into or out of a specific market. This insight combined with our fundamental market analysis should improve the decision making process leading to OUTPERFORMANCE!
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