ShotgunWedding Is the economy being held up, and forced into a bad relationship?

The Fed is forcing the economy to accept the vows of a recession.

By BRUCE MCCLENNY, ApartmentData from MRI Software

The Federal Reserve is forcing the marriage of the economy with recession. Traditionally, these types of unions are finessed with a shotgun. However, the Fed’s method of coercion is repeated blasts of interest rate increases. Despite 10 blasts of interest rate hikes since March 2022, which has moved the Fed Funds Rate by 5.0 percentage points, recession has yet to show up at the altar. What has shown up are three of the four largest bank failures of all time. Silicon Valley Bank, Signature and First Republic all got caught in a digital-age run on deposits. First from depositors’ withdrawing their money seeking a higher interest rate and then from companies protecting their uninsured deposits over the FDIC’s limit of $250,000. The Fed’s determination to fight inflation have made the vows of “For Better or Worse” very one-sided.

The Fed’s interest rate hikes are intended to slow the economy with the focus of bringing the Core Consumer Price Index (CPI) down to 2 percent and by raising unemployment to 4.5%. In March, Core CPI, which measures inflation by comparing prices paid for goods and services excluding food and energy, registered 5.6 percent. Unemployment in April edged down to 3.4% which matches a 50 year low. Unfortunately, these measures are, in a sense, objecting and moving contrarily to the Fed’s actions.

Even though the Fed does not include food prices in its strategy, grocery prices are certainly working against households. According to the Bureau of Labor Statistics, groceries are 8.4% higher than a year ago. Other items weighing on the finances of households are interest rates on credit cards going from 16.2% to 20.2% and interest rates on new car loans going from 5.2% to 7.0% from March 2022 to April 2023. According to Moody’s, a typical U.S. household is spending $313 more per month now than last year at this time.

I am, as I am sure others are, fatigued about the long running discussions about the coming recession. The endless repetition of commentators as to whether it will be a soft, hard or no-landing scenario gives credence to the confusing strength of consumer balance sheets and employment. Regardless of all this, renters are behaving as if a recession is already here.

Till Recession Do Us Part

The graph on Page 38 shows how rent and occupancy levels moved from 2021 to the end of April 2023. During 2021, overall average monthly rent grew from $1,044 at the beginning of the year to $1,190 by the end the year. This $146 of rent growth, a 14% trend, represents the best rent growth of all time. Such historic rent growth was driven by the reopening economy that also produced an equally historic absorption of 38,000 units. 2021’s occupancy jumped 3.1 percentage points from 88.4% at the beginning of the year to 91.5% by year’s end due to the soaring absorption.

2022 rent growth settled from the torrid pace of 2021 but still at a rate significantly higher than the long-term average growth of 4.0%. Rents peaked in September 2022 at $1,263 and then fell back to $1,252 by the end the year, delivering a 5.2% rate of growth in 2022. The September peak in rent was the last of 21 straight months of sequential rent growth. The fade in rent that began in October 2022 is connected to a wobbly slide in occupancy that began back in December of 2021. At that time, overall occupancy registered 91.6% and by April of 2023, occupancy had settled to 89.9%. This slide in occupancy was driven by a strong delivery of new product during 2022 and the first four months of 2023 equating to 21,179 units, while absorption could only muster 6,223 units during the same time frame. This weak demand kept rent flat from the September peak.

The Market “Guest List’ by Class

The overall statistics of rent, occupancy and absorption are an aggregation of these statistics for each class of property. Classes are determined by a bell curve distribution of market rates or price. The table on Page 39 breaks out how each class differs in performance and contributes to the overall market statistics as of April 30, 2023. In addition, Class A has been divided into two groups. One group are those Class A properties that began leasing in 2022 and 2023. Since properties in this group are in a wide range of lease-up, occupancy is understandably low at 37.1%. Due to the ever-increasing supply of this group over the time frames analyzed, rent trends cannot be properly calculated. Filtering out the lease-up properties of 2022 and 2023 from Class A creates the Class A Stable group. The most confusing information on the Classification Analysis is within the 12-Month Absorption column. The overall net absorption number is 3,067 units. The last time a 12-month absorption number was lower was in 2009, when 1,653 units were absorbed during the Great Recession, when the Houston Metro suffered 110,500 job losses. The current very weak 12-month absorption performance comes at a time when job growth is registering the third best 12-month net job change since the Bureau of Labor Statistics began recording this information in 1991. Oddly enough, the three best job growth performances all happened in the last three years following the Pandemic’s economic shutdown. The direct correlation between jobs and absorption is broken. Gone are the days when a good job growth performance would equate to strong absorption numbers or vice versa.

Taking a closer look at the 12-month Absorption by Class reveals a curious exodus of renters from Classes B, C and D. When combined, the net move-outs from these classes totals 8,464 units. Some of the moveouts can be traced to the evictions process that was put on hold in 2020 and subsequently expired in August of 2021. Anecdotally, renters are seeking more affordable accommodations by doubling-up or moving in with relatives, which is behavior reminiscent of past recessions. In addition, renters are moving into the shadow market of single-family rentals owned by Mom-and-Pop operators, as well as by corporate entities that substantially increased their supply of such product in 2021. Class A is capturing all positive absorption and is holding up some correlation to job growth. Yet, a good portion of the absorption strength is driven by would be single family prospects that are priced out of buying and choosing to rent until mortgage rates and stubbornly high prices subside. Class A’s absorption is 11,531 units and is the sum of the two Class A components on the Class Analysis table.

The overall 12-month rent trend is lackluster at 1.8% but looks rather sterling when compared to other Texas markets where Austin’s rent growth is -2.7%, DFW’s is 0.3% and San Antonio’s is -0.3 percent. All markets are laboring with strong new construction deliveries and move-outs in Classes B, C and D. The annualized 3-month rent trend is a bright spot at 3.3% but could prove to be ephemeral or short-lived as the renter’s wallet is picked by persistent inflation and student loan payments resuming in August.

Looking Ahead

Uncertainty remains overwhelmingly plentiful. Will inflation ease and allow the Fed to pause rate hikes? Will the rate hikes already done cause more economic casualites and move us closer to a broader-based recession? How much economic hardship will there be when forebearance ends on student loans? Will political brinksmanship finally push the Government into default? I could go on, but the point is that economic uncertainty detracts from the vitality of our industry.

One of the biggest surprises of 2023 is how apartment developers substantially raised the number of units to be developed in the face of soaring financing costs. As of the end of April, around 6,400 units have been delivered. There are currently 23,000 units under construction of which approximately 16,000 will deliver this year. This assumption would bring the total number of units delivered in 2023 to around 22,000 units.

Given the economic uncertainty and the continual strain on the renter’s wallet, coupled with a very strong construction pipeline, 2023 will be a challenging year for growing occupancy and rent. Occupancy should end the year slightly lower at 89.5%. Rent could possibly end the year in the 2.0% to 2.5% range. However, flat should still be considered a win.

Bruce McClenny is Senior Director of ApartmentData.com From MRI Software. For more details, call 281-759-2200, email bruce@apartmentdata.com, see Marketline on Page 75 and subscribe to his YouTube channel at: https://www.youtube.com/channel/UCaPmY9AevdjCpqe4UeQU 7xw/featured