Strong Growth in Apartment Rents

Even though home values are no longer soaring, many would-be owners still find the prices too lofty for their taste. They're raising demand for rentals, pushing rates up.

By Peter Goldstein, Senior Economics Editor, The Kiplinger Letter

Jerome Idaszak, Associate Editor, The Kiplinger Letter

June 23, 2006

Look for another strong jump in apartment rental rates next year—on average, only a bit less than the 3.5% rise we expect this year. Despite the slowdown in home and condo price gains, affordability will remain an obstacle for many working-class families through 2007, and they'll opt to rent instead. Apartment demand will also draw strength from the leading edge of the echo-boomer generation. The 20- to 25-year-old segment of the population—in the market for first homes or apartments—will see robust growth.

The exceptions: areas currently building up big condo gluts, notably San Diego, Phoenix, parts of Chicago and many cities in Florida. As condo sales nose-dive there, even more units will be dumped onto the rental market as investors seek to cut their losses. The number of new rental units hitting the market should flatten in these condo-heavy areas, possibly before year end. At the other end of the spectrum are metro areas boasting strong employment growth, such as Washington, D.C., and Los Angeles. There, average rent increases will run in the 5%-6% range next year.

Despite robust rental demand, look for construction of multifamily housing to fall off substantially next year—about a 6% decline in starts, following a 1% drop this year. Condo purchases have fueled most of the recent building boom, and they've withered. Plus builders keep their eye on a horizon a few years out, and they figure that growth in demand for rentals will level off by then.

Don't be misled by the latest housing starts figures for May, which show multifamily construction up a meteoric 25.4% from April and nearly 15% from a year earlier. More than likely, the huge jump was a temporary aberration, at least partly reflecting the rebuilding of residential properties in the Gulf Coast region. More telling is the 5.2% decline in building permits for apartment projects, to the lowest monthly level so far this year. That signals much slower construction activity during the second half of this year. Still, some cities, including Charlotte, N.C., Nashville, Tenn., and Kansas City, Mo., will remain on a building upswing. Bored with the suburbs and lured by city-center revitalization efforts, young buyers and empty-nesters are pumping up demand in those areas.

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