The Rent Narrative May Get Messy


Falling rents and high vacancies in a small number of large cities contrast with rising rents in most of the US, creating confusion for investors and potential tenants alike. Would-be renters appear to be stepping back for now. 

Investors and potential tenants could be forgiven for getting lost in the swirling narratives about rents, zoom towns are the latest hot take on the future of work from home. The reality on the ground is a divergence between a handful of large, highly visible cities and most of the rest of the country. The latest data from Zillow’s Observed Rent Index across the top 100 metros in the US reflect this and even show rents accelerating into the end of 2020. 

The chart shows the median along with 25th and 75th percentiles for the year-over-year change in Zillow’s Observed Rent Index (ORI) for each city. The median recovered nearly linearly from a March 2020 low to end the year at +4.2%. The top 25% of metros saw their ORI increase by 5.5% or more. Yet the bottom 25% of metros have seen year-over-year rent growth continue to wane. 

The list of highly visible cities with lower ORIs compared to December 2019 is short. New York, San Francisco, Boston, San Jose, Seattle, Austin, Chicago and Washington DC are the only metros with materially negative YoY changes. 

More than three-quarters of these metros are still seeing positive YoY rent growth. This runs the spectrum from larger metros including Atlanta, Phoenix, Dallas Fort Worth and even Detroit. It also includes so-called zoom towns including Memphis, Providence, Tucson and Boise City. 

Bloomberg Opinion columnist Conor Sen wrote about the potential windfall for younger professionals who could get a discount on the proximity and network effects of these cities. 

“High levels of retail and office vacancies are a problem for a city’s tax base and its landlords, but for workers and people new to a city they’re an opportunity. Low vacancy rates and high commercial rents constrained new business formation in the 2010’s. The opposite in 2021 could mean an explosion in new business creation over the next couple years as the economy comes back — which it’s likely to do, boosted by trillions of dollars of fiscal stimulus at the federal level.”

Whether that narrative sounds compelling probably has a lot to do with the stage of life, age of children, current school circumstances and how the pandemic has affected local public goods broadly in each instance. Even if it sounds really compelling, there is some evidence that potential tenants are not yet acting on the opportunity. 

Nationwide, Google search activity for apartments & residential rentals is falling sharply relative to our three-month forecasts. The week ending January 30th saw apartment searches fall to their lowest relative to forecasts since the reopening. Real estate searches broadly have also deteriorated. This will be interesting to watch as the home buy season picks up. Rising single-family home prices may push more households to take advantage of lower rents. 

The regional breakdown of state-level Google search activity for apartments & residential rentals also casts some doubt on current plans for a reversal of flows back into these large metros. Apartment searches have fallen the most relative to forecasts in the Midwest and Northeast. 

Apartment REITs saw another wave of optimism so far this year. The chart shows average total returns since the end of 2019 for U.S. REITs by industry. Apartment REITs have made another run at post-reopening highs. In contrast, office property REITs have struggled to gain traction with the vaccine roll-out ongoing. Given the weakness in rental interest, REITs may be challenged to press to new highs.  

It may seem like there should be straight-line implications for inflation if rents are on the rise in most of the country. Sadly that is not the case but Ben’s recent focus on Owners Equivalent Rent should help investors see through the fog. Below is an updated version of a chart from Ben’s December post on OER on updated weekly in our Inflation Roundup. 

The chart lags the NMHC’s Apartment Tightness index by 12 months for comparison to OER. Rental conditions are finally beginning to tighten from here on out, suggesting OER’s YOY growth should soon find a low.

However, our estimate for the probably that OER will be higher in one year has tumbled with the latest search data. Data from a list of 35 rent-related search topics are fed into a model (random forest) to produce probabilities OER year-over-year will be higher 12 months ahead. The model trained since 2004 posts an accuracy of 78% during resampling (cross validation). 

There is now less than a 1/5 chance of OER being higher in a year. We will need to see progress on vacancies and improved search intereset before buying into OER providing a material boost to inflation over the medium term. 

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