Gray Report Market Summary and Highlights: Week of July 16, 2022

Every week, The Gray Report publishes a video and podcast that covers the latest news, research, and reports from the multifamily industry, commercial real estate markets, and the economy. Below are some of the notes associated with our weekly video, podcast, and newsletter as well as the links to the sources that we discuss. These notes may be rougher and more conversational compared to other blog posts and publications from Gray Capital, but they provide additional insight into our ongoing discussion of the most important news and research for apartment investors.

The Washington Post: “June inflation soared 9.1%, a new 40-year high, amid spiking gas prices” https://www.washingtonpost.com/business/2022/07/13/inflation-june-cpi/

• A certain strain of anxiety has carried forward from the bigger-than-expected employment numbers in last week’s jobs report to the inflation numbers in this week’s consumer price index. The heated economy of the jobs report led to even higher inflation numbers, which now will lead to higher interest rates. The Fed meets on July 26th, so we have a little less than two weeks to get to that last part, but we’re way past arguing if there will be an increase, and the question of how much is pretty well settled on 75 basis points. 
  • Barry Ritholtz, who argues that we may already be past peak inflation given the falling energy prices and commodities, said that “the Fed should be looking at a 50-basis-point hike, rather than 75 basis points” shortly before the CPI numbers came out, and in a later post he acknowledged that “75 bps seems to be baked in.”
  • We’re very probably getting a .75% increase in the federal funds rate. That’s part of the repeated pattern that we’ve seen from the economy and the Federal Reserve.
  • What I’m really curious about is how much the market is going to price in these expectations in the intervening week-and-a-half until the Fed’s next meeting, or if we’ll see some scrambling in the wake of the Fed’s announcement of an interest rate hike.
  • As the Washington Post article notes, “Financial markets sank on the news” from the CPI, and I also think there’s a 
• Inflation was at 9.1% in June. In May, inflation ticked up ever-so-slightly, but things really ramped up last month.
• Quote: “There was not a drop of good news in this report,” said Michael Strain, director of economic policy studies at the American Enterprise Institute. “I had an emotional reaction to this report, and I was trying to think about the last time I had an emotional reaction to an economic data release, and I think you have to go to back to the financial crisis. Dismay. Frustration.”
• The biggest influence on the rising CPI numbers last month were energy prices.
  • CPI rose 1.2% month-to-month. Energy rose 7.5% (for listeners and viewers, I have “7.5%” in italics for extra effect) and is up 41.6% since last year.

CoStar: “Multifamily Demand Expected to Cool over the Next Six Months” https://www.costargroup.com/costar-news/details/multifamily-rent-growth-across-the-country-cools-in-q2

• I’m just going to jump right into this with a quote from CoStar’s National Director of Multifamily Analytics, Jay Lybik:
  • “Combine the fact that rent prices continue to sit at all-time highs with tempered consumer demand and a record 450,000 units expected to be delivered by year’s end, and you have a perfect recipe for a sharp rise in vacancy rates in the next 6 months.”
    • As an aside, I don’t think that this report is wrong in expecting slower rent growth than last year, but as a matter of degree, the rent cooldown or vacancy increase they predict here may not be as dramatic as they are projecting.
    • Just to unpack the quote here from Jay Lybik, there are three ingredients to this “perfect recipe” for rising vacancy rates: Rent prices at all-time highs, lower apartment demand, and a big increase in apartment supply expected by the end of the year.
    • For the first point about “rent prices at all-time highs,” I think that the author means rent “growth” is at all-time highs, because it’s not really that much news if rents themselves are at all-time highs. 
      • Rents rarely stagnate or go down on a year-over-year basis, so you could pick most any month in the spring or summer of any year and say that rents have never been higher, and you’ll probably be right. But that’s nit-picky, and I’m going to assume that the author is referring to rent growth, and in that case, he does have a more relevant point, but again, he could have said that at any point in 2022 and he would be right. 
      • The rate of rent growth has gone down from 2021’s heights, and could go down further. But, as we have mentioned before in the Gray Report, rent growth could still cool down quite a bit, and we would still have markedly elevated rent growth for the year 2022.
    • The second point is about “tempered consumer demand,” by which I think he is referring to renter demand instead of investor demand, and that’s a little circular if he’s talking about things leading to a sharp rise in vacancy rates, and vacancy is a measure of apartment demand. 
      • Yes, tempered apartment demand could lead to higher vacancy rates, but I actually don’t read the vacancy trends like that. Looking at some of the recent reports from Yardi Matrix and Apartment List, whether it’s occupancy or vacancy rates, the trend is a weak growth in vacancy and reduction in occupancy that still seems to be settling around a point that is well under historical averages. 
      • Another measure of apartment demand, which I’ll get to in a second, actually supports the author’s argument about things leading to higher vacancies more than anything else, but I want to finish up here with the apartment supply part of his comment.
    • The third claimed ingredient for the rising vacancy recipe, according to CoStar, is the record amount of apartment supply expected to be built by the end of this year, 450,000 new units.
      • 450,000 new units is a lot, and yeah, more supply is going to reduce demand, but I’m not completely convinced that this supply is even enough. I keep thinking back to the reports on construction and apartment demand from earlier this year and how, given the demand at the time, it would take several years of elevated apartment construction to bring vacancy to historical averages. Demand may have come down slightly since then, but not much.
      • Additionally, I think that, if these 450,000 units actually do get completed on time this year, that could be the sign of a more stable supply chain, more feasible labor and commodities markets for apartment developers, and perhaps, I would venture, an economy that might not be headed for recession. Well, we still could be headed for recession, but it is worth noting that many of the same macroeconomic forces that are weighing on the economy right now are directly relevant to the apartment construction industry.
• The real standout figure in CoStar’s write-up isn’t vacancy trends, rent growth, or new supply. It’s absorption.
  • For three consecutive quarters, absorption of new apartment units has been around 60,000.
  • Q2, they note, normally has the highest absorption out of the four quarters of the year, but it’s still around 60,000 this year.
  • How can vacancy be so consistently low, and then absorption drops from 260k in Q2 2021 down to 60k in Q3 2021, then hold steady at 60k for the next three quarters? Does lagging apartment construction have anything to do with this?

Bloomberg: “Rents in US Rise at Fastest Pace Since 1986, Buoying Inflation” – https://www.bloomberg.com/news/articles/2022-07-13/rents-in-us-rise-at-fastest-pace-since-1986-buoying-inflation#xj4y7vzkg

• “The big increase in CPI rents is catch-up with the consistent double-digit growth in market rents,” Zandi said. “The good news is that market rents appear to be topping out, as renters are not able to afford the higher rents and are balking. More rental supply is also coming, although this will take a year or two to have a meaningful impact on market rents.”
  • This quote, to be glib, is “legit.” Rent growth is cooling off, that new supply coming online is going to take some time to be felt in the multifamily market, and we’re getting to a point where things might be catching up vis-a-vis the rapid rent growth for renters who are starting a new lease and renters as a whole, which includes the slower rent growth of renewals.
  • There is still room to grow.
  • Interestingly, we’re almost approaching a point where market rent growth is roughly parallel to inflation, and if inflation ticks up a little and rent growth cools off a little bit, we could be there.
  • But for real rents, not just market rents, they’re increasing by 5.8% year-over-year compared to the 9.1% in total inflation. 
    • But that 9.1%, as we’ve learned, has a lot to do with the huge increase in energy prices last month.
    • Core CPI, which excludes energy and food prices in order to capture a less volatile image of the market, increased by 5.9%, just one tenth of a percentage point more than apartment rents, and well under market rent growth.
    • Rent growth, I think, will continue, and it is going to become an even bigger force in the inflation calculation. I think that trend could be the secret ingredient to the “perfect recipe” for reduced vacancy that was mentioned in CoStar’s report.

The Wall Street Journal: “St. Paul’s Rent Control Backfire” – https://www.wsj.com/articles/st-paul-rent-control-backfire-minnesota-twin-cities-permits-building-apartments-11657472375

• Could it be—now hear me out—that we’re not using enough heavy-handed government interference into the previously-established private housing market?
• Rent control is an easy target, and the narrative of the declining multifamily market of Minneapolis-St. Paul dovetails nicely with this atmosphere of government overreach, but I honestly just feel bad for the people in that city who are unable to afford homes even though the rental market is among the slowest-growing in the nation. It’s sad that people could suffer because the community is seemingly doubling down on policies that contribute to low housing supply instead of trying to chart a new path by undertaking, I don’t know, a plan to reduce regulatory roadblocks? Doing so would be politically uncomfortable in a Democrat metro like Minneapolis, but look back to the Democrat-White House’s affordable housing plan in May: They show you the way, and it’s clear of regulatory and zoning hurdles, and it recognizes the need for incentives to build new supply, and it does not mention rent control! 

Apartment List: Rent Growth and Inflation Explainer – https://www.apartmentlist.com/research/rent-growth-and-inflation-explainer

• This explainer covers much of what we’ve discussed about rent compared to inflation: Rent growth is at 5.9%, and CPI is at 9.1% (they use last month’s CPI numbers, but the point still stands).
• Quote: “Close followers of our research and other housing market indicators may be surprised to hear that the shelter component of CPI is up by just 5.5 percent year-over-year. After all, our national rent index spiked by 15.3 percent from May 2021 to May 2022.”
• While our point from earlier may be repeated here, the graphs in this Apartment List explainer provide a very clear picture of how much room there is between inflation and rents, how much room there is between rents and home purchasing costs, and, significantly, how Apartment List’s rent numbers compare with the CPI numbers. Right now, Apartment List has much higher rent growth numbers than the CPI, but from 2018 until the Spring of 2021, Apartment List rent growth estimates were actually lower than the CPI.
• This difference effectively underscores the idea that the CPI’s rent numbers are a lagging indicator, and we’re going to see much more rent growth in the CPI. I wonder if in the coming months, it won’t be energy prices that are driving CPI and inflation but apartment rents.

Yardi Matrix: “National Multifamily Report, June 2022” – https://www.yardimatrix.com/publications/download/file/2514-MatrixMultifamilyNationalReport-June2022

• Rent growth continues to be quite strong in 2022, as Yardi Matrix records 13.7% year-over-year change in rents for the month of June. The month previous, year-over-year rent growth was 13.9%. Year-over-year rent growth down only 0.2% is not much of a cooldown, and 13.7% is still quite high.
• That this report shows such elevated rent growth is a strong indication of the resilience of the apartment market during a time when so much of the economy has been unstable or trending downward.
• It’s a little bit frustrating to see the hand-wringing about the trajectory of rents in 2022 when you put our current rent growth in line with historical levels. Yardi Matrix is recording a little more rent growth than CoStar, but I wouldn’t say that Yardi Matrix’s figures are less accurate or less representative of the market than CoStar’s just because Yardi Matrix’s rent growth numbers are higher.
• It can be easy to slip into a way of thinking that carries the recession fears and economic worries into the multifamily market, and reports like this one from Yardi Matrix have been a consistent reminder of the robust fundamentals of the multifamily market. At this point, it’s a lot easier for me to see changes in the multifamily market as a result of shifting investor and purchaser demand rather than changes as a result of shifting renter demand.
• And on the demand side for renters, we can see the same slight shift downward in occupancy, about .2% shift commensurate with the small amount of rent growth reduction. For both, we’re still well above historical norms, and you need only look at the graph to see that we’re settling in on a new level of renter demand and rent growth that is not as high as last year, but certainly higher than the years before that.