In this episode of “The Inside Look,” Senior Commercial Real Estate Economist Xander Snyder discusses the impact of new excess inventory on rent growth.
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Transcript:
Hello, I'm Zander Snyder and this is First American's Inside Look.
If you're looking to rent or own an apartment, you probably want to know what rent increases will be like next year, and this will depend in large part on how much new supply comes onto the market in your city.
The number of apartments under construction nationwide remains near a record high at nearly 1 million, according to the latest new home construction report. But construction varies greatly by region. In areas with a lot of new supply, renters have more options, forcing landlords to lower rents and compete.
But supply isn't the only determinant of rent increases. For example, if a city has enough demand to rent out all the new apartments that come on the market, rents are less likely to fall. It turns out there's now a useful way to combine supply and demand into a single measure to understand which cities have an excess and which have a shortage, and therefore which cities are more likely to see lower or higher rent increases over the next year.
To measure supply, deliveries are easy enough: the total number of units put on the market in a city. But what about demand? One way to measure demand is to count all the apartments that were rented in a period and subtract the number of units that became vacant in the same period. This gives us a measure of the total change in rented apartments, commonly called net absorption.
When you subtract net absorption, a measure of demand, from supply, a measure of supply, what's left is the new surplus inventory of apartments. When new surplus inventory is positive, it means demand isn't high enough to offset the new supply of apartments. When new surplus inventory is negative, it means demand exceeds supply.
So where are rents rising and falling, and how does that relate to new surplus inventory? Take a look at this graph. It shows the relationship between new surplus inventory, a combined supply and demand measure, and rent growth. New surplus inventory is on the horizontal axis, and annual rent growth is on the vertical axis. The two dark grey grid lines show the average new surplus inventory and annual rent growth. The cities shown are the 75 largest cities by population, and the size of each bubble indicates how large each city is. Finally, the color of the bubble indicates what region the city is in.
As you can see, there is a clear negative correlation between new excess inventory and rent growth. That is, cities with a lot of apartments on the market relative to demand typically experience negative, or at least below-average, rent growth. The bottom right quadrant is dominated by Sunbelt, Southeast, and Southwest cities that have seen a lot of new supply come onto the market in the past year that exceeds demand, leading to below-average rent growth. The top left quadrant is dominated by Midwest and Northeast cities that have below-average new excess inventory and, as a result, experience moderately positive rent growth.
If you want to really play around with this graph, there's a fully interactive version here, where you can hover over your city and see exactly how it's performing relative to other cities. I've included a link to this interactive version of the graph in the show notes for this video.
I will be in Phoenix in mid-May to speak about the commercial real estate adjustment we are facing and how long it may continue for. If you are interested in attending, please contact your local First American representative.