Faltering Economy Continues to Pressure Apartments

National average rents fell for the fifth consecutive quarter, with the last three months of 2009 recording a 3.32% drop to $933 per month, from $965 a month in the third quarter. On an annual basis, rents have decreased 6.1% from year-end 2008's $994 per month.Occupancy is also down, to 91.3%, on average, in the third quarter and 92.2% in 2008.

Since RealFacts links apartment fundamentals to the condition of the overall economy, the firm compared the rate of unemployment to apartment vacancy and found that the two are "nearly identical," historically. "So it's safe to assume changes in apartment vacancy will occur to the same degree as the rate of unemployment," the firm concludes.

The survey covered 37 markets, and in Q4, only two showed net increases in rents--Oklahoma City, up 70 basis points from $612 per month in Q3 to $616, and Baltimore, up 40 basis points from $1,152 a month to $1,157.

While all the other markets are on a decline, some are faring better than others. Areas in "Code Red," defined as when market conditions cause income property to hemorrhage despite rate cuts or concessions, include once-hot housing markets such as Phoenix and Las Vegas. Rents in Phoenix fell from $760 to $695, or -8.7%, between the third and fourth quarters. The decrease in Las Vegas was -8.2%, from $837 to $768 quarter-over-quarter. Meanwhile, the quarterly decline in Salt Lake City registered -7.3%, from $804 to $745 per month.Other areas are doing better, but not by much; Denver, Vallejo-Fairfield in California, Seattle and Reno, NV showed respective losses of -6.1%, -5.7%, -5.4% and -4.9%.

Rent declines can be foretold by changes in occupancy, and nearly 70% of the markets polled showed decreases on that end. "This is in contrast to the past two quarters, where occupancy was on the rise or holding steady," RealFacts analysts note. Markets with significant losses during the third quarter include Boise, ID, down from 92.7% to 89.9%; Fresno, CA, from 93.9% to 91.7%, and Salt Lake City, down from 92.9% to 91%.

Any upticks in occupancy that were found were "negligible," with the exception of Oklahoma City, which saw a 200-basis-point increase over the quarter to 91.7%. On its tail were Reno, up 1.9% from 90.5% to 92.2%, and Denver, up from 91.8% to 92.4%. This is proof, says RealFacts, that lowering rents generally leads to occupancy improvements.

Meanwhile, concessions were offered at about 60% of the properties in the study. The most common incentives for renters was a rent-free first month on long-term leases, or savings for signing a lease upon the first visit to the property--a practice often referred to as the "look and lease" special. Upfront giveaways for securing a future quantifiable income stream are also used. Most specials, the firm reports, are specific to unit type and are used in cases where there is an oversupply.

Unlike some smaller, private properties, professionally managed communities have more options at their disposal and can therefore be more aggressive about what and how much they can give away. For instance, they can reduce or waive security deposits and application fees, as well as buy expensive merchandise such as iPods and flat screen TVs in bulk to use in giveaways.

A recent conference call with apartment professionals conducted by Bank of America-Merrill Lynch supports the findings of the RealFacts survey. Landlords, managers and brokers all report market conditions in the fourth quarter were slightly worse to flat as compared to the prior quarter. Even renewal rates in most markets have declined to new lease rate levels. Effective rents declined in Dallas, Houston, Phoenix and the San Francisco Bay Area, and Austin, TX and Orlando appear to be stabilizing, albeit at a lower rental rate.

Most private operators anticipate an improvement in fundamentals beginning in the second half of 2010 or 2011, with a robust recovery in 2012.

Meanwhile, the majority of respondents to the National Multi Housing Council's latest Quarterly Survey of Apartment Market Conditions reported that conditions have changed little between the third and fourth quarters. This is the first time in the survey's history, says the Washington, DC-based association, that at least 60% of responses to each question indicated conditions were flat quarter over quarter.

"This quarter saw a continued uptick in sales volume and equity financing, which represent another step, albeit a small one, toward a more normal transactions market, after 2009 recorded the lowest number of transactions of the decade," said Mark Obrinsky, NMHC's chief economist.

At 38 (on a scale of 1 to 100), the market tightness index, which measures vacancy and rent fundamentals, was the weakest performing metric. Almost a third of executives said vacancies have increased while rents have declined. A mere 7% believe the opposite. This, says the economist, "Underscores the fact that full recovery of occupancy and rents will require job growth to return to the economy. When that happens, and as a large wave of Echo Boomers begins to enter a supply-constrained market, we should see above-average rent growth."

For the second quarter in a row, the sales volume index read above 50—56, actually, in January--showing that investment activity is increasing nationally. An equity financing index of 66 shows that equity financing is improving; a third of those polled said it's easier to find equity now than it was in the third quarter. That was also the highest reading of that metric since April 1994. And the debt financing index, at 49 in January, shows that conditions have not changed all that much since the last survey in October. Despite the benefit of Fannie Mae and Freddie Mac, the immobile CMBS market and inactivity by banks are hurting the availability of debt financing for apartments.