The record-breaking rent growth of the past several years is showing signs of fading. earlier this month, Redfin reported Rent growth declined by 0.6% on a year-on-year basis for the first time since the pandemic. Admittedly, this is a modest drop in fares, but it also begs the question: Will this be a big improvement or even a reduction in fares? Or is it possible that rent growth will return in the coming years? Let’s dig
Where Rent Growth Stands
When we talk about rent increases in the US, the general condition is that rent increases are at or slightly above the pace of inflation. During 2010, average annual rent growth was 3–5% in most markets. But during the pandemic, as we all know, that changed, and rent growth peaked at about 17.5% on a national basis, with some individual markets seeing annual rent increases top 30%.
The explosive rent growth of 2021-2022 was mainly driven by low supply, dramatic change in migration patterns, strong demographic trends and home construction as well as economy-wide inflation.
But as the economic outlook remains confused and cloudy, rent trends have begun to reverse. The 0.6% drop in rental demand in May is clearly a very small drop and is just one data source. But it’s the trend that investors should care about, that much is clear. The Wall Street Journal recently compiled the year-over-year change in asking rents from six sources, and although the exact numbers vary, the trends are consistent.
It’s important to note that the data referenced above is “seeking rent,” which tracks what property managers publicly list units for. This final price does not reflect the leases actually signed, nor does it reflect lease renewal prices.
That said, there are recent data for lease renewals that suggest rent growth is slowing in that area as well. According to RealPage, the average lease renewal in May 2023 was up 6.5% from last year. That’s still high by historical standards, but down from an average 11% renewal growth a year ago.
Why is rent growth falling?
First, supply is increasing. The past several years have seen a multiyear construction boom, and lots of new inventory is still coming to market. Additionally, more and more single-family homeowners are choosing to rent their homes rather than sell them, which further adds to the rental supply. When supply increases, tenants have more options, and property managers must compete on price. This can reduce the rent.
Second, due to the general economic climate, rents are coming down. Americans (and economists) generally prepare for an impending recession, while inflation is reducing spending power, both of which change spending patterns. People are less likely to relocate, build a new home, or go after a more expensive home during these uncertain times.
Finally, it’s only natural that at some point, rent growth will return to around the historical average. As reversion to averages occurs, periods of negative growth are too typical to correct for recent upswings.
Of course, the above trends are on a national basis, and there are considerable regional differences in rent trends. If you’ve been following prices in the housing market over the past year, you’ll notice a familiar trend here:
The markets in the west and south, which saw the biggest jump during the pandemic, are seeing the biggest improvement. Meanwhile, the Midwest has remained consistent for nearly a year. The Northeast has come down from the height of the pandemic, but is still experiencing higher-than-normal rent increases.
What does this mean?
This change in market conditions is important for investors for several reasons.
First, it’s important to note that for investors with existing properties, none of this data suggests that current rents will decline. Remember, the data we’re looking at here is for new leases, which tend to be more volatile than existing leases. Personally, I think rent demand will drop a bit more before going down, but I expect current rents to stay pretty much the same. Rent is very sticky for existing tenants, even during economic downturns.
Second, if you’re looking to make a new investment, I wouldn’t count on any rent increases until 2024. At least that’s what I’m doing. I think we’ve had what’s known as a “pull-forward” over the years. Meaning rents normally increase 3-5% per year, and we’ve had a few years of double-digit rent increases, essentially stretching several years of future rent increases into 2021 and 2022. In other words, there can be a rental hangover.
Are rents likely to rise again before 2025? Yes of course. A great opportunity, indeed. But there is too much uncertainty to make any meaningful predictions. Given the uncertainty, I think underwriting for no rent growth for the next two years is one way to hedge risk at this time. If a deal doesn’t increase rents for the next two years, grab it! That way, if I’m wrong and the fare goes up, it’s just a bonus on top of an already good deal for you.
In recent years, some investors I know have been buying properties that don’t generate cash flow or barely generate cash flow because they rely on rental growth to help them reach solid cash-on-cash returns over time. Was doing. While it’s still possible, I think it’s a risky proposition at this point in time. I personally would not do this. If you’re investing for cash flow, buy cash flow deals today. Don’t expect anything to change in the future.
Analyze Deals Like a Pro
Deal analysis is one of the first and most important steps in real estate investing. Maximize your confidence in every deal with this first-to-last guide to deal analysis. real estate by the numbers Real estate makes the math easy, and makes real estate success inevitable.
Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
