The national vacancy rate for multifamily remained moored at 4.4% in the third quarter, unchanged since the fourth quarter of 2015 despite the large number of new deliveries.
This confirms what we have posited thus far about demand remaining robust even as supply growth increases. With that said, this equilibrium is tenuous and likely won’t last.
For markets that experienced either a large increase in rents over the last few years, or a steady influx of new buildings – or both – landlord pricing power is being tested.
Market conditions in the apartment market softened a bit in the third quarter, a period they generally see the highest activity and strongest rent growth.
On Pause, Those Fine Hopes for 2016
We started 2016 feeling fairly optimistic about the prospects of the office sector. With the national vacancy rate declining by 40 basis points last year, we were poised to finally see an acceleration in improvement in fundamentals for the office sector.
With national vacancies remaining stuck at 16.0% in the third quarter, it appears that optimistic hopes about the prospects of the office sector have been put on hold – at least till the fourth quarter.
While the numbers disappointed in the quarter, much of the decline was a lagged response to tepid employment and economic conditions in the first quarter.
Two Steps Forward, One Step Back
The national neighborhood and community center retail vacancy rate increased by 10 basis points during the third quarter to 10.0%; the retail mall vacancy rate decreased by 10 basis points to 7.8%.
Both minor changes represent a reversal in the second quarter when the neighborhood and community center vacancy rate decreased and retail mall vacancy increased, both by 10 basis points.
Neighborhood and community centers have lagged due to the slow growth in median household income that has kept a lid on discretionary spending over the last few years.
Both neighborhood and community centers and regional malls face competition from newer and fresher retail concepts as well as e-commerce.
A Downshift in Demand
The momentum in the industrial market slowed a bit as demand growth decelerated. Nevertheless, vacancy held steady in the warehouse and distribution sector as net absorption exceeded new construction by a small margin.
Although the industrial sector has outperformed other property types in terms of occupancy growth, the down-shift observed in the third quarter puts the asset class on par with office and retail which followed a similar pattern.
Echoing the sentiment we expressed last quarter, the slow but steady rate of growth should continue going forward as most metros continue to see demand growth for industrial space.
Vacancy declined in the Flex/R&D subsector largely due to a sharp drop in new construction.
Net absorption slowed somewhat but remained positive. Market rents increased but also at moderate rates, similar to the second quarter.
Once again, every metro posted positive rent growth for the quarter, although some outperformed others.
New Construction at the Cusp of Economic Change
The third quarter of 2016 was marked by a somewhat consistent trend – a pronounced pullback in new completions, relative to recent quarters.
This is readily apparent in the apartment and office sectors, but less so in neighborhood and community shopping centers where supply growth has been anemic for several years anyway.
What caused this pullback – especially in multifamily where we were expecting a deluge in new supply?
Any pickup in activity for new completions is likely to be driven by projects that are already in the pipeline, just waiting to come online in what may well be a deluge for the apartment sector in the fourth quarter.
Q3 2015 Apartment Trends – After holding steady at 4.2 percent for the first two quarters of 2015, the national vacancy rate rose by 10 basis points to 4.3 percent during the third quarter. We have been expecting that vacancies would rise given the amount of new supply coming online. Vacancies have been bouncing around at these levels for the last two years, with a similar 10 basis point increase in the third quarter of 2014 (only to fall once again at the start of 2015). Overall, market fundamentals remain tight.
Asking and effective rent growth was very impressive, rising by 1.4 and 1.5 percent respectively. On a year-over-year basis, asking rents rose by 4.2 percent, and effective rents rose by 4.3 percent. These are robust figures, strong enough to fuel the hopes of optimists banking on resilient rent growth even if occupancies stay flat or deteriorate. For perspective, apartment rent growth has not been this strong (on a year-over-year basis) since 2007.
Supply and Demand Trends
Over 40,000 units were brought to market during the third quarter, which is less than the second quarter figure; yet – vacancies rose. It is only in retrospect that we will be able to proclaim this third quarter rise in vacancy as a true inflection point, but if the market is showing signs of being unable to absorb 40,000 units of new construction, what will happen when close to 100,000 units come online over the next quarter or two, as our latest projections show? Fundamentals remain tight, but it will be interesting to see where the intersection of demand and supply plays out over the next few quarters.
We expect national vacancies to rise modestly over the next few years, but we’re not very worried about the multifamily sector if these projections come to pass – vacancies will be in the low to mid 5s by 2019, which doesn’t portend lean times ahead.
Q3 2015 Office Trends: Office vacancies fell by 10 basis points to 16.5 percent in the third quarter, after holding steady at 16.6 percent for the first half of the year. The sector is treading a familiar path of a sluggish downward trend in vacancies, which began in late 2010 after the vacancy rate peaked at 17.6 percent.
Given how monthly job growth has actually been weaker in 2015 relative to 2014’s monthly average, this is fairly impressive. Aided by very constrained levels of supply growth, absorption and construction have mostly kept pace, and asking and effective rents also continued their march upwards, albeit at a modest pace.
Asking and effective rents grew by 0.6 and 0.7 percent respectively during the third quarter, marking the twentieth consecutive quarter of asking and effective rent growth. These growth rates are more or less in line with the growth rates from last quarter. However, even though quarterly rent growth did not accelerate, year-over-year rental growth rates for both asking and effective rents did accelerate. Effective rent growth of 3.5 percent is quite strong for a property type with a relatively elevated vacancy rate. We are on track for a 30 basis point decline in vacancies for 2015, the strongest showing for the sector since 2012.
Supply and Demand Trends
Very slowly, the recovery in the Office market is gathering pace (as contradictory as that sounds). 2015 is shaping up to be the best year for demand for office space (as measured by net absorption) since 2007, before the recession.
Year-to-date figures for most metrics are already well ahead of last year. Because the improvement in the Office market has been so gradual, it has largely gone unnoticed by many in the industry. However, improvement is becoming stronger and more consistent. Unless we encounter a major downturn in the near future, this argues for better times for the office market over the next five years.
National Retail Market
On a quarterly basis, retail fundamentals have been improving only slightly. The third quarter was no different – the national vacancy rate for neighborhood and community shopping centers was once again unchanged at 10.1 percent. This marked the second consecutive quarter that vacancy was stagnant. Over the last 12 months, the national vacancy rate declined by just 20 basis points, a rather modest change for that duration of time.
Asking and effective rents both grew by 0.5 percent this quarter. This is just about on par with rent growth over the last couple of quarters. This rate of rent growth is understandable, given the relative lack of demand for these centers.
What about regional malls, the larger property type? During the third quarter, the regional mall vacancy rate was unchanged at 7.9 percent. The vacancy rate has remained essentially the same between the fourth quarter of 2013 and the third quarter of 2015. Asking rents did grow by 0.5 percent during the third quarter – year-over-year rent growth remains at its strongest since before the recession in 2007. However, this continues to be largely driven by the performance of higher end malls. Malls further down the quality spectrum are often burdened with high vacancy rates, often from unfilled anchor tenant space, preventing them from exercising pricing power over current and potential tenants.
Supply and Demand Trends
The outlook should be relatively bright for retail sales, with consumer spending still relatively healthy and benefiting from cheaper oil. However, any benefit of said brighter outlook for retail properties is likely to remain muted, given how eCommerce appears to be acting as a constraint on demand for brick and mortar space.