Are tenants thinking twice about accepting rent increases?

Apartment fundamentals improved in the first quarter, as the vacancy rate fell by 20 basis points, dipping to 4.3%. Reis has not observed vacancy rates this low since late 2001. Asking and effective rents both grew by 0.5% during the first quarter. This is the slowest rate of growth for both asking and effective rents since the fourth quarter of 2011; every single quarterly data point in 2012 showed stronger asking and effective rent growth. What does this mean? Optimists will point out that the first quarter tends to be weak, as most households move during the second and third quarters, bolstering leasing activity and rent increases. The seasonality of rent growth was evident in the prior year, when the strongest periods centered around the second and third quarters. However, given how tight vacancies have become, rent growth ought to be stronger (for perspective, in prior periods when vacancies were in the low to mid-4s, annual rent growth was well above 4%). Analysts have wondered how rents could keep climbing when jobs are being created at a sluggish rate and wage growth has been relatively stagnant: all of Reis's major markets now boast rent levels well beyond peaks achieved prior to the recession. One answer is that the moribund housing market left households with little choice but to absorb rent hikes, but with the housing market now recovering, renters may not swallow rent increases as easily. A combination of rising supply growth and rent levels that may have climbed to unsustainable levels will pose a test to the robustness of apartment fundamentals in 2013 and beyond. A New York Perspective New York remained the tightest market in the country, boasting a 1.9% vacancy rate, down 20 basis points from the previous quarter. Yet rent growth has disappointed of late. Asking and effective rents were both down 0.2% in the fourth quarter of 2012 and up just 0.1% and 0.2%, respectively, in the first quarter. These are very underwhelming numbers for a market whose vacancy rate is below its longer-term average of roughly 2.1%. For example, when rents were last under 2%, quarterly asking and effective rents spiked 2.6% and 2.5%, respectively. So why have rents seemingly hit a brick wall in the past two quarters? The seasonality discussed above for national rent figures may be having a similar dampening effect for the New York metro. But we would still expect decent rent growth in off-season quarters given how high occupancy has reached. The more likely answer has to do with the economy. In mid-2001, the U.S. economy was nearing the end of a long period of strong economic growth. Moreover, the stock market was at the end of an unprecedented period of rising prices, which bolstered Wall Street, the key driver of New York's economy. Contrast that with today's economic landscape. GDP is growing, but at a sluggish rate. A tepid 2.5% annualized growth figure for the first quarter was actually a welcome sight after the minimal growth in 4Q2012. Meanwhile, healthy gains in the stock market have not translated into a booming financial sector. On the contrary, most large financial firms are still retrenching by cutting personnel. Rent levels in New York are at an all-time high, with effective rents ending the first quarter at $2,989 per unit. Yet, with income fairly stagnant, perhaps the local market isn't able to handle huge rent increases despite such a tight vacancy. The ratio of New York rents to the average of all primary market rents jumped from 2.099 in 1990 to 3.183 in 2007 before falling slightly during the recession. However, the ratio has been rising since 2009 and reached 3.152 at the end of 2012. The growth of finance sector pay packages over the past twenty years has much to do with this significant increase. But with general income growth restrained and the financial sector cutting back instead of expanding, New York's rents may be bumping against the budget constraints of many city dwellers. The next couple of quarters will be a good indicator of whether New York renters have the ability to stomach more substantial rent increases. Victor Calanog is vice president, research & economics and Brad Doremus is an associate at Reis, Inc., New York, N.Y.