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U.S. economy may be nipping at apartment sector

A man climbs a set of stairs built into the sidewalk in the North Beach neighborhood in San Francisco, California May 27, 2012. REUTERS/Robe
A man climbs a set of stairs built into the sidewalk in the North Beach neighborhood in San Francisco, California May 27, 2012. REUTERS/Robe

By Ilaina Jonas

NEW YORK (Reuters) - The U.S. apartment sector posted its smallest vacancy decline in nearly two years, raising the possibility that the strongest commercial real estate category may be succumbing to the sluggish economy, according to real estate research firm Reis Inc.

For nearly two years apartment landlords have been able to boost rents and fill their buildings as Americans, either burned by the housing bust or unable to get a mortgage, turned to renting instead of owning a home.

But rent growth ultimately depends upon significant job growth and rising incomes, and during the third quarter neither have come through.

The national vacancy rate inched down to 4.6 percent in the third quarter, typically one of the stronger quarters, from 4.7, according to Reis' preliminary figures released on Wednesday. The dip was the smallest since the recovery began in early 2010.

"I think the market is getting so tight at this point that further declines in vacancy not supported by strong economic growth are just not going to be possible," Victor Calanog, Reis Head of Research & Economics, said. "We're already in no man's land now where vacancies are so low and yet the unemployment rate is above 8 percent. At some point economic gravity is going to kick in, and even this sector will feel the brunt of it."

In another sign of cooling and discounting apartments that were given up, only 22,615 more units were leased in the third quarter, down from 31,014 units in the second quarter and 36,423 units in the first. It was the lowest net lease-up since the first quarter 2010.

The average asking rent in the third quarter rose 0.8 percent to $1,090 per month, Reis said. Reflecting landlords' ability to offer fewer perks to lure tenants, such as months of free rent, the average effective rent rose 0.9 percent, to $1,041 per month.

Despite being marginally less than the prior quarters, the numbers still reflected strong rent growth, Reis said.

"Landlords appear to be shifting their revenue-maximizing strategy away from occupancy improvements to raising rents," Calanog said.

Large apartment companies such as Equity Residential and AvalonBay Communities Inc already have shown they are willing to sacrifice a little occupancy for higher rents.

Of the 79 markets Reis follows, New York had the lowest vacancy rate at 2.1 percent, the same as in the second quarter. It also had the highest average rent - $2,990 per month, up 1.7 percent from the second quarter. It was the second-highest rent increase after San Jose, where rent increased 1.9 percent to $1,599 a month.

Reis expects the apartment sector to remain strong, with vacancy declining by the end of the year but not falling below 4 percent.

The sector faces some potential risks in the near future. One may be competition from single-family home buying, Reis said. Another could be a spike in construction next year in rental markets such as Seattle, Washington D.C. and suburban Maryland.

A third threat could show up in Boston or Chicago. Both cities have surpassed previous rent and occupancy peaks and may be nearing the point where landlords will no longer be able to raise rents if the median wage remains stagnant, Calanog said.

(Reporting by Ilaina Jonas; editing by Prudence Crowther)

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