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Rising vacancies, slowing rent growth may boost apartment affordability, but only slightly

March 26, 2018 | By

It’s shaping up to be an up-and-down year when it comes to apartment affordability. On one hand, the production of new rent-restricted apartments will likely continue to struggle. On the other, rent growth will likely slow and wages strengthen in 2018 – a positive sign for the affordability of multifamily rentals. (View video on 2018 outlook on affordability)

While some of these signs are positive, they will likely do little to reverse the significant erosion in the affordability of rental apartments since the end of the Great Recession. That’s because ongoing demand for affordable rental units has kept the estimated vacancy rate for these types of units fairly low. For example, the estimated vacancy rate for class C apartments, which tend to be some of the most affordable, was only about five percent as of the end of 2017.

Vacancies at rent-restricted properties were even tighter — less than two percent. These include properties with rent-restricted apartments that benefit from the federal Low Income Housing Tax Credit program (LIHTC).

What About New Supply?

Although there have been a lot of new apartments added over the past few years, most of the new stock is higher end – class A units – commanding higher rents. In addition, strong demand has led developers to renovate older, more affordable apartments into high-end units. This leaves fewer affordable class B and C rentals.

Most new affordable apartment rentals are generally funded by LIHTC. After falling below 80,000 units during the recession, the number of new rent-restricted units placed in service annually appeared to be returning to more normalized levels of about 90,000 to 100,000.

Read more: Fannie Mae re-enters Low-Income Housing Tax Credit market

However, the recent passage of the Tax Cuts and Jobs Act (TCJA) may cause these numbers to plunge again.

While the TCJA left LIHTC intact, the decline in the corporate tax rate from 35 percent to 21 percent will likely still have negative consequences for new rent-restricted supply. As shown on the chart below, tax credits are now less valuable and their price has declined substantially since discussions on implementing a tax reform began at the start of 2017.

This means that developers may end up struggling on new projects with rent restricted apartments to fill the financing gap left by lower proceeds from the sale of LIHTC.

Low Income Housing Tax Credit Equity Pricing per Credit (January 2016 – December 2017)

Source: Novogradac & Company LLP

Tax reform also contained some good news in the form of a new program that could provide funding for affordable housing.

Among other incentives, the TCJA allows investors to defer paying tax on gains (up to nine years) if those gains are invested in Qualified Opportunity Funds that in turn invest in economically distressed communities designated by the governor of each state.

These areas are known as qualified “Opportunity Zones.”

Rent Growth Expected to Ease Slightly

Going forward, the onslaught of new supply expected in 2018 should start to spill over to the more affordable Class B and C apartments.

As shown on the chart, the expectation for 2018 is that rent growth for Class B apartments will moderate but remain positive at 1.8 percent. Similarly, rent growth in the most affordable apartment category, Class C, is projected to moderate to an estimated 2.2 percent.

However, in both cases, rent growth will still be above the 1.6 percent rate projected by CoStar for Class A apartments which command the highest rents.

Read more: The crisis in affordable rental housing: How we got here and finding our way forward

When Can We Expect Improvement?

Meaningful improvement in affordability can only be attained when wage growth outpaces rent growth.

With the recent tax cuts anticipated to stimulate the economy, Fannie Mae revised its economic growth forecast for 2018 upward by 0.6 percentage points to 2.7 percent and anticipates the addition of over 2 million jobs. The improved outlook stems largely from stronger anticipated consumer spending and business equipment investment.

With the unemployment rate at just 4.1 percent, and employment adding a strong 200,000 new jobs in January 2018, it is hopeful that wage growth will continue to strengthen and perhaps even outpace rent growth in 2018.

Still a Long Way to Go

Momentum in the overall multifamily sector will likely slow in 2018 due to elevated levels of new, mostly expensive Class A supply. As a result, the national vacancy rate is expected to increase slightly in 2018, and, while rent growth should remain positive, it is expected to grow at a more modest pace. This is likely to do little to reverse the significant erosion in affordability of multifamily rentals seen since the end of the recession.

Indeed, with about one-fourth of the nation’s renters spending over half of household income on rent and utilities, improvement in the affordability of rental housing still has a long way to go.

For more information, read our February Market commentary.

Opinions, analyses, estimates, forecasts and other views of Fannie Mae’s Multifamily Economics and Market Research Group (MRG) included in these materials should not be construed as indicating Fannie Mae’s business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the MRG bases its opinions, analyses, estimates, forecasts and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts and other views published by the MRG represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management.

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