The Race Is On Between Multifamily Rental Increases And Inflation

Rising inflation  — now at its highest annual rate in three decades — has only added fuel to the multifamily fire, with rents skyrocketing across the nation in 2021. 

For developers and owners, this has led to a race of sorts between market forces largely out of their control: rising rents versus rising costs. 

Heading into 2022, the longevity of rental increases is no certain thing, while the cost of labor, materials, taxes and insurance represent a suite of wild cards for the industry. But for now, rents are outrunning costs, as owners continue to enjoy expanding revenue and profits, industry experts tell Bisnow. 

“We're seeing rent escalations keep pace with rising construction costs in a way that we haven’t seen in at least the last five years,” Focus CEO Tim Anderson said. “Delayed deliveries and pent-up demand as a result of the pandemic have had measurable impacts on rent growth.”

Anderson, who is a developer and general contractor in the Chicago area, doubts that dynamic can last. Eventually, due to increased supply and the normalization of local and national markets, those rates will level out, he said.

For now, though, demand is in the driver's seat.

“None of our landlord clients report that tenants are having difficulty qualifying at higher rents,” John Burns Real Estate Consulting President CEO John Burns said.

“Rental occupancy has reached the highest point in decades, allowing landlords to raise rents because demand is so strong,” Burns said. “Renters are staying put rather than moving, because they tend to get a better deal on rent renewal than leaving to get another apartment.”

Rent hikes are being measured against the uncharacteristically weak rent growth seen in 2020 due to the pandemic, National Multifamily Housing Council Senior Director of Research Chris Bruen points out.

Nevertheless, recent rent growth has been epic. The Apartment List annual National Rent Report in November found that national median rent had increased by 17.8% from January to November — compared with an average 2.6% increase over the same pre-pandemic periods from 2017 to 2019.

Rents have cooled in recent months, however. The month-over-month gain for November, according to Apartment List, came in at 0.1%, in a month when seasonal considerations typically drive average rents down.

That will probably amount to a pause, with demand strong enough to resume rental growth in the spring, Zillow analyst Alexandra Lee said, meaning that any monthly rent cooling is unlikely to continue fast enough or long enough past winter to make much of a dent in the rapid pace of annual growth.

“Vacancy rates have remained low, and affordability pressures on the for-sale market are likely to bolster rental market demand next year as some would-be buyers are priced out,” Lee said.

During an inflationary period, rising household formation is unusual, Burns said. People whose incomes and savings are being eroded by inflation historically have been more reluctant to form new rental or ownership households. This time around, he said, the surge is being driven by people born in the 1990s, many of whom are coming late to household and family formation.

Against this backdrop of rental increases is cost inflation for multifamily developers and investors.

For residential projects, construction input prices rose 23.5% in November compared with a year ago, according to the Associated Building Contractors. Energy costs were an important driver of construction input inflation, with natural gas prices up 150.6% for the year and crude oil up 115.2%. Building material prices also swelled, with iron and steel up 105.1%.

“There is no indication that materials prices will fall in the near future," ABC Chief Economist Anirban Basu said in a statement. “With the omicron variant now circulating around the world and leading to a next wave of lockdowns and supply chain disruptions, demand for key commodities will continue to exceed supply.”

Construction labor costs are up as well, ABC reports, citing Census Bureau data, with average hourly wages up 4.8% in November compared with last year, the same as in all private industries. As the number of residential projects swells to meet demand, the number of workers in the industry has grown as well, up 6.2% year-over-year, potentially putting further upward pressure on wages as contractors scramble to find workers.

Construction costs affect owners of existing properties as well. “Landlords are also forced to spend significantly more for any significant improvements ... with rising material prices and construction labor,” Burns noted.

There are more hidden cost increases affecting multifamily owners as well, NMHC Vice President of Research Caitlin Walter said. For instance, the shortage of some items — such as refrigerators and other appliances  — has the potential to delay the opening of a multifamily project, which represents the cost of lost rent for the waiting period.

Walter also cites regulation as another important factor in rising costs, one that jurisdictions can act to mitigate, but many places have not.

“The impact of regulation, especially in some parts of the country, goes back well before the pandemic, adding to the cost of developing and operating apartments,” she said.

Nationwide, housing providers have also seen increased premiums across all lines of insurance, according to NDP Analytics in a May survey for the Institute for Real Estate Management, the National Apartment Association and other sponsors. For general umbrella/excess liability insurance, 60% of survey respondents said they experienced increases of more than 15% over the previous year. One in 10 saw their premiums double or more than double.

To deal with swelling insurance costs, the survey found that most housing providers are increasing their deductibles, with about half of respondents saying they would both decrease operating expenses and increase rent.

For tenants, even those who can keep up, an increase in rent means an increase in financial stress. For those who can't keep up, rental inflation exacerbates the affordability crisis. On average nationwide, a two-bedroom apartment requires a wage of $24.90 an hour to afford, meaning that nearly 60% of all wage and salary workers can't afford it, according to the National Low Income Housing Coalition.

Ballooning rents haven't appeared to result in missed payments overall, at least not yet. 

The NMHC reports that 77.1% of apartment households made a full or partial rent payment by Dec. 6, down from 78.2% by Nov. 6. But that is also a 1.7 percentage point increase from the number who paid rent through Dec. 6, 2020, and compares to 83.2% that had been paid by Dec. 6, 2019.

Walter cites federal support for renters and landlords as part of the reason the rate is still relatively high, along with the recovery of the employment market and rising wages. But that has only amounted to a temporary fix.

“Whatever the short-term fluctuations in rent increases in the near future, affordability will remain a long-term problem,” she said.