Q3 2023 Asset Services Update
As mentioned in last quarter’s U.S. Multifamily MarketBeat, many expect workforce housing to outperform. The resilience in this sector of the multifamily market has been long documented, typically attributed to a few factors working in favor of Class B housing.
- Renters in this subset form the backbone of the U.S. economy: teachers, policemen, firefighters, et al. These jobs tend to be resilient during any economic headwinds, offering a degree of recession resistance compared to more cyclical sectors.
- It’s difficult to deliver new housing into this segment. Very little new construction is targeted for midrange renters, given construction costs versus rents, and fewer than a third of the roughly 1 million units underway today will likely serve this market. While concepts to help incentivize more construction for this product— such as a middle-income tax credit, like the Low-Income Housing Tax Credit (LIHTC)—have been proposed at the federal level, these ideas have yet to gain real traction.
- In a recession, the resultant job losses will likely result in renters needing to save on costs. Those living in Class A residences stand to save an average of about $540 per month by trading to a Class B apartment, a 30% savings. The premium has narrowed somewhat in recent quarters but is still much wider than the $340 historical average. To narrow that gap, Class A landlords would need to offer generous incentives, a practice that’s been employed almost exclusively by new lease-ups, rather than stabilized product to date.
The product has broadly outperformed over the past few years, but it has become more desirable given the recent economic uncertainty. As the third-largest property manager nationally, with more than 178,000 units managed, Cushman & Wakefield’s portfolio offers unique insight into the underlying trends in the sector.
The broader portfolio remains resilient in the face of rising national vacancies, as outlined in Cushman & Wakefield’s latest U.S. Multifamily MarketBeat. However, the strong performance of our clients’ Class B assets within our portfolio necessitates a deeper dive.
Cushman & Wakefield’s Asset Services team regularly shares updates and other operational insights in the Multifamily Monthly newsletter.
No Weakness in the Renter Profile Yet
Class B apartments are typically the most resilient due to the type of jobs that renters typically hold, but incomes are still typically lower than those from renters who live in Class A properties. The pinch of inflation tends to affect Class B renters more, which is why we consistently analyze our dataset for weaknesses that would signal an underlying frailty in the economy. Thus far, we haven’t found one. Our team tracks the reasons that our renters are moving out—the left chart shows the number of Class B residents moving out for cost reasons as a share of our total Class B move-outs. Historically, the data is volatile, but we’ve observed the broader trend level out in the last few months around a sustainable 6.5%–down from more than 8% last year. Similarly, we’ve seen little reason for concern when it comes to delinquency. For confidentiality reasons, we can’t share the overall level of delinquency, but the trend is instructive–as there has been a clear downward shift in delinquency among Class B renters over the past year.
Demand Has Improved Over Last Year
As outlined in the MarketBeat, the broader market has seen considerable demand for apartments this year after a weak end to 2022. That demand hasn’t been limited to new lease-ups. Across our portfolio, we see applications—a leading indicator for apartment demand— for Class B rentals picking up as well, thanks to continued strong economic growth. While higher rates have had a significant impact on commercial real estate, the broader economy continues to show strong GDP and job growth, both of which tend to correlate well to apartment demand. As was the case with delinquencies, we can’t share the overall level of applications, but the trend remains instructive. August and September were the two highest months for Class B applications of any month in the past year.
Stabilized Occupancy Improvements Continue
Across Cushman & Wakefield’s multifamily portfolio, Class B continues to post strong occupancy figures, as well as meaningful occupancy improvement over the past year. Driven by strong demand for multifamily and healthy renewal rates, Class B occupancies were about 65 basis points (bps) higher than the broader portfolio’s stabilized occupancy, with an increase of about 130 bps over the past year. As the market enters a slower leasing period, occupancy has slipped slightly, but both the broader portfolio and our Class B portfolio’s occupancy remain well above this point last year.
Class B Has Shown Strong Trade Outs
In the third quarter, rent growth matched its weakest quarter-over-quarter (QOQ) decline in 15 years, as outlined in the MarketBeat, but the Cushman & Wakefield third-party management portfolio has been able to weather much of the storm. There are some markets that outperformed and underperformed, but at the Class level, Class B continues to outperform the high-tier assets. The graph below demonstrates the relative insularity from supply-side pressures that are most acute in the Class A sector.
There is no guarantee that Class B product will continue its run of strong performance, especially with the supply-side pressure the market hasn’t experienced since the 1970s. But with rents that are more affordable to the average renter, there is a case to be made for continued optimism.
With more than 170,000 units managed nationwide, our team is constantly leveraging data for our clients, along with our on-the-ground experience and knowledge of property management. We look forward to sharing these insights with you in future quarters.