Mortgage rates are up, so fewer people can afford to buy homes. That means additional demand for single-family rentals and apartments, right? Well, probably not. We’re increasingly skeptical of that prevailing view.
We would bet instead on rental demand fundamentals remaining healthy, but trending down below 2021 peak levels.
Why? A few key reasons: First, there’s little evidence of a trade-off effect between for-sale and for-rent homes.
Second, declining consumer confidence will likely reduce household formation, which means less demand for all types of housing.
And third, a possible hangover effect from the accelerated housing demand boom of 2020-21.
Of course, there are plenty of strong tailwinds (i.e. incomes, jobs, demographics) for rental demand, too, which is why we’re projecting moderation of occupancy and rent growth levels, not a collapse – aligning with our outlook going into 2022. The rental market is playing out as expected, and higher rates don’t change the story.
Higher Mortgage Rates Do Not Create Additional Renters
Let’s walk through these factors in a little more detail, starting with some myth busting. There is no evidence of an inverse relationship between demand for rentals and for-sale homes. They don’t really compete with one another in real life. Demand for all types of housing tends to ebb and flow together. All housing feeds off the same core demographic and economic drivers.
Low mortgage rates in 2020-2021 certainly didn’t weaken demand for rentals. So why would high rates boost demand for rentals in 2022? And inflated home sales in the mid-2000s housing bubble didn’t slow down rental demand, either. Why would slower home sales boost rental demand?
Yes, some renters will stay in place longer because home purchase is less accessible. That boosts retention somewhat, but it doesn’t create additional renters – and the underlying driver behind higher rates (inflation) could actually reduce household formation, which feeds housing demand.
Weakening Consumer Confidence Could Dampen Demand
We might see some clues from plunging consumer sentiment levels. When people feel unsure about the economy and their personal financial health, they’re less likely to form new households and make major housing decisions like signing a new lease or buying a home. That translates to less demand for all types of housing. Rental demand certainly isn’t evaporating – thanks to continued growth in jobs and wages – but it would likely be even stronger if consumer sentiment were higher.
Low consumer sentiment is not the same thing as affordability. Uncertainty tends to have a temporary freezing effect on major decisions like signing a new lease or getting a mortgage – even among households that can afford to do it. Indeed, the typical market-rate apartment renter signing a new lease in the first half of 2022 is spending 23.2% of income toward rent – well below the affordability ceiling of 30%.
But when it doubt, wait it out. Especially if you think there’s a chance prices or rents could decrease in the near future. We’ve seen the same behavior among many rental housing investors, who’ve slowed acquisitions even though they’re sitting on plenty of capital.
Rapid household formation – such as roommates decoupling and young adults moving out of their parents’ house – was a big driver of housing demand in the COVID era starting in summer 2020. Our view is that household formation has exceeded the Census’ official numbers.
If that trend slows down (even temporarily, in our view), it’ll mean moderately more doubling up and more staying put in existing combined households.
A related, short-term headwind is that (as we and others said repeatedly in the last couple years) COVID likely pushed forward some future housing demand into 2020-2021. Lockdowns followed by the work-from-anywhere movement triggered accelerated relocations that might have otherwise occurred in later years. That was inevitably going to ding 2022 demand a bit, regardless of inflation and mortgage rates. The 2021 demand numbers were crazy high, and unlikely to be topped any time soon, in part due to these factors.
Good News: Rental Tailwinds Remain Plentiful
To be clear: This is not a doomsday outlook. We’re just making the case for continued moderation (in demand and in rent growth) as we had forecasted going into 2022. Rentals are in strong shape, but high mortgage rates do not boost the demand outlook.
Our view is that consumer sentiment will eventually tick back up sooner than later as inflation mitigates, and rental demand in 2023 will come in somewhere between 2021 and 2022 levels.
Of course, there are plenty of strong tailwinds for rental housing. Unemployment remains low. Job growth continues to exceed expectations. Incomes continue to climb. There are signs inflation could be mitigating somewhat. And consumer spending suggests consumers are voting with their wallets differently than how they answer survey questions on consumer confidence. Additionally, household debt remains low, despite inflation.
Furthermore, demographics remain very favorable both for apartments and for single-family homes. Unlike in the 1990s, when the comparatively small Gen X group replaced the much larger number of Boomers in the young adult category, there is no such valley ahead. There’s a large number of older Millennials moving into a single-family stage of life (whether as renters or buyers), and there’s a large number of younger Gen Zers replacing them in apartments.
The net impact should be solid-but-moderating demand that lifts vacancy to more balanced – not alarming – levels. But don’t expect higher mortgage rates to boost demand for rentals.
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