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Commercial Department: Property TypeCast: June 2017

 

Property TypeCast

Job growth can be a good predictor of rent growth

c_2017-06_Chart_property_typcastThe apartment market has arguably been the best-performing asset class over the past few years. Apartment rents have climbed 5 percent to 10 percent in some markets, and cap rates are at their lowest with investors pouring billions of dollars into these properties.

Both domestic and global investors have been drawn to gateway markets more so than others, because they are deemed safer markets, but plenty of other cities have grown at similar or faster rates as these larger metropolitan areas. So, what should investors look for?

While it is easy to look at rent growth retroactively and say which markets would have been good investments, it is difficult to look forward to find the best investment opportunities with accurate foresight. The recent success of the apartment market, however, has shown that two key variables drive apartment demand — job growth and tech-related job growth — which implies that these variables are a compelling gauge of future apartment performance.

The top five markets that saw the highest rent-growth rates from 2011 to 2016 were Seattle; Portland, Oregon; and the California cities of Oakland, San Francisco and San Jose. All five cities saw rent-growth rates of 43 percent or more over this period. Yet job growth in Seattle, Oakland and Portland was not as strong as the five markets with the highest job growth over that period.

The metros that did add the most jobs saw sharp rent increases, but some of the less urban metropolitan areas — such as Austin, Texas; San Bernardino/Riverside, California; and Nashville, Tennessee — did not see the high rent growth of the more urban or tech-related metros. Some of these suffered more during the recession as well.

Likewise, metros that saw low job growth from 2011 to 2016 had correspondingly low rent growth, but this was not always the case. Pittsburgh, the most urban market among the low job-growth cities, saw relatively strong rent growth. The other metros in the bottom five markets ranked by job growth — Hartford, Connecticut, and the New York cities of Syracuse, Rochester and Buffalo —should not surprise most prospective investors.

The job-growth versus rent-price numbers beg the question: Is job growth an accurate predictor for rent growth? The answer is yes, but with some caveats.

First, note that the correlation coefficient between job growth and rent growth from 2011 to 2016 for the 82 markets that Reis tracks was 66 percent, high by most standards but not a perfect correlation. Second, the tech boom was clearly a bigger driver of rent growth because these markets outperformed the others.

This variable could possibly be more properly measured using income or wage growth instead of job growth. Boston and New York, however, saw high income growth over these years while their job- and rent-growth rates put them in the middle of the pack.

It should be noted that when the top five tech markets are removed from the list of 82 cities, the correlation coefficient between job growth and rent growth jumps to 72 percent, which is significant. In other words, job growth is a considerable driver of rent growth, but other idiosyncratic factors also affect local economies.

At the end of 2016, rent-growth rates slowed across the U.S. because of an abundance of new construction. Although this concerned landlords and investors alike, occupancy growth remained positive in nearly every market because job growth held demand for apartments steady.

Construction is expected to stay robust through 2018, so rents may stay flat, but net absorption should stay positive and keep in line with job growth. Consequently, the market should still see positive returns, but the rate of return will not be as robust as it has been over the past five years.


 

Victor Calanog is chief economist and senior vice president for research at Reis Inc. (www.reis.com). He writes a monthly column on property types for Scotsman Guide. Calanog and his team of economists are responsible for data models, forecasting, valuation and portfolio services for clients in commercial real estate. Reach him at victor.calanog@reis.com. Barbara Byrne Denham is an economist in the research and economics department at Reis Inc. She previously served as chief economist at Eastern Consolidated and is a Ph.D. candidate at New York University, where she has studied economics, monetary theory and game theory. Reach her at barbara.denham@reis.com.

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