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Commercial Department: Property TypeCast: October 2018

 

Property TypeCast

The impact of wage growth on apartment rents merits examination

c_2018-10_property_typecast_chart

For guidance on the apartment market, we often use employment growth as the best gauge for apartment demand and rent growth. One overlooked variable that deserves some consideration, however, is wage growth. Rent growth should be tied as much to wage growth as it is to employment growth, but is it?

At the national level, yes, effective rent growth has moved in line with wage growth as shown in the chart on this page. Wages, however, are inherently more volatile than jobs — at least in an expanding economy — and rent growth is generally steadier, like employment growth.

To illustrate how rents do not necessarily follow wages, consider the gap in wage growth by metro area. In 2017, the top two metros with the highest wage growth were the California markets of San Jose and San Francisco, with rates above 7 percent — driven, one would assume, by technology companies. Yet, effective rent growth for 2017 was only 2.1 percent in San Jose and 2.9 percent in San Francisco. Miami and Denver saw the highest effective rent-growth rates in 2017 — just over 7 percent, but wage growth in those metros was 3.3 percent and 3.8 percent, respectively.

At the other end of the scale, Fairfield County, Connecticut, was the only metro area to see a decline in wages, of -0.7 percent. Its rent growth was extremely low, 0.2 percent, but it was not the lowest metro. That distinction went to Providence, Rhode Island, with a decline of 1.8 percent. The average wage growth in Houston also was low, 1.3 percent, and was likely impacted by Hurricane Harvey. Houston saw robust effective rent growth of 5.3 percent, however, again likely due to Harvey as so many residents had to find temporary shelter.

There were a number of other outliers. In New York City, wage growth was 4.4 percent, ranking it sixth, just behind Los Angeles, in terms of the top metros for wage growth in 2017. Rent growth in New York City, however, was 0.5 percent in 2017 as landlords had to compete for tenants with a great deal of construction underway. In contrast, New Orleans had rent growth of 5.4 percent, yet wages only grew 2 percent.

So, if New York’s rents are low while wages are growing at a healthy pace and, at the same time, New Orleans’ wage growth is low and rent growth is strong, this means, oddly enough, that affordability is actually improving somewhat in New York City while it is deteriorating in New Orleans.

One also could argue that rent growth lags in relation to wage growth and/or employment growth. This is somewhat accurate: The correlation between recent effective rent growth (second-quarter 2018 over 2017) and lagged employment growth (2017) by metro area was higher than that for the concurrent data. There was no difference in correlation between recent rent growth with lagged wage growth and the equivalent concurrent data, however.

What the numbers suggest is that high levels of construction are impacting rents more so than the underlying economy, at least in the last year or so. The current pipeline of construction is expected to drop off after 2019, at which point the underlying fundamentals — occupancy and rent growth — should start to move more in line with wages and job growth. 


 

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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