Occupancy and rent change are improving a bit in the most upscale communities, where a big wave of new supply had held back earlier results. At the same time, however, performance fundamentals are deteriorating across the lowest-priced housing stock that is generally referred to as Class C inventory.
Affordability struggles for households with limited incomes are putting downward pressure on rents in the country’s bottom-tier properties. That said, the market influence that’s now really moving the needle on revenues in these communities isn’t financial health of the resident base. Instead, it’s immigration policy.
Newcomers to the United States are a key component of demand for Class C apartments. Loss of some of these households—or at least a drastic reduction in the number of new arrivals—is making it tough to fill any available units, prompting housing providers in some locations to slash pricing.
Inherent Vulnerability
Residents of the nation’s housing offered at the lowest price points are always walking a financial tightrope. Their rent-to-income ratios generally run quite a bit higher than is typical for those living in luxury or middle-market apartment developments. Furthermore, they rarely have savings that are adequate to deal with an interruption in employment or any other type of financial emergency.
An increase in inflation like the one that is occurring right now hits these households hard. Necessities account for the bulk of their total spending, making it tough to deal with significant increases in the costs of not just shelter but also food, healthcare, energy, or transportation.
Class C housing providers are accustomed to dealing with missed rent payments that are comparatively frequent and bad debt that runs deeper than is typical in Class A and B projects.
Key Statistics
The nation’s lower-end apartments remain basically full. Occupancy is reported at roughly 95% in the Class C segment of the RealPage data set, and CoStar cites occupancy in what the company calls one- and two-star properties at a similar level of approximately 94%.
Digging deeper into the occupancy data, status variation from one community to another is getting more pronounced. Significant resident losses are reported in properties where immigration agents have been active during recent months. Shaping these performance results, housing providers say that the visible removal of just one household can have a chain reaction effect, prompting additional residents to turn in their keys and leave the community.
Loss of pricing power is more pronounced than the shifts occurring within the occupancy data, indicating that it’s getting harder to fill any vacancies that do develop.
Nationally, move-in rents are down by just over 3% compared with year-ago pricing in the Class C product inventory tracked by RealPage. The pricing pullbacks are especially pronounced in areas with immigrant-heavy populations. State-level cuts in Class C rents over the past year reach approximately 9% in Arizona and Colorado, while the decline registers between 7% and 8% in Texas. Prices are off by some 4% to 5% across Florida, Georgia, Nevada, North Carolina, Oregon, Tennessee, and Utah.
Backtracking of pricing power goes quite deep in select metros and in some key neighborhoods where immigrant households tend to cluster. Examples of areas taking a pounding in performance include spots like southwestern Phoenix, southeastern Denver and the adjacent suburb of Aurora, and the Lake Highlands and Bachman Lake areas of metro Dallas.
What Comes Next
We’re already seeing an upturn in the number of Class C apartment loans moving into special servicing. That flow of properties experiencing financial stress seems apt to accelerate during the near term. The properties that traded hands when multifamily asset values were peaking in 2021-2022 are especially in danger, since those communities never realized the rent growth that was generally assumed when the deals were made.
We’ll have to wait to see whether this product distress will lead to some shifts in the ownership profile of Class C properties. There’s a move among larger national firms and institutional capital providers to expand their portfolios beyond the traditional focus on luxury assets, incorporating some affordable housing into the mix. Does the “affordable” descriptor truly just mean middle-market product for this investor set, or will these firms reach down to acquire the Class C offerings that have been owned by small investors and local/regional experts in the past?
Another still unanswered question focuses on the outlook for the renter base living in Class C apartments. It seems unlikely that we’ll return to the international immigration volumes that were typical in the past–between 1 million and 2 million people annually during the 2000s and 2010s. However, it’s certainly possible that the numbers will stabilize, if you assume that the current wave of household removals is short-lived.
In the best-case scenario, another group of renters could emerge as an alternative to the immigrant households that are now missing. It’s not outside the realm of possibility that cuts in Class C rents will encourage some young adults now living in multigenerational households—typically young men without college degrees still residing with their parents—to form their own households.
The Bottom Line
Occupancy and rent production levels have hit a rough patch in the nation’s Class C market-rate apartments, and there will be some challenges to work through over the near term. The slowdown in apartment construction that will limit luxury product deliveries over the next couple of years won’t fix what’s ailing the lower-end segment of the rental inventory, since difficulties primarily reflect a reduction in the demand volume that was typical in the past.
In the big picture, however, it’s important to remember that there’s a shortage of housing across the United States. That shortage is most pronounced for the inventory available at comparatively affordable price points. Opportunities for Class C apartment investment and operation are not permanently damaged. There’s just some momentary recalibration taking place.