Investors that are interested in these apartments are finding severe shortages of product.
By Greg Willett
The nation’s ongoing health crisis and troubled economy are increasing the need for market-rate apartments at the lower end of the price spectrum. Some renters are looking to downgrade their housing choices due to income interruptions. Others simply would prefer to save some money at this point, given uncertainty about what might lie ahead.
However, the available stock of Class C product—defined here as roughly the 25% or so cheapest market-rate units in a metro—is virtually exhausted in many places across the country.
Today’s US occupancy rate for Class C properties stands at 96.3%, a little above the 95.7% occupancy for the middle-tier Class B stock and way above the 94.6% occupancy for luxury Class A projects. Occupancy in the Class C product niche has been hovering around the 96% mark for the past three years.
The tightest occupancy in the Class C product segment tends to be in places that have been slow-growth economies over the long term.
Keep in mind that building new market-rate apartments at the Class C price point isn’t possible, simply because those deals don’t work financially. Today’s construction costs and land prices are too much for the lower rents that can be charged in Class C product. Given Class C projects are older properties that have now aged into becoming the market’s most affordable stock, product shortages tend to be most severe in places where construction was limited 30 to 40 years ago.
Among the country’s 50 largest metropolitan areas, Class C occupancy is tightest at 98.9% in Providence, Rhode Island. Limited building decades ago likewise means Class C product is full today across most of the Midwest—notably in Detroit, Cleveland, Minneapolis and Milwaukee. Philadelphia is another spot that fits this chronic slow-growth, limited-construction description and has high occupancy in its Class C apartments.
One more noteworthy place with an especially notable Class C product shortage is Miami. The South Florida area has the highest rent-to-income ratio anywhere across the country, so the local population’s affordability struggles really keep the lowest-priced properties full.
Looking at the other end of the story on product availability, the lowest Class C occupancy rates—and, in turn, the biggest stocks of vacant lower-priced units—are in places where lots of product was built 30 to 40 years ago. That’s across the Sun Belt generally and in Texas specifically. Class C product occupancy comes in under the 94% mark in Houston, San Antonio and Austin. The rates are just a hair higher in Dallas and Fort Worth.
A couple of other locations with low Class C product occupancy right now are San Francisco and San Jose. That’s in sharp contrast to what’s typically seen in these expensive areas, where lower-priced housing is usually in high demand. But the Bay Area suffered a huge block of net move-outs in 2020, as households left the extremely expensive metro for cheaper options elsewhere. The biggest occupancy drops registered in the Bay Area’s most expensive urban core properties, but the Class C projects experienced some move-outs too.
Stable to Rising Rents in Most Places
While Class C properties are the lowest-priced market-rate options, they’re still a financial stretch for households facing the most severe financial challenges.
Across the US, the average monthly rent in this Class C stock is $1,139, compared to typical rates of $1,377 for Class B product and $1,777 in the luxury Class A inventory.
Today’s health crisis and resulting recession essentially stabilized Class C rents for the nation as a whole during 2020. Effective asking rents for new leases inched down 0.4% in the Class C product niche. Price reductions also were minor at 0.8% for the Class B product set, while bigger declines of 2.3% occurred in the Class A stock.
The past year’s basically flat Class C product rents masked that most individual markets experienced price growth. Looking at the 2020 rent change results for some of the largest metros, the most notable increases were bumps of 4% to 5% in Phoenix, Atlanta and Baltimore. Pricing climbed at least 3% in another nine locations: Sacramento, Columbus, Memphis, Greensboro/Winston-Salem, West Palm Beach, Las Vegas, Riverside/San Bernardino, Charlotte and Miami.
National results for Class C rent change during 2020 were dampened by sizable price declines in some of the country’s biggest and most expensive metros. Rent cuts for Class C properties proved drastic at 20% or so in San Francisco and San Jose. New York’s Class C rents declined by roughly 8%, and there were drops in the range of 4% to 5% in Oakland and Austin.
Those big price drops in San Francisco and New York certainly didn’t fix the huge affordability challenges that exist in those areas. Average monthly rents for Class C product still are at nearly $2,300 in San Francisco and a hair over $2,000 in New York.
Missed Rent Payments
Evictions for missed rent payments have been banned in much of the country for the past year. But RealPage information on rent collections suggests that residents of professionally managed Class C properties are somewhat more vulnerable to future eviction than their counterparts living in Class A and B product, with the outlook varying quite a bit from place to place.
Looking at communities using RealPage property management software, about 87.8% of the renters in Class C apartments paid their monthly rents on average in the time period from April through December.
That’s lower than the payment rates seen in Class B product at 93.5% and in Class A product at 92.9%.
Keep in mind, however, that missed rent payments tend to occur more frequently in Class C properties even in the best of economic times. Residents of Class C communities often live paycheck to paycheck, and they generally don’t have cash reserves to help them through emergencies.
Since the spread of COVID-19 emerged, Class C rent payments have only declined about 1.6 percentage points from pre-pandemic levels.
Again, there are differences across locations. Missed payments over the past year well exceed the U.S. standard in a few spots, most notably New York, Los Angeles, Seattle, Portland and Las Vegas. While RealPage analysts don’t think future evictions from professionally managed apartments will occur to nearly the extent that some media reports have suggested, those five metros do appear to be very vulnerable to spikes in evictions.