This could be the year of falling rents

If you want to rent an apartment in one of those high-rise buildings going up in major cities nationwide but can’t find one in your price range, this could be your lucky day -- or even your lucky year. Rents may slowly be spiraling downward by as much as 20 percent.

Jay Rollins, the head of real estate investing firm JCR Capital, is predicting that the booming urban rental market in places such as Denver, New York City and San Francisco may have finally become overbuilt and overbought. “A lot of new buildings have come on-line,” said Rollins. “There’s too much, and prices are getting too high.”

Why should perspective apartment dwellers pay attention to Rollins? First, he has skin in the game. Rollins’ firm provides financing for acquisitions in the rental and condo markets with both debt and equity. He describes his mini-investment bank as “opportunistic.” 

Rollins also looks for those who want to take over buildings whose original owners end up over their heads in debt and are forced to sell to someone who would “buy it for a dollar in order to make two.” Simply put: high-end “flippers.”

Rollins’ ability to stay in business and profit depends on timing the elusive real estate market. In July 2007, when it was lurching toward the crisis that brought on the Great Recession five months later, he predicted in an article written for National Real Estate Investor magazine that the market was “As Good As It Gets.” And while he didn’t hit the panic button at the time, Rollins did take aim at subprime lending, the immediate cause of the disaster.

Once again Rollins is sounding the alarm, even if it’s more like a whistling kettle than a gong. That’s because he’s looking at only one subset of rentals, so-called “luxury apartments.” These are the ones young urban professionals are seeking as a way to escape two- to three-hour commutes and baby boomers are interested in as they downsize from their McMansions.

Built mainly during the last five to seven years, these apartments have all the amenities, including the most modern stainless steel appliances, fitness centers, swimming pools and concierge services. They rent for approximately $3 a square foot, or a median monthly rent of $3,000 for a two-bedroom apartment, although it can vary from city to city and region to region.

“That’s a big hit for many renters,” said Rollins, who lives in Denver. “Many of them can’t handle it.”

And that could be particularly true for millennials. While Silicon Valley continues to pump up salaries and workers in Washington, D.C., appear to be recession-proof, data elsewhere in the country shows that younger people -- those most likely to become urban apartment dwellers -- aren’t keeping pace with their parents when it comes to salaries.

And as millennials age, they tend to get married, have children and look for homes -- often in the suburbs -- which appears to be what’s happening now as that housing market heats up

The basic real estate principle is that the rental and housing markets tend to run opposite of one another. Rents had a good run during the recession, when the sales market turned toxic. Now the wheel is turning counterclockwise.

But if that’s so, it’s not turning fast. Rollins isn’t looking for a crash, even in higher-end urban rentals. The first signs, which he’s already seeing, are when the market begins to “flatten.” Rents stabilize, and apartment buildings begin to offer perks such as free gym memberships and one-year leases with “one month free.”

“Lowering rents will be the last option,” predicted Rollins, “but in the end, they’ll do it. The rule is: You’ve got to keep ‘heads in the beds.’”

The decline won’t be drastic and forever, probably only two to three years and with a 15 percent to 20 percent rent decline before the population pressure once again puts the market on an upward course. Lower-cost units in the inner cities will see some carryover but not much, and the “garden apartment” low-rise rentals in the suburbs will be stable. “They’re renters for life,” said Rollins,” and you don’t see much migration to urban apartments.”

Rollins’s theory is gaining a lot of support in data coming from firms that measure rental prices. San Francisco has dropped several places on RentRange’s chart of the highest-priced rental markets in the country. RentRange said in some areas “builders and investors may have to compete for a limited number of renters.”

CoStar Group, which also provides information and analytics to the multiunit real estate industry, said rentals in New York City are still seeing an “impressive demand,” but about 50,000 units were about to come on-line, and “increased competition is already taking a toll at the top of the market.”

In Philadelphia, “vacancy expansion is on a slow rise, and rent growth is decelerating,” according to CoStar.

But any predictions for the rental real estate market have to factor in the different ways owners can alter the equation. Their buildings can be turned into so-called college dorms by allowing renters to double, triple and quadruple up in one apartment. They can relax rental guidelines by lowering the income standard that rents are based on.

For instance, prospective renters in New York City are often subject to a requirement that they have an earned income four times the amount of their monthly rent. In Boston, landlords can now simply require three times the amount. 

And security deposits, once a requisite, are often either no longer mandatory or are reduced. Instead, tenants are now required to buy renter’s insurance that protects the owner against damage or an early vacancy.

And yet another inflationary force is keeping the market high. The allure of cosmopolitan cities like Miami, New York and San Francisco attracts wealthy foreigners who retain apartments as a hedge against trouble in their home countries. 

“Instability stemming from Brexit, coupled with other global weakness, should further drive demand for residential assets,” said CoStar. A city such as New York continues to be viewed as a “safe haven.”

  • Ed Leefeldt

    Ed Leefeldt is an award-winning investigative and business journalist who has worked for Reuters, Bloomberg and Dow Jones, and contributed to the Wall Street Journal and the New York Times. He is also the author of The Woman Who Rode the Wind, a novel about early flight.