Apartment Rent Growth: Small Buildings Lag Behind Large Properties

It turns out you can rent a two-bedroom in a small apartment asset for less than a studio in a large apartment asset. Is this a value proposition for multifamily investors?

Riding on strong demand, apartment rents have risen at a rapid pace in the post-crisis period across the country. In 2015, rental vacancy rates reached historic lows of below 5 percent in the largest markets. This occurred even as a record level of new apartment inventory was brought online.

The present tightening of the rental market is being reinforced by higher household formation rates, as growing numbers of Millennials become first-time renters. Further, the current economic recovery has resulted in a disproportionately large share of jobs being added to the top metro areas. This has creating additional demand for housing in these already tight markets. Taken together with a limited supply of developable land for new units in downtown cores, rents may continue to rise even as new inventory comes online.

At the same time, rent levels and growth differ significantly between small and large apartment buildings. These differences are mainly due to the fact that larger buildings tend to locate in downtown cores, and are highly amenitized.

As seen below, Chandan Economics’ tabulation of data from the American Community Survey shows that the US average monthly unit rent in small buildings was around $860 in 2014 – only about three-quarters of the average rent in large buildings.

(Hover over chart for data points.)

Rent growth in small buildings in the post-crisis period, at an annualized rate of 2.7 percent, was also lower compared to 3.4 percent in large buildings. Lower rent levels and slower growth means that investors could find a value proposition in smaller apartment buildings.

These trends are further amplified when looking at rent levels by unit mix across small and large buildings, as shown below.

In 2014, while a monthly rent of $1,000 could just about secure a studio unit in a large apartment building, one could easily rent a two-bedroom unit in a small building at this price. Further, as exhibited below, 2014 renters paid a premium between 20 and 40 percent to live in large apartment buildings. For example, a household seeking a two-bedroom unit paid a premium of as high as 40 percent more rent to live in a large building.

The contrasts between small and large buildings call to attention the balance between location, unit size and the packaging of amenities. In future posts, we’ll examine the distribution of apartments between downtown cores and suburban areas of large metro areas by building size, and the type of amenities included in such buildings.