Greater Washington Apartments Poised for Relative Growth and Resilience

Against the negative headwinds of a potential, looming recession and geopolitical instability, multifamily rental demand in greater Washington may be positioned for a period of relative growth and resilience. Currently supporting an optimistic outlook are a for-sale housing market, in which costs have risen dramatically, and migration trends, which have reversed from the pandemic’s early stages. In fact, data suggests that owners of Class A buildings may even have room to raise rents further from record-high levels, but affordability for the broader population remains problematic.

The rise in interest rates in 2022 has significantly changed the value proposition of homeownership versus renting in greater Washington. Figure 1 shows the year-over-year change in the average cost of a mortgage in the Washington, D.C. metropolitan area, reflecting an historic 46% increase over the past year. In Q2 2022, the estimated average monthly mortgage payment in greater Washington surged above $3,700, its highest level ever, making it 86% more expensive to own versus rent.

Even as mortgage rates have pulled in over the past six weeks, homeownership costs still remain at record-highs, pushing demand to rental properties.?

FIGURE 1: Greater Washington Cost of Homeownership Surges. (Sources: Federal Reserve Economic Data, Federal Reserve Bank of St. Louis, National Association of Realtors. Note: Assumes a 10% down payment.)

In greater Washington, early signs of a softening for-sale housing market are materializing and appear poised to weaken further. According to the Greater Capital Area Association of Realtors, tight market conditions persist in terms of months of supply of homes for sale (1.5) and median days for a property on the market (7), but in June, there was a -20.8% year-over-year decline in closed sales, and a -12.4% month-over-month decrease in new pending sales.

Some of the pullback is seasonal, but higher interest rates suggest dynamics have changed. Figure 2 shows the relationship between thirty-year fixed mortgage rates and single-family housing permits in greater Washington over the past 10 years. The relationship indicates we should expect the construction of single-family homes to decline, providing less homes for sale for would-be buyers and causing more people to rent.

FIGURE 2: Greater Washington?Single-family Housing Construction and Mortgage Rates (Sources: Federal Reserve Economic Data, Federal Reserve Bank of St. Louis. Note: Housing permits are a 12-month moving average of not seasonally-adjusted data and lagged by 12 months.)

As the for-sale housing market adjusts, some the migration trends exhibited during the early stages of the pandemic have begun to reverse, or soften, and this should support overall demand for housing. Analysis from the Federal Reserve Bank of Cleveland shows the urban flight that occurred early in the pandemic from the urban core of Greater Washington has reversed itself. Additionally, data on gross migration from the region, as a whole, to other regions has slowed.

FIGURE 3: Percentage Change in Estimated Number of Migrants Leaving Urban Neighborhoods to Suburb of the Same Metro Area (Sources: Stephan Whitaker, Federal Reserve Bank of Cleveland, Federal Reserve Bank of New York Consumer Credit Panel/Equifax Data, American Community Survey, National Association of Realtors.?Notes: The changes are calculated as the sum of the differences between the quarterly flows from Q2 2021 through Q1 2022 and the average of the equivalent quarterly flows from Q2 2017 through Q1 2020 divided by the sum of the same pre-pandemic average quarterly flows.)

Owing more to economic growth, but boosted by trends in the higher cost of homeownership and shifting migration in the short-term, the region’s apartment market should see its rents grow more rapidly than other property types. But economic conditions remain fragile and vulnerable to various, significant risks over the next several months.

With record-high rents expected to grow, though, and inflation and economic trends possibly challenging otherwise higher apartment construction, the affordability crisis persists. The average Class C rent paid as a share of income in its demographic is approximately 34%, higher than the typical 30% threshold considered to be cost burdened. On the other hand, the average Class A rent paid as a share of income in its respective demographic is only 24%, signaling a possible opportunity for owners of such top-tier apartment units to raise rents more than they might have anticipated.

In conclusion, greater Washington’s apartment market appears well-positioned to navigate any increasing headwinds in the near-term, helped considerably by higher homeownership costs and a reversion to pre-pandemic migration trends.

FIGURE 4: Greater Washington Rents Forecasted by Property Type and indexed to 1.00 at Q1 2022 Levels (Source: CBRE Econometric Advisors)

Supplementing this Research Brief is a larger report with more analysis and charts regarding apartment trends in the Washington, D.C. metropolitan area.?Read it here.