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Is the Apartment Rental Market Overheating?

The still faltering housing recovery, tight credit, lackluster employment growth and overall weak consumer confidence has kept demand for apartments high, despite historic housing affordability.

That, plus a shortage of supply, means rents are going higher, increasing at their fastest pace since the fall of 2007, according to Reis Inc., which expects rent growth to accelerate even more as vacancies tighten.

Photo by: Simon Law

How tight are supplies? Less than five percent of the national apartment supply was vacant this past spring, according to Reis. That’s only the third time that’s happened in over thirty years.

“The target renter demographic (younger Americans) has seen what’s happened in home buying, and the ease of just writing a monthly check is compelling,” says analyst Alexander Goldfarb at Sandler O’Neill.

For investors in apartment REITs (real estate investment trusts), that means higher returns. For buyers in the space, however, that means pricier properties, and smaller gains.

While some analysts believe the space is overheated, Goldfarb notes that given incredibly low financing today make apartments a good buy overall, even in the pricey coastal markets.

“What people never say is, let’s put it in context. You’ve got a ten-year [U.S. Treasury bond yield] under two percent, so if you go back to the 2006 peak, the ten-year was around 5-6 percent…so while absolute valuations are back to historic peaks, the cost of financing is a lot cheaper, so people can still make money buying at current prices,” explains Goldfarb.

He does, however, like the sunbelt over the coastal markets, as prices there are not as high. Post Properties focuses on the sunbelt, with 30 percent of its portfolio in Atlanta, which has very little supply and high demand due to a surge in foreclosures.

“We still love the apartment sector,” says Mitch Roschelle of PwC, citing the falling home ownership rate. “We’re going to have, for the foreseeable future, an excess of people who want to rent versus apartments that are available.”

Still he cautions that investors looking to the future may move away from the pricey apartment market and toward office, “because they think that offices may be the next story down the road.” The office space is still struggling to find its footing, especially in the smaller, inland markets.

“A shift in improving investor sentiment across the office sector is really a function of the fact that apartments are sort of yesterday's story. They're overbought,” warns Roschelle.

Analysts at Reis also warn that supply in the apartment sector is coming fast. They estimate 70,000 units to come online in 2012, double the rate of 2011, and around 150,000-200,000 in 2013.

“While this kind of supply growth need not push apartment fundamentals back into contractionary territory, it is important for individual investors to consider how greater competition in specific submarkets caused by the proliferation of apartment rentals will impact their property’s or portfolio’s performance,” notes the Reis report.

Questions? Comments? RealtyCheck@cnbc.comAnd follow me on Twitter @Diana_Olick

  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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