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Urban Exodus Upends Rental Housing Landscape In Wake Of Pandemic

Suburban Gains Come At The Expense Of Urban Markets

Tenant migration away from cities will pressure performance in urban residential rental markets.

Amid the COVID-19 pandemic, tenants are leaving dense urban markets and going to smaller cities and the suburbs. As a result, rated multifamily REITs heavily exposed to large cities are underperforming peers with greater exposure elsewhere. Within rated REITs, average occupancy rates in suburban markets were several percentage points higher than in urban ones--most notably in New York, San Francisco, and Boston--at the end of the third quarter. For instance, at Equity Residential, the largest multifamily REIT by total market capitalization, occupancy was 95.9% for its suburban properties as of Sept. 30, 2020, compared to 89.2% for its urban core assets. Rent concessions have increased in the major urban markets (now commonly four to six weeks of free rent per year) to attract new tenants and retain existing ones. (Please see "Residential REITs: Why Renters Are Flocking to Suburban Markets," published Oct. 7, 2020.)

Meanwhile, Apartment List's quarterly Renter Migration Report for the third quarter of 2020 shows that inbound migration for the 50 largest metro areas dropped to about 29% from 31%, while outbound migration remained relatively flat. This could signal that renters are interested in smaller metro areas. Further, the report found that inbound migration fell within popular tech hubs such as San Francisco, Denver, Raleigh, Austin, Nashville, Seattle, and San Jose, while inbound migration to more affordable communities on the periphery of large metros has increased.

Although we expect greater pressure on urban assets over the next year or two, it remains to be seen how this plays out beyond that, and whether tenants opt to remain in suburban spaces more permanently. We think remote working is here to stay, with many corporations likely to grant employees more flexibility to work from home post-pandemic. Given this view, we do think the need for increased space will be critical for many renters and drive a more permanent shift in demand that benefits larger suburban dwellings. To a large extent, this will depend on the pace of workers returning to the office. According to JLL, the reentry to the office will likely be slow, with only 50% of workers returning to the office by June 2021 and 80% by December 2021.

Despite pressure on urban markets, we believe long-term fundamentals for rental housing remain favorable given the housing shortage in the U.S. and increased focus on the home as a sanctuary due to the pandemic.

The potential for increased tenant protections adds to growing regulatory risks, particularly in urban markets.

In early September, President Trump extended eviction moratoriums, protecting renters from being evicted through year-end, provided they can prove they have suffered from the pandemic and meet additional qualifications. Many local governments also have moratoriums on renter evictions. For example, the New York Tenant Safe Harbor Act has extended its eviction moratorium to January 2021. Although the extended moratorium adds some uncertainty to future rent collections, we think the vast majority of tenants will continue to pay rent to their landlords.

Moreover, rent controls remain a relevant topic due to lack of affordability of housing in the U.S. However, increased rent controls in certain cities and states have only had a negligible effect on residential REITs' financial performance over the near term and we don't expect this to materially affect our ratings.

We expect fundamentals for rental housing to remain resilient.

Given lockdown orders and social distancing measures, homes have become a sanctuary for many. In the near term, rent collections for rental housing REITs were relatively strong in the high-90% area in the third quarter ended September 2020. Although we expect modest pressure on rent and occupancy in 2020 from the recession, with a modest uptick in delinquencies amid eviction moratoriums, we generally expect a recovery beginning in 2021 driven by economic growth and improving employment trends. For rental housing REITs, we expect credit metrics to recover to pre-pandemic levels by late 2021 to early 2022.

Expectations For Recovery

Chart 1

image

As the sluggish economic recovery continues, rental housing landlords will face weaker growth prospects after a period of prolonged expansion in the real estate sector. We believe residential REITs will face modest operating pressure over the next year, with net operating income declines in the low- to mid-single-digit-percent range and some deterioration in credit metrics due to lower rents and occupancy pressure followed by slightly negative to flat results in 2021.

S&P Global Ratings now expects GDP to contract by 4% (versus our previous estimate of 5%) but we lowered our growth forecast to 3.9% in 2021 (compared to our previous forecast of 5.2%). Although the unemployment rate dropped to 6.9% in October from 14.75% in April, we don't expect it to reach its pre-crisis level until mid-2024. Demand for housing should recover along with job and wage growth. Our economists' base-case forecast had expected a gradual recovery over the next two years, with unemployment at 6.7% in 2021 and 5.7% by 2022. We think the recovery in jobs and wages should drive a recovery in housing demand.

Homeownership trends are unlikely to rise significantly higher, which should result in relatively healthy rental demand.

Given record-low interest rates, home purchases surged in the second quarter, pushing the national homeownership rate up to 67.9% (up from 65.3% in the second quarter of 2020 and 64.1% in second-quarter 2019). Homeownership is back to where it was before the Great Recession, and near the all-time high of 69.2% set in 2004. Despite the economic pressure facing many households, we don't expect homeownership levels to fall far from the high-60% area. That said, the national rate is also unlikely to push through 70% anytime soon, as the lack of affordable housing in many states, coupled with the financial hardships caused by this recession, restrain many renters from buying.

Chart 2

image

As a result, we expect this yearning for larger spaces will also likely continue to prop up demand for larger rental apartments (two to three bedrooms) and single-family home rentals in suburban markets. We note in "The Not-So-Secret Sauce In State Housing Finance Agency Programs' Stability," published Oct. 15, 2020, that demand for multifamily housing units experienced a historic shift in the second quarter of 2020; the average rental vacancy rate in the U.S. decreased the most in any quarter since 1956. Demonstrating the significant demand for affordable rental units, the rental vacancy rate declined to 5.7% in June 2020 from 6.6% earlier this year, the lowest rate since 1984.

The Effect On Credit Quality

Credit quality for rental housing issuers should remain stable.

We expect credit quality for rental housing landlords to remain relatively stable in the next year as they can absorb the near-term pressure caused by declining rents and occupancy and modest uptick in delinquencies. For the REIT sector, there were no downgrades and all ratings of rental housing REITs maintain a stable outlook with the exception of Apartment Investment and Management Co. (AIMCO). (We placed the 'BBB-' ratings on AIMCO on CreditWatch with negative implications following announcement of the spinoff of its Apartment Investment REIT.) This compares favorably to the overall rated REIT universe, whereby 19% of issuers have negative outlooks, and we have taken 23 negative rating actions year-to-date.

Rental Housing REITs Ratings
Company Rating

American Homes 4 Rent

BBB-/Stable/--

Apartment Investment and Management Co.

BBB-/Watch Negative/--

AvalonBay Communities Inc.

A-/Stable/--

Camden Property Trust

A-/Stable/--

Equity Residential

A-/Stable/A-2

Essex Property Trust Inc.

BBB+/Stable/--

Mid-America Apartment Communities Inc.

BBB+/Stable/A-2

UDR Inc.

BBB+/Stable/A-2

In structured finance commercial mortgage-backed securities transactions, delinquency rates for retail- and lodging-backed loans have risen significantly since the onset of COVID-19, while multifamily delinquency rates remain relatively low in the 2% area, far lower than the levels for retail (14%) and lodging assets (18.4%), as of October 2020. However, we will closely monitor the future performance of the multifamily properties in urban markets given the ongoing pressure we have observed in rental rates and occupancy.

image

Stability And Stress Among Different Public Sector Multifamily Ratings

We continue to expect stable performance for housing finance agencies' (HFAs') multifamily lending programs.

Largely driving this stability are the programs' strong overcollateralization through a combination of mortgage loans and reserves, as well as the active management of HFA staff. As discussed in "How Job Losses And Rent Moratoriums Might Affect HFA Multifamily Program Performance," published on May 7, 2020, HFA programs' debt service coverage averaged 1.5x with vacancies less than 4% as of 2019, providing an initial line of defense if rent collections dip, and we recognize the availability of property-level reserves to offer additional liquidity if needed. Many of the loans in these portfolios also benefit from federal rental support and rigorous underwriting that includes operating and capital reserve requirements and annual reporting. The multifamily program ratings range from 'AAA' to 'AA-'. Over the past year, there has been one upgrade, which reflected the program's significant overcollateralization and twin revenue streams securing the bonds--resolution assets and the agency's general obligation pledge--as discussed in "The Not-So-Secret Sauce In State Housing Finance Agency Programs' Stability," published on Oct. 15, 2020.

Our view of the stand-alone affordable multifamily rental housing sector remains in line with our view last year, with financial stress resulting in potential rating volatility for non-federally subsidized properties. Early in the pandemic, in "How The U.S. Municipal Housing Sector Is Bracing For COVID-19 Related Impact," published on April 14, 2020, we expected revenue declines due to eviction moratoriums, an uptick in operating expenses, and extended vacancies would pressure ratings, particularly for those properties with already slim margins and limited operating reserves. Within this sector, we revised the outlook to negative on seven senior living transactions due to what we view as potentially severe, ongoing effects of the COVID-19 pandemic. Seniors have been susceptible to serious consequences of COVID-19, which has placed age-restricted properties with assisted living and memory care facilities in particularly vulnerable positions. As expected, we have seen slower lease-ups and a slight increase in operating costs, though some properties have also received relief funds through the CARES Act. Still, we believe the pandemic presents near-term pressure on these properties to meet debt service payments given the private-pay nature and lack of ongoing government rental subsidies for a majority of the rated senior living transactions.

This report does not constitute a rating action.

Primary Credit Analyst:Ana Lai, CFA, New York + 1 (212) 438 6895;
ana.lai@spglobal.com
Secondary Contacts:David Greenblatt, New York + 1 (212) 438 1383;
david.greenblatt@spglobal.com
Marian Zucker, New York (1) 212-438-2150;
marian.zucker@spglobal.com
Dennis Q Sim, New York (1) 212-438-3574;
dennis.sim@spglobal.com
Michael H Souers, New York (1) 212-438-2508;
michael.souers@spglobal.com
Research Assistant:Jessica L Pabst, Centennial

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