Anatomy of an apartment market downturn

Founder and CEO , SVN Rock Advisors Inc.
  • May. 1, 2020

During an economic downturn it is crucial for owners and developers of purpose-built rental product to consider the intricacies of our industry and the multivariate nature of rental demand: Buildings exist within communities, and every community experiences the effects of a recession differently.

Here, I outline the potential effects of a recession on the purpose-built rental market.

Overbuilt student housing is an analogy of how a recession unfolds:

Student housing is likely the best example when trying to explain the effects a recession has on the purpose-built rental asset class. I always joke student housing is the second-most impacted asset class by location – the first being airport parking.

Even moreso than conventional apartments, student housing is strongly locationally dependent and relies heavily on its proximity to amenities – in this case to the university or college, but also other commercial or leisure amenities.

The ideal student housing site sits directly within the affiliated university. As more distance is placed between the two, the site becomes less and less conducive to student rental.

Students are highly sensitive to location and prefer short commutes. Many will not have cars and will choose to spend the majority of their time on campus.

This means sites with the best proximity have the greatest competitive advantage and achieve the strongest rents in the surrounding market, irrespective of age and quality.

The negative impacts of a recession evolve and spread:

IMAGE: (Source: Google Earth with Wilfrid Laurier University)

(Source: Google Earth with Wilfrid Laurier University)

Imagine a series of concentric rings drawn around a university, each gradually expanding further into the surrounding market. If that market were to reach saturation, the effects would not be immediately experienced across the market. They will instead gradually roll across the landscape.

Student housing sites in the outermost ring would be first to experience a reduction in rents and potentially a vacancy increase.

During this time, properties closest to the university would likely experience the least negative effects. They maintain their competitive advantage; students will continue to lease them due to the benefits of location.

Student housing exists in a vacuum, conventional apartments don’t:

Ultimately student housing is univariate and exists in a relatively closed loop system which means these events would only occur if a specific market were to be overbuilt, or if university enrolment were to suddenly decrease.

This describes a perfect market in which renters have all the information required to make perfect decisions. Conventional rental buildings do not exist in this vacuum and cannot be compared with only a single deciding factor.

Student housing is univariate whereas purpose-built rental is multivariate:

Let’s turn our attention to the more complex apartment market.

Purpose-built rental apartments are highly locationally dependant. Their strength is not determined based on proximity to any one amenity. Instead, they are multivariate and compared based on individual tenant needs and neighbourhood characteristics.

Basic requirements of transit accessibility, walkability, and availability of green space are quite common, but they do not paint the full picture of how prospective renters make housing decisions.

Factors to consider:

As with the broader market; recessions come in waves and impact different market segments differently, both locationally and over time.

Due to the highly individualistic nature of each building there are several factors to consider when trying to identify whether a building is likely to experience difficulties with rents, vacancies, and turnover.

These factors include property management/service, price (class), and location. These are the key determining factors when identifying the potential negative implications for a purpose-built rental property.

Quality property management is a prerequisite:

This factor is often overlooked in older buildings as many consider property managers to be more of a back-of-house service (meaning it’s less important).

Property managers manage the buildings’ functions and maintain order. However, this perspective is limited because it ignores that, other than the physical structure, the second largest facet of a building is its tenant base.

Poor property management leads to unhappy tenants. Unhappy tenants don’t pay their rents and are more likely to leave.

Location is fixed, service is not:

Unlike location which cannot be changed, property management can continuously be refined and improved.

Whereas location can drastically improve the rents a building might achieve due to the value residents place on accessibility and amenitization, customer service can take that a step further. It can enable a building with a poorer location to achieve stronger rents due to the value residents perceive.

This value is likely the most important part of the property managers’ job as it determines the quality and stability a property can offer. This enables the property to achieve stronger rents.

Poor property management can drag down a building by creating an unwanted stigma and reduced resident satisfaction.

The discontent created by poor management can increase turnover, increase vacancies, and ultimately in times of economic instability reduce a property’s level of rent collection.

Not all buildings are made equal:

Rents in the purpose-built rental market vary considerably.

Although quality customer service and improved interior finishes can significantly improve the rents a building can achieve, rents are typically based on building class.

Buildings can be segmented into classes based on their age and level of refinement. Typically, buildings built prior to the year 2000 are considered old stock, whereas buildings built post-2000 are considered new stock.

The quality or level of refinement allows these buildings to fall into a sliding scale of categories including class-A which offers the highest quality, through B and C, which is considered the lowest quality rental stock. Similarly, new stock typically achieves the highest rents in a market, whereas old stock, unrenovated units achieve the lowest rents of a respective market.

Reducing spending is the tenant mindset:

During economic uncertainty with rising unemployment levels and dwindling consumer spending, many residents consider either downsizing or reducing spending. Residents might move into a smaller apartment within the same building or, in the case of younger households, may either double up or move in with family.

This disproportionately affects class-A buildings (a U.S. phenomenon which doesn’t significantly affect Canada due to the limited availability of class-A product) which are typically newer and achieve the highest rents. That means many residents are likely paying a disproportionate percentage of their incomes on rent.

By moving to a lower priced unit they can experience significant savings.

Another factor is that “luxury” goods are the first to be sacrificed within household budgets. Again, this would typically impact the highest-quality rental buildings, whereas older stock buildings with lower rents will likely experience reduced turnover as rent is not seen as a “luxury” expense.

This is typical of a highly competitive market where renters can choose or cross-shop properties when making housing decisions.

Equilibrium is always achieved:

The rents B- and C-class properties achieve are typically lower and therefore offer greater affordability to prospective residents.

This can have a more complex and rolling effect in which A-class buildings reduce rents to spur interest, which in turn puts pressure on B-class buildings to drop rents to maintain competitiveness. This can also have the opposite effect, as residents from B-class buildings paying strong rents upgrade to an A-class building with only a moderate increase in rent. Demand continues to shift until there is equilibrium in the market.

As with location, this indicator varies by the circumstances imposed from the broader market.

The limited supply of A-class rental product in major markets across Canada such as Toronto, and their relative strong locations in transit-accessible downtown sites, suggests if present, these effects will be minimal.

The upper end of rental product in many markets will likely experience strong sustaining power throughout a recession. This is due to the significant imbalance between the supply of purpose-built rental product and the demand for rental apartments by the surrounding population.

Location, unlike price and service, is fixed:

Properties that offer the most central location, greatest levels of transit accessibility, proximity to employment opportunities, or natural amenities, will always be in high demand as residents look to live in proximity to their daily needs.

Although location may be fixed, the value of a location and its surrounding amenities is not based on any single hard-and-fast rule. It’s based on the needs and wants of the property’s resident profile.

Location is key:

Apartment buildings closest to transit or within commuting range of a major population or employment hub will be in greatest demand by renters.

Downtown sites, or those near major employment areas, will be less affected by an economic downturn than locations in suburban locations which offer lower levels of accessibility, or those in secondary markets which offer the fewest employment opportunities.

This does not apply to all locations equally, as a property’s resident profile can also have a determining effect on the types of amenities that may enable it to succeed. Suburban locations with an older, affluent renter profile will likely benefit more from improved walkability than the availability of employment opportunities, whereas a younger renter profile will benefit more from accessibility to employment and proximity to nightlife.

The potential impact of a recession on rental rates and vacancies should be reviewed on a case-by-case basis, as building requirements will vary based on the resident profile.

Housing will always be in demand:

People will always need food and shelter, which means that regardless of financial position rental will always be in demand.

During times of economic uncertainty as with the 2008 recession, homeownership decreased across the United States due in part to many households being unable to maintain a mortgage. These households became displaced, but required housing and as such turned to the rental market.

Many already resided in suburban locations and whether through a preference to remain in a similar location, or to maintain social connections, chose suburban rental product.

There is no single hard-and-fast rule:

All of this is to say, again, there is no hard-and-fast rule in identifying the risks associated with purpose-built rental during a recession. Even if a B-class building were located at a strong location, with a solid tenant profile, it does not exist in a vacuum. It could still be affected by buildings in the surrounding community, and the actions of other operators.

Reactionary responses to rental rates can create a drag on your pro forma and don’t address the issues at hand. Owners need to price their apartments in real time, based on a revenue management model more like a hotel or an airplane (in good times).

The only way to truly deal with rentals in a recession is to analyze the risks, understand the factors, and plan ahead.

Please join us for our webinar on Friday May 8th“Defensive Strategies to Protect Apartment Cashflow During These Times”.  Derek Lobo, CEO of SVN Rock Advisors will be discussing how a recession manifests step by step within a rental apartment market, and the defensive strategies every apartment owner should take to protect their cash flow. This discussion will build on this article to help you to better position your portfolio for success.

Follow this link to register https://www.crowdcast.io/e/theanatomyofanapartmentrecession.


Derek Lobo is the Broker of Record and CEO of SVN Rock Advisors Inc., Brokerage. Derek is regarded as a ‘thought leader’ in the apartment & student housing industries, specializing…

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Derek Lobo is the Broker of Record and CEO of SVN Rock Advisors Inc., Brokerage. Derek is regarded as a ‘thought leader’ in the apartment & student housing industries, specializing…

Read more





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