Luxury Apartment Boom Looks Set to Fizzle

America’s luxury-apartment craze is coming to an end.

Landlords of upscale properties in cities across the U.S. are bracing for rough conditions in 2017 that will likely force them to slash rents and offer deep concessions, including as many as three months of free rent, to attract tenants.

“This will be a very challenged leasing environment almost everywhere,” said Jay Parsons, vice president for MPF Research, a division of RealPage that tracks the U.S. apartment market.

The turnaround comes after a seven-year boom during which apartment rents have risen more than 26%, far outstripping inflation and income growth.

Demand for urban properties jumped after the housing bust as young, high-earning professionals eschewed homeownership and flocked to big cities. Developers responded by focusing most of their efforts on high-end properties.

But a slowdown is happening. In a report set to be released Tuesday, MPF found that rents rose a modest 3.8% in calendar year 2016, a significant drop from the recent high of 5.6% year-to-year growth in the third quarter of 2015. Monthly rents now average $1,248 nationally.

Mr. Parsons of MPF said he expects little or no rent growth in urban markets in 2017.

The slowdown, he said, is being driven not by a pullback in demand but rather a flood of new supply. More than 50,000 new units were rented by tenants in the fourth quarter, six times the number in the year-earlier period. But that demand was overwhelmed by the 88,000 new units that were completed in the quarter, the most since the mid-1980s, according to MPF.

Nationally, more than 378,000 new apartments are expected to be completed in 2017, almost 35% more than the 20-year average, according to real estate tracker Axiometrics Inc.

Most of the new construction in recent years has been on the high-end. Of 189,100 multifamily rental units completed between the fourth quarter of 2015 and the third quarter of 2016 in 54 U.S. metropolitan areas, 84% were in the luxury category, according to CoStar Group Inc., a real-estate research firm.

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© Marty Paoletta

For apartment units currently under construction, renters would need to make at least $75,000 a year to afford 88% of those units, compared with 37% of apartment units overall.

The New York area alone will be flooded with nearly 30,000 new apartments in 2017, double the historical average, according to Axiometrics. Roughly 85% are luxury units.

Rising rents in the past few years have helped buoy the housing market by making home purchases more attractive. Home-price appreciation is outpacing rent growth in all 23 of the metropolitan areas tracked by a national index produced by Florida Atlantic University and Florida International University.

But the flattening of rents in 2017 could shift the financial equation back toward renting, posing potential challenges to the housing market, which saw record prices in October.

Rents in San Francisco, New York, Houston and San Jose, Calif., all declined about 1% year-to-year in 2016, according to MPF.

The sluggishness is expected to spread across the U.S., hitting markets from Nashville, Tenn., and Dallas to Los Angeles and Atlanta.

Dallas is expected to see nearly 25,000 new apartments delivered, compared with the long-term average of roughly 9,000 new apartments a year, according to Axiometrics. Los Angeles is expected to get roughly 13,000 new apartments, nearly double the historical average.

Nashville could see some 8,500 new apartments, more than triple the typical 2,400 apartments completed annually.

John Tirrill, managing partner at SWH Partners, an Atlanta developer that has several projects under way in the Nashville area, is leasing a new five-story property with a fitness center, yoga and barre studio and swimming pool. He has lowered rents from $2.25 a square foot to $2.10 a square foot—a $150 discount on a 1,000-square-foot apartment—and is offering one to two months of free rent.

Mr. Tirrill said developers are lowering their expectations about the rents they are likely to get and might try to renegotiate loans or sell properties, though he doesn’t anticipate many foreclosures. The market, he said, is taking a “pause as we work through some excesses at the top end.”

The bad news for landlords is good news for tenants.

“This is going to be one of the best apartment markets that I’ve seen [for renters] since 2011,” said Ric Campo, chief executive of Camden Property Trust, one of the country’s largest apartment owners. “The consumer is going to have much broader choice at a lower price.”

Benjamin Gable, a 31-year-old advertising copywriter, recently scored a $200-a-month discount on 1.5-bedroom apartment in Brooklyn’s trendy Greenpoint neighborhood.

The apartment was originally listed for $2,700 and had sat on the market for six weeks, according to Rich Cassell, Mr. Gable’s real-estate agent from Citi Habitats. The landlord had already dropped the price to $2,500 and Mr. Cassell negotiated it down again to $2,300.

“There’s just so much that has hit the market, it is oversaturated with high-end luxury,” Mr. Cassell said.

Banks are pulling back on lending, which could help slow the pace of construction starting in late 2018.

“We’re just being really selective,” said John Cannon, a senior vice president at Pinnacle Financial Partners, a Nashville-based financial-services company that has increased its focus on multifamily lending in the last couple of years. “Multifamily has a large number of units on the ground that they really have to demonstrate some absorption.”

Most analysts expect luxury construction to slow in coming years as markets work through supply gluts.

Landlords believe the market will revive over time, however. While they don’t expect it to return to the highflying days of 2015, they say the apartment market should settle into its usual position as a steadily growing but largely unexciting part of the real-estate market.

“I don’t see it getting white hot again,” said Mr. Tirrill.

Read the original article here.

Write to Laura Kusisto at laura.kusisto@wsj.com

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