Even before COVID-19, apartments in some downtown locations were facing pressure from new supply. Eighty percent of 611,000 units under construction are at the top end of the market, according to CoStar Group.
“I think we’ve been talking about this on the multifamily side for a while,” says CoStar Portfolio Strategy Senior Consultant Juan Arias. “There was going to be a significant supply overhang, specifically in luxury urban multifamily, if a recession came. They were building a lot of apartments. Before the pandemic, we were seeing a sufficient amount of demand coming in, but obviously, all bets are off at this point.”
The pandemic has made things even worse. Downtown apartments—across all class levels—appear to be bearing the brunt of the pandemic impact, according to CoStar.
Rent growth in four- and five-star apartments (five-star apartments are the highest quality, while one-star apartments are the lowest quality on CoStar’s scale) has underperformed.
“There is a double whammy for four or five stars,” says CoStar Advisory Services Consultant Joseph Biasi. “We have this supply overhang that we’ve been expecting for quite a while now, On top of that, COVID has forced people to reconsider where they want to live with work from home [bring accepted] and cities being hit harder, particularly New York City.”
With people moving out to the suburbs, four- and five-star apartments are more vulnerable, according to Biasi. CoStar data shows that rent growth for these apartments dropped almost 1.5% in April. It ticked back up by early July, but fell to nearly 0.5% in late July.
While rents have fallen in these high-end apartments, demand for four- and five-star apartments grew by almost 1% in Q2.
“Four- and five-star occupancies have fallen the least relative to all the other star ratings in the dense primary urban areas,” Biasi says. “That tells you that the issue isn’t the existing four- and five-star apartments. Whatever is in the pipeline getting delivered now or what has delivered in the last few months is just not going to be leasing up [well]. We haven’t seen much lease-up of that new product.”
Demand actually ticked down slightly in “prime” urban locations in Q2, according to CoStar.
“We’re seeing a supply wave of multifamily units and demand is slowing down significantly for those units that are specifically supposed to be delivering,” Arias says. “That is where we see the concern.”
Not all urban apartments are of the luxury variety, though. In Q2, CoStar saw demand for one- and two-star apartments drop almost 1% in prime urban areas. It also fell slightly for one- and two-star urban apartments. As lower-income households struggle with layoffs and unemployment benefits running out, it’s no surprise that occupancy in those more-affordable apartments is weakening.