So you're a renter on the West Coast. For years, that meant you were in for world of pain, as the "superstar cities" of Seattle and San Francisco just got more and more unaffordable. The shoe is on the other foot now, says Capital Economics, a London-based research firm. To be sure, their analysis looked at the rental market from the perspective of commercial landlords, and it sees "the greatest pain" in west-coast apartment stock, and it's Seattle, not San Francisco, in for the biggest hit. But renters in Seattle could finally be catching a real break.
As the rental market softens in several pockets of the country, the West Coast will be most affected, according to Kiran Raichura, Capital Economics’ deputy chief property economist. He sees a few reasons that apartment vacancies will double in Seattle by 2025, jumping to 14%, leading rents in the city to fall and apartment values to crater. As Raichura's team put it: "Those forecasts mean only Austin and Houston are forecast to see a net increase in capital values over 2023–27 with Seattle predicted to see values fall by more than 30%."
That’s welcome news for renters in the West, whose housing costs have soared in recent years. It will surely be less welcomed by landlords and apartment owners, who have been able to rely on steadily rising rents—and apartment valuations—for years.
The rise in vacancies across Seattle is directly linked to the rate of newly constructed apartments, according to Capital Economics, and it’s increased from 5.2% at the end of 2019 to 7% by midyear 2023. Already, Seattle’s asking rent growth rate is at -2% and could fall further. With that, the city’s apartment values will fall, and average annual total returns could become negative by 2027, meaning those properties are losing value as an asset and investment.
Overall, the firm expects capitalization rates (which is calculated as the ratio between annual rental income to its current market value) to remain poor, with only Austin and Houston forecasted to see a net increase in capital values over the next four years. Poorer capitalization rates can reflect perceived risk, which can be particularly bad for investors looking to refinance. It also expects vacancies to rise in all 17 markets it tracks between 2023 and 2025, except Boston.
Some of that has to do with demand, which it links to employment and job growth. Capital Economics expects demand to be the weakest in the six major markets: San Francisco, Los Angeles, Washington D.C., Boston, New York City, and Chicago. Each of those major markets has seen a slower and weaker post-pandemic recovery compared to some southern metros, in terms of job growth, which “will also put them at the bottom of the pile over the forecast period,” Raichura wrote.
For example, San Francisco saw less than a 2% increase in total employment since its pre-pandemic peak, whereas Austin saw more than a 14% increase in its total employment and is expected to see more growth in the coming years. And it doesn’t help that the city centers belonging to the six major markets above have been hit particularly hard by the pandemic, Raichura added.
On the supply side, apartment completions nationwide accelerated in the second quarter of this year, bringing the yearly total to 351,000 units—a record high, according to commercial real estate firm CBRE. Over the next two years, Capital Economics expects completions to continue to be strong, particularly across Seattle, Austin, Miami, and Phoenix, driving up vacancies in the short term.
That said, “further ahead, we expect completions to drop back in all markets thanks to the sharp rise in the cost of development finance and the fall in apartment values,” Raichura wrote.
Still, asking rent growth rates across the 17 metros ranged from 3% in D.C. to -2% in San Francisco and Seattle, he said, citing data analytics software REIS. By the end of this year, Capital Economics expects to see additional drops in rent growth in some metropolitan areas.
Between this year and 2027, Raichura forecasts that only Austin and Houston will see a net increase in capital values—and of course, Seattle will experience the largest decline, followed by San Francisco. In that same period, he expects total returns to be highest in southern metros, particularly Austin, Dallas, and Houston. In Seattle and San Francisco, average annual returns could be negative.
