The lure of city life today tugs at young job seekers drawn to hot start-up companies as much as it does at retirees eager to trade their cars for walkable neighborhoods with plenty of cultural stimulation. But advisors will have to stay on their toes to offer advice on how clients can best participate in this dynamic trending residential rental market via today’s real estate investment trusts (REITs) and exchange-traded funds (ETFs).

Critics question whether the cycle that spurred residential REITs has passed. Headlines this fall barked that rental markets, especially luxury apartments, had not done well in 2016, with vacancies rising and rental growth dropping across the country.

Many top-rated cities are facing a new nationwide construction glut, with at least 378,000 new apartments planned for 2017, breaking through a 20-year average by nearly 35%, according to real estate tracker Axiometrics Inc. And the New York Times’ Sunday Real Estate section of January 8 proclaimed 2017 “The Year of the Renter,” because such residents had been given various incentives from free months to American Express gift cards.  New York City’s annual rental growth fell from 4.6% in December 2014 to 1.5% in December 2015, and a low of negative 0.9% in December 2016, according to Axiometrics.

Housing volatility is not only a phenomenon in the United States. Catherine Mann, chief economist of the Organisation for Economic Co-operation and Development (OECD), told Britain’s Telegraph newspaper on January 2 that the group is concerned about “very high” commercial and residential property prices in a “number of countries,” including Canada and Sweden, that were “not consistent with a stable real estate market.” And the International Monetary Fund recently noted that its average of real house prices for 57 countries was now almost back to its pre-crisis level. That benchmark seems to be exacerbating negative expectations.

The fear of another financial crisis and high housing prices has also kept most millennials out of the housing market in favor of renting, notes Jeff Olshan, a vice president responsible for leading the asset and property management of Passco Companies’ multifamily portfolio.

Overheated rental cities have refocused Passco on the U.S. Southeast, says Olshan: second- and third-tier locations including Tampa/St. Pete and Cape Canaveral, Fla.; Austin, Texas (not Houston because of its energy market woes); and Greenville, S.C., which benefits from a new BMW plant. Passco likes areas around the Panama Canal, which the company expects to heat up following the widening of the waterway. “We think a lot of smaller ports will see growth as a result—particularly Mobile, Ala., and Savannah, Ga.—because port projects will bring more traffic,” says Olshan. The goods will have to park somewhere, and port company workers will need places to live, he reasons. The takeaway: Exercise caution and think granular.

Of course, higher interest rates may send REIT investors to other instruments.

Regardless, some advisors are reluctant to drop real estate as a diversification strategy. Since this century began, people have been trading suburban living for urban centers, and Arrow Funds’ Joe Barrato doesn’t expect that to change. But can these investments still deliver against rate rises and other potential problems? Barrato, CEO and director of investment strategy at the fund company, says, “Yes, a rising interest rate [environment] is always good for real estate as a broad asset class.”

He notes in his January market outlook that a mix of geopolitical forces is currently affecting global investment—the Brexit, which has implications for the British and European economies; trade war threats from Washington; and rising interest rates, which usually pull inflation rates up with them. But Barrato doesn’t expect disruptive inflation. “If interest rates keep rising, rental rates will remain strong,” he insists.

Axiometrics agrees in its “Apartment Market Outlook 2017”: “Though the pace of job growth is down, the Bureau of Labor Statistics’ report that wage growth was 2.9% in December could ease worries about apartment affordability. Rising wages mean workers can spend more on rent.”  

“There are probably ways to take advantage (of rental growth) at a granular level,” adds Barrato.

Statistics from Axiometrics back up Barrato. Even though just 36 of the top 120 apartment markets recorded rent growth above 4.0% in December, “most of these are smaller markets,” writes Jay Denton, senior vice president of analytics at Axiometrics. “It’s a signal that the apartment industry is still flourishing in many places throughout the country.”

Adding support to Passco’s strategy of second- and third-tier growth, Axiometrics’ report notes, “Class B and C properties are outperforming the nation, with rent growth of 2.5% and 2.8%, respectively. Class A rent growth of 1.7% brought down the national total.” So instead of Dallas/Fort Worth, think the submarket of North Arlington, with its 9.0% rental growth in 2016.

The researchers’ top five cities for rental and revenue growth from December 2015 to 2016 include Sacramento, Calif.; Riverside, Calif.; Las Vegas; Phoenix; and Salt Lake City (see the table). Among the smaller markets is Baton Rouge, La., which grew quickly from negative to 7.7% during the time period.




Not all economic outlooks are preaching doom for the housing sector. In the second quarter of 2016, residential property prices rose significantly in almost all advanced economies, on average by 4% year-on-year in real terms, according to the Bank for International Settlements. House prices increased over the past year in most countries. The IMF found house prices grew faster than rents in over half the countries it studies.

Zacks, an independent research firm, noted that the U.S. economy enjoyed a third-quarter GDP growth of 3.5% with unemployment of 4.7%, and consumer confidence at a 15-year high. “With economic activity growing, landlords can ask for higher rents for their properties,” say the researchers.

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