Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / Why Stagflation Is Reshaping the Apartment Rental Market
Transcript
- Lucas: You know, Luna, we talk a lot about how stagflation hits consumers at the grocery store or the gas pump. But one area that I think is quietly breaking along new fault lines is the apartment rental market. Luna: Interesting. You mean because rents are still rising even as the economy slows? Lucas: Partly. But what's really striking is the divergence. The latest data we have — core PCE hit 3.4 percent in May, highest since late 2023. And unemployment is stuck at 4.3 percent. Wages are up maybe 3 percent annualized, but with inflation running above that, real purchasing power is flat to down. Luna: So renters are squeezed. But why would that create a divergence? Wouldn't everyone just trade down? Lucas: That's the intuitive take. But what we're actually seeing is a barbell effect. At the top end — Class A luxury apartments in gateway cities — rents are still climbing five, six percent year-over-year. High-income renters who might have bought a home two years ago are priced out of the for-sale market because mortgage rates are still elevated, so they stay in luxury rentals and bid up the nicest units. Luna: Right, so demand at the high end is actually getting a boost from the housing market dysfunction. Lucas: Exactly. Meanwhile, the middle of the market — Class B apartments built in the eighties and nineties, no doorman, no fancy gym — those are seeing occupancy slip. Rent growth there has slowed to maybe one or two percent. Some landlords are even offering concessions again: a month free, waived parking fees. Luna: That sounds like the opposite of what you'd expect in a high-inflation environment. If everything is more expensive, why would landlords give discounts? Lucas: Because the tenant base in that segment is the most squeezed. These are households earning forty to sixty thousand dollars a year. Their rent to income ratio has crept up from 30 percent to maybe 38, 39 percent. They're cutting back on other spending, some are doubling up with roommates. So landlords have to compete for a smaller pool of qualified tenants. Luna: So it's a K-shaped recovery for apartments: luxury booms, middle struggles. Lucas: Exactly. And it shows up in the data from apartment REITs. The big publicly traded owners of Class A properties — think AvalonBay, Equity Residential — they're reporting same-store revenue growth of four to five percent. But the smaller, private owners of Class B and C properties are seeing rent collections slip. Luna: What about the bottom end, Class C? Older buildings, maybe not renovated in a while. Lucas: That segment is actually holding up better than Class B, believe it or not. Because those units are already the cheapest option in the market. Tenants there are the most rent-burdened, but they have nowhere else to go. So occupancy stays high, even if rent growth is minimal. The squeeze is really in that middle tier where tenants have just enough income to consider upgrading to a nicer unit or moving to a cheaper city — but they're staying put and negotiating. Luna: So if I'm a landlord with a Class B building in, say, Atlanta or Phoenix — markets that saw huge rent growth during the pandemic — what do I do now? Lucas: You have a few options. One, you can invest in upgrading units to push them into Class A territory: new countertops, stainless steel appliances, in-unit laundry. That can justify higher rents. But that costs capital, and financing is expensive right now. Luna: So you're betting that the high-end demand will continue. Lucas: Right. Option two is to offer targeted concessions to keep occupancy up, hoping inflation eases and wages catch up. Option three is to sell. And we are seeing more Class B properties hit the market, especially in Sun Belt markets where supply has ramped up. Luna: New supply is a big factor too. A lot of apartment construction that started in 2022 and 2023 is just now coming online. Lucas: Exactly. Multifamily completions are near multi-decade highs. That new supply is almost all Class A. So you have this wave of luxury units hitting the market just as middle-market demand softens. That puts even more pressure on older Class B properties to differentiate. Luna: It sounds like the rental market is becoming a story of two economies, same as everything else in stagflation. Lucas: It really is. And I think for renters listening, the takeaway is: if you're in a Class B building, you probably have more leverage than you think to negotiate rent, especially if your lease is up in the next few months. Landlords are nervous about turnover right now. Luna: That's a concrete tip. And for investors, it suggests that not all apartment REITs are created equal. The ones with high exposure to Class A in supply-constrained markets are in a better spot than those heavy in the middle. Lucas: Right. And the bigger macroeconomic question is whether this bifurcation persists. If inflation keeps running at three-plus percent and the Fed doesn't cut rates aggressively, then that middle-market squeeze continues. But if we get a soft landing — inflation comes down to two percent, the Fed cuts, mortgage rates drop — then some of those high-end renters might finally buy homes, which would soften luxury demand. Luna: So the rental market is a kind of leading indicator for the broader economy. Lucas: I think it is. Rents are sticky, but they reflect real household cash flows. And right now, the data is telling us that the middle is the place to watch. Luna: Speaking of the middle — you know, it's funny, we spend a lot of time here on the show digging into these dynamics. And if that kind of analysis has made something click for you, if it's helped you think about your own rent or your own investments, it's worth remembering that this show stays ad-free because of listeners who choose to support it at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small thing, but it genuinely makes a difference. No pressure, just if today's episode was worth the cost of a coffee to you, that link is there. Luna: Alright, back to the market. Lucas, where do you see the biggest risk to that middle-market apartment segment over the next six months? Lucas: I'd say the biggest risk is that the job market softens more than expected. Right now, unemployment is at 4.3 percent and jobless claims have been trending down. But if we see a few months of rising claims and slower payroll growth, then that middle-tier tenant base shrinks further. Landlords might have to cut rents outright, not just offer concessions. And that would ripple through the REITs and the broader commercial real estate market. Luna: So keep an eye on those weekly jobless claims and the next jobs report. Lucas: Exactly. The June employment data comes out next week. If we see a big miss on payrolls or a tick up in the unemployment rate, that's the signal that the rental bifurcation is about to get even more pronounced. Luna: Alright, we'll be watching. Thanks Lucas. Lucas: Thanks Luna. Talk to you next time.