RESEARCH
Provided by CoStar
PHOENIX APARTMENT OVERVIEW
A persistent mismatch between supply and demand continues to hamper the Phoenix multifamily market. Though leasing showed signs of rebounding in 2023, it was not enough to absorb the record amount of new construction that completed, causing the Phoenix vacancy rate to move higher. The increased competition from new deliveries has kept rent growth negative since the end of 2022, as operators reduce rental rates and increase concessions to attract and retain tenants. Expectations are for tepid conditions to remain over the near term as the market digests the largest supply pipeline in four decades.
About 9,400 units were absorbed over the past 12 months amid a pickup in consumer sentiment and easing inflation. This outpaced the pre-COVID five-year average of 7,200 units per year. The stronger performance was a welcomed sign for property owners and managers, who were contending with a near evaporation of demand in 2022. A recovery in the 3 Star segment has led the turnaround, going from the primary drag on net absorption in 2022 to posting modestly positive performance last year.
Although the demand picture has improved, a wave of deliveries has kept vacancy on a clear trend upward. Over the past 12 months, developers completed 17,000 units in the Valley, outpacing the 9,400 units of net absorption. This imbalance has contributed to metrowide vacancy increasing from an all-time low of 5.1% in mid-2021 to 11.0% today and caused rents to decline -2.3% over the past year. With the majority of the pipeline focused on high-end luxury properties, rent growth has held up better in the 1 & 2 Star segment, which doesn't directly compete with much of the new supply. These properties have seen rental rates decrease just -0.7%.
What is the current vacancy rate for multifamily units in Phoenix?
Multifamily demand began to rebound in 2023, providing some signs of cautious optimism to Phoenix-based owners and property managers. The Valley recorded about 9,900 units of positive net absorption last year, outpacing the pre-COVID five-year average of about 7,200 units annually.
The main drivers causing net absorption to nearly evaporate in 2022 were high inflation and economic uncertainty. Phoenix was one of the hardest-hit metros in the country in terms of inflation, and higher prices for food, energy, and other goods and services eroded the budgets of potential renter households. Reduced discretionary income was compounded by the surge in multifamily rents in the 24 months following the onset of the pandemic, making it difficult for the marginal renter to comfortably sign a new lease. Additionally, consumer sentiment was compressed, as broad-based economic uncertainty paralyzed household formation. Both of these key metrics—inflation and consumer confidence—have been moving in the right direction over the past 12 months, releasing pent-up demand and returning some seasonality to the market. Macroeconomic conditions will guide the demand outlook for the Phoenix multifamily market moving forward and if a worse-than-expected economic recession materializes, demand could soften again.
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Phoenix Multi-Family Construction
Supply-side challenges plague the Phoenix multifamily market as a wave of deliveries overshadows rebounding rental demand. Over the past 12 months, apartment builders delivered a staggering 17,000 net new units, outpacing the pre-COVID five-year average of about 7,100 units per year. The surge in construction activity has kept vacancies on an upward trajectory since mid2021 and turned rent growth negative.
The effect of the construction pipeline will be felt through 2024 and could linger into early 2025. About 35,000 units are under construction, representing 9.1% of existing inventory. That figure ranks Phoenix as one of the most aggressively built markets in the country. With much of the development activity focused on luxury properties, supply pressure has been most acute in the 4 & 5 Star segment, though weakness has extended to 3 Star properties, as well.
Phoenix Recent Sales Transactions
The impact of higher interest rates is evident in the Phoenix multifamily investment market, with sales activity slowing considerably in 2023. About $3.6 billion traded last year, a 75% decline from the record levels seen in 2022 and 2021. Additionally, the higher cost of debt, coupled with weaker rent growth and occupancy projections, has put upward pressure on yields. The average cap rate climbed 200 basis points since bottoming out in early 2022, and property values have weakened.
The persistent mismatch between buyers' and sellers' pricing expectations is the primary impediment to sales volume. Investors saddled with higher interest rates, stricter financing terms, and tighter underwriting standards are demanding stronger in-place yields when making acquisitions. Potential sellers, meanwhile, have opted to hold assets rather than sell at a perceived discount, causing a stalemate in the investment market. Transaction activity could re-engage this year if interest rates stabilize and greater clarity emerges on the future economic outlook.
Phoenix Apartment Rents
Increased competition from new supply continues to hamper Phoenix's rent growth. Annual gains turned negative in 22Q4 and have remained in the red ever since. Over the past 12 months, the average asking rent declined -2.3%, ranking the Valley as one of the worst performing rent growth markets in the country. For comparison, during the post-COVID demand surge in 2021, Phoenix multifamily properties saw annual gains approach 20%. Softer performance is expected to continue into the first half of 2024 as the market digests the sizable construction pipeline.
Local property managers are reporting a decline in retention rates. This has led many to place increased focus on maintaining occupancy at the expense of higher rents. This "heads in beds" strategy often includes offering concessions at the time of renewal, as well as price-matching competitors. Additionally, operating costs for insurance, payroll, and other expenses have increased significantly, further pressuring profitability. As a result, many property managers are anticipating flat to modestly positive net income growth, with much of the gains coming from closing the loss-to-lease gap at renewal.