Moody's Finds Record Number Of Americans Are Rent Burdened — Here's What That Means For REIT Investors

American renters are paying an average of 30% or more of their income for rent, which is the threshold for being “rent burdened,” according to Moody’s Corp., which provides data for investors and tracks several metrics that provide a picture of the economy. Benzinga explains why that could be a worrying trend for investors in real estate investment trusts (REIT).

Appreciation Is Still The Name Of The Game

Regardless of what asset class they specialize in, every residential REIT has a very specific mission: to raise rents, which elevates the property’s capitalization rate and accelerates its appreciation. The faster a REIT can raise rents, the faster the asset appreciates in value.

This leads to increased passive income for investors and provides the basis for a big payoff when the asset is sold. When fund managers can replicate this strategy with multiple assets across an entire portfolio, investors are able to reap impressive profits.

The surging value of multifamily assets around the country is a testimony to just how successful REITs have been at delivering returns for their investors. The historically low-interest rates investors have been able to get for financing assets have only helped REITs across the country acquire more assets in more markets.

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Now The Other Shoe Has Dropped

Moody’s has been tracking the percentage of rents paid by Americans for 25 years, and 2023 was the first time since it began monitoring rents that the 30% threshold was crossed nationwide. In simple terms, that means multifamily REITs are becoming victims of their own success. As the rent-to-income ratio climbs, so does the likelihood of tenant default.

Most property managers have used a 33% threshold to assess whether a tenant can successfully pay the rent — if the rent is more than one-third of the tenant’s income, they will be spending too much on rent. Tenants who are spending too much on rent typically don’t have money set aside for emergencies, which means they may be one car breakdown away from not being able to pay rent.

Complicating matters further is that pro forma budgets for most residential REIT assets call for tenant occupancy and on-time payment rates of around 95% to 97%. So, if a plurality of any residential REIT’s tenants is perpetually rent burdened, eviction rates are almost bound to go up. Tenant defaults are costly, causing REITs to lose revenue and spend money on legal fees and reconditioning the apartment.

The Appreciation Problem

All REITs have a pro forma budget that schedules rent increases throughout the life of the asset cycle. Rent increases are the backbone of investor revenue and appreciation profits. Some rent increase projections are less aggressive than others, but what happens when the rents are already at the limit tenants can afford?

All indications are that residential REITs will continue to bump into this ceiling in terms of rent-burdened tenants. Theoretically, they could push through and pursue the rent increases, but if that results in an uptick in vacancy or default rates, the increases won’t make up for the lost income.

The Most-Rent-Burdened Markets

The Moody’s study found that rents nationwide had grown 135% since 1999, while incomes had grown by 77%. In 1999, New York City was the only metro area in the country where the rent burden was over 30%. Only 25 years later, that list has expanded to seven metro areas. According to Moody’s, the top 10 rent-burdened metro areas are:

• New York
• Miami
• Fort Lauderdale, Florida
• Los Angeles
• Northern New Jersey
• Boston
•  Orlando, Florida 
• Tampa-St. Petersburg
• San Francisco

What Segment Of The Market Feels The Most Pain?

Families and earners on the lower end of the income spectrum are most likely to be rent burdened. As rents continue to rise in the most popular metropolitan areas, their incomes remain stubbornly stagnant, which has left them bearing the brunt of the housing affordability crisis.

Complicating matters further, the cost of building new housing recently got more expensive because of higher interest rates and borrowing costs. That means there is little financial incentive for builders to develop property in any sector except the top of the market.

How Are REITs And Real Estate Investors Responding?

The housing affordability/rent burden issue is complicated and has a lot of different causes. REIT fund managers and general partners are in the business of making money for their investors, not solving society’s problems. With that in mind, they are making adjustments.

Markets like New York City, Miami and Los Angeles will always have tremendous appeal. But many of the communities on the ren- burdened list, such as Orlando and Tampa-St. Petersburg, are newer additions. Ironically, their appearance on the rent-burdened list is largely the result of a surge in property values brought about by renters leaving cities like Los Angeles and New York in search of lower rents.

Many REITs have responded to that need by aggressively building in these emerging markets. This is especially true in the Sun Belt, which includes states like Florida, Arizona and Texas. For the time being, there is still enough upside in many of these new markets for REITs to buy or develop residential assets that generate income for investors.

The Next Big Markets

The profit for real estate investors comes with being out in front of the wave and getting in early — not riding the wave with everyone else. As the Sun Belt continues to heat up, many Florida markets are showing signs of overheating. Hundreds of thousands of units are due to come on-line throughout Florida in the next few years, and it may well be more units than there are renters.

In the meantime, investors can look at places like Florida and Arizona, and it’s not hard to see where the next hot real estate markets might be. States like Texas, Arizona and Alabama all offer a combination of warm weather, affordability and low taxes — characteristics that make Florida such a hot market.

The Long-Term View

REITs have been efficient when it comes to generating money for their investors, especially in the multifamily sector. The fact that so many Americans are rent burdened is proof positive. This metric may not have been so important 25 years ago, but it is increasingly becoming a consideration and valuable market indicator.

Assets concentrated in rent-burdened metropolitan areas may not have the same upside and return potential for investors that they did 25 years ago. But nearby metro areas in neighboring states may be diamonds in the rough and feature a lower buy-in. In the meantime, keeping an eye on rent-burdened estimates is a good way to gauge the upside potential in a given real estate market before making your next REIT investment.

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