Cracks Emerging Among Class C Apartments

Class C apartment rents have grown at a much slower rate compared to Class A and B, yet it’s Class C – catering to working-class households – showing the first signs of softening.

To be clear, overall Class C fundamentals remain very healthy. Occupancy remains very elevated at 96.8%. Incomes among new lease signers continue to grow briskly, and vacant units are getting leased quickly as ever. But several key indicators weakened among Class C apartments in July.

Most notably: Class C retention rates dropped more than expected in July, falling 2 percentage points year-over-year to 58.1%. That’s still well above Class A and B (as Class C renters tend to be stickiest with fewest available alternatives), but it’s also a five-year low. By comparison, retention in Class A and Class B inched down slightly, in line with expectations, and remained well above pre-2022 norms.

At the same time, Class C rent collections fell 0.2 points year-over-year and 0.5 points month-over-month to 93.7%. Class C rent payments tend to be lower than Class A or B, even pre-COVID. But the gap has widened over the last year. By comparison, collections in July measured 97% in Class A and 96% in Class B – on par with recent trends.

Slower Class C Rent Growth Isn’t Enough to Offset Overall Inflation

Interestingly, the root challenges in Class C appear to be much deeper than rent increases. In fact, rents by every measure have grown much slower in Class C compared to Class A or Class B.

Rents for Class C renters renewing a lease in July increased 7.8% above the prior lease. That’s below headline inflation of 8.5% – meaning that housing costs increased at a slower rate than other expenses. By comparison, renewal rents increased nearly 12% in both Class A and Class B. Additionally, among new lease signers, Class C renter incomes have nearly kept up with asking rents – with incomes up 16.3% and rents up 17.6% since March 2020.

But it appears that Class C renters are more impacted by faster-rising costs for essentials like food and gas eating up a larger share of spending. For example, grocery costs surged 13.1% in the last year, according to the Bureau of Labor Statistics, the biggest increase since 1979.

Class C – also known as workforce housing – serve a higher share of renters working hourly paid jobs in sectors like hospitality hit hard by the pandemic in 2020. Because of that, Class C renter incomes didn’t return (and stick) to pre-pandemic levels until May 2021. By comparison, Class A and Class B renter incomes dipped only briefly before rebounding to new highs by August 2020.

Incomes among Class C renters have surged since 2nd quarter 2021 as the labor market tightened and employment plunged. But that sharp hit in 2020 left Class C renters playing catch up with Class A and B. Between March 2020 and June 2022, household incomes among new lease signers increased 17% in Class C compared to 21% in Class A and 25% in Class B.

Class C new lease rents averaged $1,348 nationally in July. That’s 23% cheaper than Class B and 40% below Class A. But despite lower prices, Class C renters tend to pay a larger share of income toward rent due to lower household incomes. Median rent-to-income ratios among new lease signers measured 24.5% in Class C versus 22.1% in Class B and 20.5% in Class A.

That’s a big reason why affordability tends to be more of a challenge at the lowest price points, even though rents tend to grow fastest among upper-income renters at the higher price points.

Class C Retention Trends Vary Notably Among Markets

Looking at Class C resident retention trends by market, there was not a clear pattern. Nearly half of the nation’s top 50 markets recorded year-over-year declines in July, with Phoenix standing out with an especially large drop. A handful of Southeast metros also recorded sizable declines (including Atlanta, Charlotte and Orlando). But at the same time, a number of comparable Sun Belt markets with big rent increases recorded gains in Class C retention – including Nashville, Jacksonville and West Palm Beach.

Overall apartment retention has been abnormally high in the pandemic era, first due to lockdowns and later due to a lack of housing availability. Retention nationally (for all asset classes) averaged 55.8% since March 2020, compared to 51.6% in the decade before COVID. Retention peaked at 59.5% in February 2022, which is also when apartment occupancy peaked. (Note that retention rates include only renters signing renewal leases and excludes the impact of eviction moratoria on the small share of renters behind on rent.)

Retention rates are highly seasonal, peaking in the winter months and declining in the summer months as more people move around.

Retention has been widely expected to normalize to more sustainable levels in 2022. Overall retention (among all asset classes) measured 55% in July 2022, down 0.9 percentage points year-over-year but still the second-highest July retention rate on record.