The latest Zillow rental markets report shows that the areas experiencing significant rent rises are also the ones building fewer new homes.[1] Inventory remains very limited in most urban locations across the Northeast and the Midwest.
At the same time, we’re seeing that areas undergoing a construction boom, notably the South, are experiencing less of an uptick in rents. Some areas, such as Austin and San Antonio, experienced rent declines. In Austin, rents fell by a whole percentage point.
Does new construction always lower rents?
The main questions for investors here are: do new construction rates reliably impact rent levels? Should investors simply avoid areas that are building a lot of new homes?
The answer to the first question is a simple “yes.” A brand-new study by researchers from New York University found a clear correlation between an increase in new construction and a decrease or slowing of growth in rents.[2] This is true ‘not only for the city as a whole but also for apartments located close to the new construction.’
How does this work? It’s simple. When a brand-new, market-rate apartment block is built in an area, it attracts wealthier renters who often prefer rental options with newer amenities. This frees up other rentals, particularly older properties favored by lower-income residents.
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Is this bad news for investors?
Does this relationship affect those who hope to earn passive income via real estate investing?
If you are investing in an area with a construction boom, you should expect that rent growth will slow down once those newly constructed rentals are up and available. However, there are important caveats to bear in mind.
While new construction does lower rents (by 5 to 7%, according to the study), it also stabilizes local housing markets over time. Markets that see unsustainable rent growth due to huge demand and heavily restricted supply eventually experience drops in demand, sometimes significant. This is exactly what happened in Austin. Demand was unprecedented during the pandemic; rents grew by a whopping 40% between 2020 and 2021, according to Redfin.[3]
The problem with rents being this high is that, eventually, a metro area becomes unaffordable for most new renters. People stop moving into an area, and some residents leave. We are observing this right now in Boston, which saw a 0.7% rent decline, the second-highest negative rate in the country. Yet Boston is not experiencing a construction boom and is located in the very desirable Northeast. What’s going on?
The truth is that Boston’s rent prices are just not sustainable. It’s the fourth most expensive location in the country for renting a one-bedroom, which will cost around $2,700 per month.[4] Renters are feeling increasingly “priced out” and leaving in significant numbers, particularly those in younger groups. If Boston starts building more new homes, eventually rental prices will stabilize again, attracting more renters, but it will take a while.If you’re not sure where to invest, or have a location in mind, consider fractional investing through a real estate platform like Ark7. This strategy lets you build a diverse portfolio of curated properties across different locations, helping you achieve better balance and mitigate risk.
Final thoughts
The takeaway is that investors shouldn’t be wary of areas with a high volume of new construction. By setting the right expectations and adopting a long-term perspective, investors can understand that in areas with huge short-term demand and limited inventory, rent growth will eventually slow, and the market will stabilize. It’s also important to focus on areas where rents are consistently rising but remain affordable, offering renters a variety of options at different price points.
Source: [1] Zillow [2] CommonWealth Beacon [3] Redfin [4] Boston.com
