S&P Equity Research recently lowered its fundamental outlook for the residential (apartment) REIT sector to negative from neutral based on the excess supply of vacant houses being rented out.

Until recently, the general market consensus was that apartment operators could benefit from the nation’s housing slump. The U.S. Census Bureau puts the nation’s fourth-quarter homeownership rate at 67.5 percent, the lowest level since early 2001.

An excess supply of new construction in recent years has pushed housing inventories to record levels. And, as existing home sales slow, many of these houses went up for rent, providing fresh competition for apartments. Despite the recent slowdown in new housing starts, the Census Bureau estimates the overall homeowner vacancy rate (the proportion of the homeowner inventory which is vacant for sale) in the fourth quarter of 2008 was 2.9 percent, matching the highest level in over 50 years.

S&P believes the excess supply of housing inventories is hurting the apartment sector. The impact is more severe in overbuilt markets and particularly in Sunbelt metropolitan regions such as Phoenix and South Florida.

Moreover, as the U.S. job outlook becomes bleaker, potential renters are seeking alternatives. Although the evidence is largely anecdotal, younger renters in particular are pursuing alternatives such as doubling up and moving back in with their parents.

The average fourth-quarter occupancy is still high at about 94.7 percent, but down about 20 basis points from a year ago and a steeper 60 basis points from the third-quarter 2008 average. Rental rates increased a meager 1.3 percent, on average, during the final period last year and as landlords struggle for pricing power. S&P expects these trends to worsen as 2009 progresses.