May 2 (Bloomberg) -- The glut of U.S. properties for sale is about to hit the rental market.

A record number of homeowners who can't sell condominiums and houses are competing for tenants with the country's biggest apartment owners led by Chicago-based Equity Residential, said Jack McCabe, the founder of Deerfield Beach, Florida-based McCabe Research & Consulting LLC. Metropolitan New York, where demand for housing exceeds supply, may be the only place where rents increase, albeit at a slower pace, he said.

``Competition already is forcing the big apartment owners to offer concessions like two months free rent,'' McCabe said.

Vacant rental apartments rose to 6.1 percent in the U.S. during the first quarter, the most in almost two years, even as the average monthly rent reached a record $991, said Sam Chandan, chief economist of New York-based real estate research company Reis Inc. Vacancies will continue to rise through 2007, he said. New York had the lowest number of vacant units in the first quarter, according to Reis data.

Nationwide, 2.8 percent of houses for sale were unoccupied in the first quarter, the highest since the Census Department started collecting the data in 1956. Unsold properties on the market totaled a record 3.45 million in 2006, according to the Chicago- based National Association of Realtors.

``Unsold properties being turned into rental units are creating a shadow market that's driving up the vacancy rate and slowing the growth of rents,'' Chandan said in an interview. ``Areas that saw the most speculative investing, particularly in condos, will see the biggest pressure on rents.''

Reluctant Landlords

Anthony De Silva said he's not happy to become a landlord. He bought a two-bedroom condominium on the ocean in Hollywood, Florida, 18 months ago expecting to sell at a $100,000 profit. Instead, he's looking for tenants at $1,700 a month.

``I don't want to sell for less than I paid, so my only choice is to rent it,'' said De Silva, 45, a New Yorker who made $80,000 in November 2005 by flipping, or selling quickly, his first Florida real estate investment, a condominium in Fort Lauderdale. At the time, prices had gained 29 percent from a year earlier, the peak of the market in that area.

The increase in competition from landlords like De Silva is spurring apartment owners to offer enticements. Lincoln Green Apartments, a Philadelphia complex that rents units from $840 to $1,370 a month, is offering two months free rent for people who sign a one-year lease. Citrus Park Apartments in Tampa, Florida, and Ten Faxon in Quincy, Massachusetts, have the same deal.

Hidden Inventory

``Increasing vacancies does not bode well for rental incomes,'' said Nabil N. El-Hage, a professor at Harvard Business School in Boston, across the Charles River from Harvard University's main campus in Cambridge, Massachusetts. ``We've seen a softening in apartment REITs as a result.''

A Bloomberg index of 19 apartment-focused real estate investment trusts, or REITs, has fallen 14 percent over the last three months, the longest consecutive monthly decline since a three-month rout that ended February 2003.

Frustrated sellers who become landlords have created an inventory of for-sale properties that could derail a housing recovery next year, Chandan said. If home sales improve in early 2008, as predicted by Freddie Mac, the No. 2 mortgage buyer, properties now being rented could reappear in 12 months time to flood the spring market.

Prices Weak

``Those homes that are disappearing off the sales market can just as easily appear again when demand is stronger,'' he said.

U.S. real estate prices ``continued to weaken'' in many districts during March and April, the Federal Reserve said last week in its regional survey known as the Beige Book for the color of its cover. The report cited the San Francisco and Richmond, Virginia, markets as ``falling or soft.'' Sales declined in the Cleveland, Atlanta, Kansas City, and St. Paul, Minnesota regions, the Federal Reserve said.

The exception was New York, where homes were ``selling well,'' the Fed survey said. Manhattan's median apartment price rose 1.2 percent to $835,000 in the first quarter from a year earlier, said Jonathan Miller, president of New York residential appraiser Miller Samuel Inc. For all of the U.S., the median fell 2.1 percent to $212,300, according to Fannie Mae, the largest mortgage buyer.

`Further Stress'

The city's average rent was $2,605 a month in the first quarter, the highest in the nation, and the vacancy rate was the lowest, at 2.5 percent, according to Reis. Fairfield County, Connecticut, had a 3 percent vacancy rate, central New Jersey was 3.6 percent, and New York's Long Island was 3.9 percent, fueled by demand from New York commuters, said Chandan of Reis.

In markets such as South Florida, Nevada and Arizona that led the country in speculative buying, owners who can't rent their properties may default on their mortgages, Chandan said.

``A bigger supply of units for rent means fewer opportunities for speculative owners to cover their mortgage payments by renting,'' Chandan said. ``It has the potential of placing further stress on mortgage performance that has already deteriorated because of subprime defaults.''

Many houses that end up in foreclosure probably will be bought by investors who rent them until demand improves, adding to supply on the market, said Martin Cohen, co-chief executive officer of New York-based Cohen & Steers Inc., which oversees almost $34 billion.

More Rentals

The Center for Responsible Lending in Durham, North Carolina, said in a December study that as many as 2.2 million borrowers are at risk of losing their homes, at a potential cost of $164 billion, from subprime mortgages originated from 1998 through 2006.

``If you get foreclosures of homes, they're going to be homes for rent,'' said Cohen, whose firm holds 4.8 million shares of AvalonBay Communities Inc., a Washington-based real estate investment trust that owns 49,400 apartments. Shares of AvalonBay dropped 17 percent since February, after surging 47 percent in the prior 12 months.

Rachael Babinchak, a real estate agent, is trying to rent an investment property she bought for $224,000 last May in Phoenix, after home prices climbed 26 percent from a year earlier. Since then, demand has dropped because of a glut of for-sale properties and prices have ``softened,'' she said.

Babinchak is asking $1,100 a month for the two-bedroom house on the north side of the city, with a one-car garage, a pool and a hot tub. The average rent in Phoenix was $756 in the first quarter and the vacancy rate was 7 percent, exceeding the national average, according to Reis.

`Elevated Inventories'

``I didn't buy an investment property with the hopes of being a landlord, but I'm not going to get a good price right now,'' Babinchak said. As soon as the real estate market rebounds, she said she'll put the property back up for sale.

Demand to purchase real estate will begin to improve in the final quarter of 2007, the Mortgage Bankers Association said last week. Until then, home prices may decline 2 percent, the Washington group said on April 24. The average U.S. rate for a 30- year fixed mortgage probably will be 6.4 percent this year, matching the 2006 rate, the trade group said.

``Elevated inventories of unsold homes, especially those for vacant units, should put downward pressures on home prices,'' the report said.

Sales of existing homes, including condominiums and single- family houses, may fall to 5.55 million this year from 5.71 million in 2006, the National Association of Homebuilders said last week. Sales reached an all-time high of 6.18 million in 2005.

Housing Starts

Single-family housing starts will drop to 1.16 million this year, the lowest since 1.13 million in 1997, the Washington-based trade group said. Starts will rebound to 1.23 million next year, it said.

The drop in construction will help shave 1 percentage point off economic growth this year, the homebuilders said. The U.S. gross domestic product will expand 2.3 percent this year, slowing from 3.3 percent in 2006, the trade group said.

``The market is flooded with condominiums,'' said De Silva, who has yet to find a tenant for his 1,200-square-foot property in Florida.

The New Yorker left his Manhattan job in 2005 to become a full-time real estate investor, using equity from his condominium on the Upper West Side. He invested in two Florida properties, the one he sold for a profit and the one he now is trying to rent.

Hoping For Profit

De Silva signed a contract to buy the 11th floor unit at the Residences on Hollywood Beach from a developer in April 2005 for $400,000, expecting to sell it for $500,000 when the deal closed six months later. Trump Hollywood is going up next door, with 200 luxury condominiums in a 40-story building.

His apartment faces westward toward the Intracoastal Waterway and has a balcony with views of the sunset, De Silva said. The kitchen has grey granite countertops and maple cabinets.

He rented the unit for six months last year to help pay the mortgage and condominium fees that total about $1,700 a month.

``I didn't want to be a landlord, but I had to bite the bullet so I can afford to wait for a real estate recovery,'' said De Silva, who last week started a full-time job as a project manager for a construction firm, consulting with New York City on renovating school buildings.

``I'm hoping the good times for real estate will be back in next year's spring market,'' he said.

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net.

Last Updated: May 2, 2007 10:15 EDT