Long- and Short-Term Outlooks on the Multifamily Apartment Market

The last few weeks have seen the release of a great deal of research on housing, much of it relevant to apartment ownership. The conclusions are mostly welcome to investors in multifamily real estate: (1) the outlook appears rosy for apartment owners for the rest of 2014; though (2) vacancies could climb in 2015 as new supply comes online; and (3) the supply and demand fundamentals appear favorable to owners in the longer term.

2014: A Great Year to Own Multifamily Real Estate

One unambiguous conclusion of this research is that 2014 is shaping up to be a banner year for the owners of multifamily rental properties. As reported in Multifamily Executive and Multihousing News, the Dallas-based research firm Axiometrics recently reported that annualized year-to-date rent growth through June was 4.6% nationally, putting multifamily on track to have its “strongest year of the recovery,” which began in 2009. Occupancy rates nationwide exceeded 95%, according to the study. Rent growth is slower in urban cores, where new building has been most intense since the recovery began, but outside the big city centers supply has lagged demand. “Suburban and class B properties tend to have the best rent growth at this point,” Jay Denton, Axiometrics’ vice president of research, was reported as saying.[1]

Earlier in the month, Denton and KC Sanjay, also of Axiometrics, explained in a column in Multifamily Executive that five basic reasons underlie the current strong occupancy. First, supply is constrained because few rental properties were built in the early recovery years, and new supply in 2012 and 2013 grew by only 1.3% annually, below the long-term average of 1.5%. New supply in 2014 will barely reach the historic average. All the while, older, obsolete properties are being torn down at an accelerating rate.

Second, Dention and Sanjay say, single-family homes are less popular than they once were: the home ownership rate has declined to 64.8%, its lowest level since 1995. Third, the “millennial” generation is not yet ready to buy, partly because they still want to live in urban cores where they have to rent and partly because they are deferring life events like marriage and parenthood that usually lead people to buy a home. Fourth, because of the strengthening economy, many millenials who had been doubling up with friends or Mom and Dad, are starting to leave and form their own households. Typically, newer and younger households are renters rather than owners. Finally, most of the new supply of rental properties is urban-core, class A luxury property that appeals to professionals who used to buy homes instead. This new supply does not affect occupancies at older properties, which usually rent to a different demographic at a lower price point. In sum, the authors say, the current recovery is differing from previous ones as the pent-up demand from new household formations is flowing into rentals at a greater rate than in past recoveries.[2]

2015: A Bumpy Year Ahead for Apartment Occupancy?

Despite the rosy forecasts for the rest of 2014, some researchers express caution about 2015. One such researcher is Ryan Severino, associate director of research at the commercial research firm, Reis. Though he forecasts that rent growth will continue in 2015, he believes it will be tempered by the new supply coming online next year, causing “fundamentals in the market to weaken for the first time since 2009.” Demand for rental apartments will continue to be strong, he writes, because home ownership for people under age 35 fell to 36% earlier this year, the lowest since records began to be kept in 1982. Though an improving economy will improve the job situation for the under-35 group, the corresponding increase in demand will fall short of the forecast increase in supply. Severino is careful to note that the “ramp-up in supply [won’t be] consistent across markets,” and the “majority of units being developed are Class A,” meaning that they will be beyond the reach of many renters.[3]

Long-Term Fundamentals May Favor Owners of Rental Properties

Many people already believe that “the rent is too damned high.” They won’t like the direction that rents appear to be heading in the future, as the supply of apartments looks to lag demand for the foreseeable future.

A recent post on the “Housing Perspectives” blog published by the Harvard Joint Center for Housing Studies sheds light on this issue. Demand for apartments has climbed dramatically in recent years: “from 2005 to 2013, the U.S. saw a net increase of around 740,000 renter households per year. This far exceeds historical renter household growth of around 410,000 per year on average from the 1960s through the 2000s.” Furthermore, the blog reports, “supply of multifamily rental units – which house over 60 percent of all renter households – did not keep up,” as new supply lagged demand nationally by nearly 200,000 units in 2010 and 170,000 units in 2011. By last year, construction completions were nearly equal with rental household growth. However, the growth in supply is uneven, with the volume of construction permits lagging historical levels in more than half of the metro areas in the United States. Echoing Denton and Sanjay’s point that most new construction is of class A luxury apartments in the urban cores, the Harvard blog also points out that new construction is not contributing very much to the supply of housing for less affluent renters.[4]

Meanwhile, a blog post on Freddie Mac’s website by David Brickman, EVP of Multifamily Business, argues that “[g]iven current trends in renting and multifamily rental-housing inventory, apartment demand should exceed supply for years to come.” Brickman cites a Harvard study to suggest that “[d]emographic forces alone could create as many as 4.7 million more renter households by 2023.” In the meantime, even with annual construction returning to historic levels, he writes: “we’re looking at about 3.1 million new units over the next ten years. Not enough.” Indeed, even without this forecasted shortfall, existing “[s]upply already could be 1.5 million apartments short, by some estimates. And low vacancy rates have sped up rent growth – faster than inflation and income growth.”[5]

Though apartment owners will certainly benefit from the imbalance of supply and demand in their favor, it comes at a price to the economy as a whole. The Harvard Joint Center attributes the strong demand for apartments to the fall in home ownership rates, particularly among those aged 25-44, which in turn results from the dramatic decline in real incomes among this group. The home ownership rate and real median income for this group are both at levels not seen since the early 1970s.[6] Moreover, with rents consuming an ever greater proportion of people’s incomes, renters have less money “left over to buy other goods and services, such as food and healthcare,” negatively impacting their quality of life as well as the national economy.[7]

[1] “Occupancy Stays Above 95% in June,” Multifamily Executive, 22 July 2014;“Apartment Market Remains Strong in First Half of 2014,” Multihousing News, 24 July 2014.

[2] Jay Denton and KC Sanjay, “5 Reasons Occupancy is Growing Stronger,” Multifamily Executive, 9 July 2014.

[3] Ryan Severino, “Bumpy Road Ahead for Occupancies,” Multifamily Executive, August 2014.

[4] Elizabeth La Juenesse, “Rental Supply is Catching up with Strong Demand, but not for Affordable Units,” Housing Perspectives blog, July 11, 2014.

[5] David Brickman, “Multifamily Housing Can’t Live on Construction Alone,” in Executive Perspectives blog on Freddie Mac’s website, posted July 14, 2014.

[6] Chris Herbert, “What Will Stop the Slide in Homeownership Rates? Keep Your Eye on Incomes,” Housing Perspectives blog, July 2, 2014.

[7] La Jeunesse, July 11, 2014.