Outlook Continues to Be Bright for B and C Class Apartments

The near future continues to appear bright for investors in B and C class apartments, according to the third quarter Apartment Outlook released last week by Marcus and Millichap Research Services (MMRS).

A number of factors continue to drive strong demand for apartments. Job growth has accelerated and unemployment is down to 6.2 percent, with payrolls forecast to add almost 3 million new jobs over the course of the year, “further tightening the unemployment rate.”Yet, because of “stringent credit requirements, downpayment hurdles, and student loan burdens,” the demand to purchase homes is restrained.In particular, first-time home buyers comprised only 28 percent of all home buyers in the first quarter of 2014, below the historical trend, meaning that they must continue to rent in higher proportions than usual.Indeed, MMRS noted that 2013 saw the addition of “1.1 million new renter households and only 299,000 new owner-occupied households,” as the national homeownership rate declined to 64.8 percent in the first quarter. And the demand for rental apartments shows no signs of abating, as the “U.S. is expected to add 1.6 million residents in the prime renter cohort of 20- to 34-year olds over the next five years.”

Development of new apartments has yet to catch up with the increased demand.Over the past five years, MMRS reports, increased demand has totaled nearly 980,000 apartments, more than 1.5 times the number of new apartments delivered to the market.Though new overall new deliveries in 2014 and 2015 will be closer to meeting current demand, the deficit left from 2010-2012, when little new construction occurred, continues to be felt.Moreover, development is concentrated in a small number of larger markets:“metros such as Houston, Dallas, Austin, Atlanta, Seattle, and Washington, D.C., . . . account for the majority of new construction.”

Moreover, according to MMRS, “[m]ost new supply on the horizon is characterized as upscale units offered at premium rents and located in infill submarkets.”In other words, most of the new development is aimed a the “high-income segment of the renter population,” rather than “the broader market of renter households, whose incomes are constrained, and whose tenure [in a rental apartment] is a matter of necessity.”

As a result, nationwide occupancy in the first quarter stood at 95 percent, and rents grew at an annualized 3.5 percent rate.But class C (1970s) and class B (1980s) apartments did even better, with rent growth at 4.0 and 4.5 percent, respectively. Rent growth in class A apartments, which are on average $500/month higher than class B and C apartments, may be running out of runway, having grown only 1.0% during the first quarter.

So, what’s the takeaway of the MMRS report? If you are an investor in B and C class properties, the future continues to look good.The population of renters continues to grow as the Echo Boomer generation moves out of Mom & Dad’s house, with few of them able to buy.And, even though new development is starting to catch up with demand, it is disproportionately aimed at the upper income segment of the renter population, not average renters, and focused in a few metros. Occupancy rates should continue to be strong for older properties in smaller metros in the near term.