Population Growth - NOT the Only Important Factor?

Question

This is an interesting article which takes a look at the statistical correlations behind property valuations. The assumption seems to be that high population growth areas are the places that make the most sense for multifamily investments for valuations and rent purposes alike.

We can consider the problem from a rent perspective as well. It's true that the supply and demand of units generates an equilibrium rent price. But if there is an ever-increasing supply of rental units available in a city with high population growth, than existing properties will undoubtedly experience pressure on rental rates.

Let me know what you think!

http://www.tpimag.com/smart_money/what-really-drives-real-estate-values/

David Thompson · Answer

Cary,

Our experiences have been that job and population growth are key of the many factors you could look at in determining your market health. Rent growth would be another key one and should be further defined to the submarket.  Now, much of the data that you read is slanted toward new development.  Certainly, Class A is what can get overbuilt / over supplied over time and hence, those folks playing in that space need to watch metrics more closely that impact new constructions like absorption rates.

In BP, most of the syndicators I know including ourselves look at value add like class B/C where rent disparities on 2-3 bedrooms vs class A are so great that if class A gets overbuilt the discounting in rents that must occur by those operators still do not compete w/the B/C property rents even after renovations are complete. In Dallas we easily see $2K rents in tonier locations where Class A likes to go vs $1K rents for value added in decent areas of town.  Add in some class B/C getting converted to condos, our take is that there is less supply of B/C properties that naturally occurs.  Hence, the demographic that B/C targets sees lack of supply and hence, rents can be maintained and even grow in markets that are experiencing more saturation w/new class A supply.  We saw this in Houston w/a vertically integrated operator who was the property manager on some of our deals there.  They held up very well w/their 10+ value add B/C properties while class A really took a hit when oil went from $100 barrel to $50.

Andy D. · Answer

Cary, good point on the leveling out, and I tend to agree with your guess In that regard (I also have no data though).

With respect to older units I'd just say that this is the "normal" way of things: they only become "old" if they are not updated. This might happen when you have real long-term tenants that never "demanded" an upgrade and landlord maybe also being on the older side with no more interest in upgrading etc. Rents for these places will simply not increase - but I wouldn't call it pressure. They just remain where they were some 10ish years ago. I do agree though that this situation could be considered "pressure" on the rent rate as you can't increase the rent without putting money into the place to upgrade it. But one should not forget that this money has also been put into the new places with higher rents as they are much more expensive to buy compared to what the owner of the old place paid for some 25 years ago (even factoring in inflation). Factoring in wear and tear, inflation and whatnot I'm not so sure that this pressure on the rate really is a result of new construction. I belive it's more a result of not sufficiently upkeeping old construction. Because generally a tenant doesn't care how old a place/building is - as long as it seems to be newish (either because it is indeed new or is as good as new due to a rehab/upgrade). And for this newish state he will pay more as this is what the market demands for new(ish) rentals. Yes, here and there we build differently than we did some 40 years ago but overall, with a proper rehab, you can't really tell afterwards.

All in all I do not see a problem. But it does show that upkeep is important. You can't keep good value if you neglect a property. And there are many, many different ways of neglect...

Andy D. · Answer

"But if there is an ever-increasing supply of rental units available in a city with high population growth, than existing properties will undoubtedly experience pressure on rental rates."

I'm not seeing the logic in that statement? If supply and demand are in an equilibrium then in theory there would be no impact on rent - neither positive nor negative (from whichever point of view). So if there is high population growth as well as increased supply of properties following suit then any existing property will remain pretty much the way it is with "normal" appreciation on the property as well as only marginally increasing rent rates (due to increasing cost of living, inflation etc). I see no reason for any pressure on the rates based on the above.

Actually, in all good reality, supply will be following suit slower than the influx of people drawn to this "hot region" simply because cities have no interest in allowing too much, i.e. uncontrolled, growth and will limit the ability to develop new construction. Also, any clever developer will take it easy to not put too much pressure on prices. They would have no interest whatsoever in putting pressure on their margin by building too quickly and having units sit in their hand for too long.

Result of this is an equally limited/controlled availability of rental units, simply also because not every new construction is rented - there are actually people who owner-occupy as well, so I've heard LOL. This will, typically, lead to a (slow) increase in rent rates: more demand than supply drives prices up. This is what I've been taught and this is what I have seen and experienced myself over the last couple years of my real estate endeavor in different markets that were exactly in the position as described above.

Cary F. · Answer

@Andy D. Good points. I was saying that an increase in supply would put pressure on existing rents. In other words, I'm saying that the market has not yet found an equilibrium price for rent. You're right that if demand outpaces supply, prices will go up. But eventually demand will level off and I'm guessing that builders usually find this out after the fact. I don't have data to support this so it is a guess.

The pressure here, in my opinion, would be felt by investors with older apartments. When there are a lot of new developers in a market, it increases the supply of new apartments. This most likely creates an equilibrium rent for new apartments and a lower equilibrium rent for older buildings. I've actually heard the guys on Old Capital Podcast talk about this economic event happening in the DFW area of Texas.

These ideas are just that...  Ideas. I don't have data to support them but am interested in the conversation. I'll probably start to build some statistical models so as to have some concrete empirical evidence behind what I'm saying.

Thanks for your thoughts..

Population Growth - NOT the Only Important Factor?

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