No Fits, Just Starts:
Apartment development ramps up

The apartment sector is the only sector within the commercial real estate industry where development makes sense, according to industry experts. While other sectors such as office, retail and industrial are not overbuilt, existing demand is minimal and future demand is not forecasted to be strong. Demand for apartments, on the other hand, is expected to increase substantially over the next three to five years, and apartment owners and operators are ramping up their development activity.

Denver-based UDR Inc., for example, has three communities with 1,104 units under development for a total estimated cost of $218.2 million. During the second quarter, the REIT broke ground on the Savoye II in Addison, Texas, the second phase of its Vitruvian Park development. The community is being built to meet LEED Gold standards and will consist of 352 units and 28,140 square feet of retail and office space, at an expected cost of $69 million.

“If we have decent job creation, there could be a lot of jobs matched up with a growing renter pool and low apartment supply; there could even be a shortage of apartment housing,” says Mark Wallis, a senior executive vice president with UDR, which owns a portfolio of 53,197 units in 184 communities.

Increasing demand

Demographics and American attitudes toward homeownership point to increased demand for apartments.

Although apartments suffered during the most recent housing boom as many renters left apartments to buy homes, stricter lending standards have made homeownership less attainable and renting the only option. The number of qualified homebuyers has shrunk, and Americans are staying in rental housing longer because they’re unable to come up with a hefty down payment for a home.

Moreover, a growing segment of Americans prefer to rent instead of own. In fact, industry experts suggest the apartment sector is benefiting from a shift in the American consumer’s attitude about homeownership.

Now, more than ever before, Americans are less interested in owning a home. A survey by the National Apartment Association conducted earlier this year found that 76 percent of consumers deem renting to be the more favorable option to owning a home in the current real estate market, a 5 percent increase over 2008.

Over the past five years, the number of rental households has increased by more than 3.5 million, roughly 10 percent, while the number of owner households has remained virtually the same, according to Green Street Advisors, a California-based research firm. Considering that the number of homeowners increased every year for 40 straight years prior to 2005, this data is all the more astounding.

Homeownership is projected to decrease to 65 percent over the next five years. This, in conjunction with annual growth of 1.3 million households, is expected to create an additional 4.5 million total renter households through 2015, according to Green Street Advisors.

Perhaps most importantly, the renter pool is expanding to include Echo Boomers, also known as Generation Y and “millennials.” No matter what you call them, they are the children of the Baby Boomer generation, and there are nearly 80 million of them. Born between 1982 and 1995, the oldest of them is already out of college, and the youngest is still in high school.

Strengthening fundamentals

While demand alone isn’t enough to compel new development, apartment developers and operators also are encouraged by strong operating fundamentals. Across the nation, occupancy in the apartment sector is increasing, enough so that owners are able to push rents – something that owners in other sectors find difficult, if not impossible to do.

The nationwide vacancy rate at the end of the second quarter was 7.1 percent compared to 8.1 percent at the end of 2009, according to AXIOMetrics Inc., a Dallas-based research firm. Over the next three years, the firm expects vacancy rate to continue to decrease, reaching 6.4 percent next year and 4.9 percent by 2013.

Rent growth has moved from negative territory to positive territory: at the end of last year, rent growth was -5.9 percent. During the second quarter, it was 1.9 percent, according to AXIOMetrics, which expects rent growth of 3.3 percent for this year. Next year, the firm forecasts growth of 3.8 percent.

As fundamentals improve, development activity is ramping up after reaching a near 40-year low.
Last year, 259,800 multifamily units were completed. This year, completions averaged roughly 14,000 per month during the first six months of 2010, according to the U.S. Census Bureau, and will average close to 8,000 per month during the second half of the year.

“From a big picture standpoint, if you look at the total numbers, the units delivered nationwide last year represented a post WWII low,” Wallis says. “When you consider obsolescence and those units taken offline, that’s a pretty low number. We went into the downturn without an oversupply, and the pipeline has virtually been shut off.”

Development opportunities do not exist in every market, according to Mike Salinksy, vice president with RBC Capital Markets. “Every project doesn’t [make sense financially], those in Phoenix or Las Vegas, for example, but there are markets that can absorb new development,” he explains.

Without question, apartment developers have pinpointed the Washington, D.C. metro area as a market that can support more rental housing. UDR, for example, plans to break ground on a project in Northern Virginia later this year, and in the fall, Wellington, Fla.-based Bainbridge Companies will begin construction of a 200-unit luxury high-rise rental apartment community in downtown Bethesda, Md.

“We’re going to see many more apartment projects started later this year,” Salinksy says.
  

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