The often-overlooked “middle market” rental sector offers significant business opportunities. That's the conclusion of a new research report conducted by Harvard University's Joint Center for Housing Studies, commissioned by the National Multi Housing Council, the National Association of Realtors and the Mortgage Bankers Association, with funding support from Freddie Mac and WMC Management Co.
Traditionally, most attention on rental housing from both academia and the media focuses on either the affordable sector or the upscale market. That leaves the vast middle market out of the discussion, even though it provides housing to millions of American families.
The Harvard study, “Middle Market Rentals: Hiding in Plain Sight,” is the first to explore where these properties are and who lives in them. It offers evidence of a vibrant market with significant equity investment, debt finance, brokerage and development opportunities. (For the purposes of this study, middle-market rental units are defined as those that rent between the 40th percentile and 80th percentile of area median rent, i.e., the fair market rent.)
Defining the Market
It turns out the middle market is widespread and diverse. Forty percent of all renters live in the nation's 14.2 million middle-market rentals, and they spend nearly $10 billion on housing annually.
Middle-market renters cannot be typecast. More than half have incomes of $20,000 to $50,000, but nearly one-quarter have incomes of more than $50,000. Most spend less than 30% of their income for housing, suggesting that, unlike many low-income households, they are not struggling to pay the rent.
Like renters generally, middle-market households tend to be younger and early middle-aged adults, although older middle-aged renters were the fastest-growing age group in the middle market in the 1990s.
Unlike much federally subsidized housing as well as some upscale rental properties, middle-market rentals are not geographically concentrated. They were found in nearly every community in a range of neighborhood types. This runs counter to the notion that middle-market rentals are primarily in the suburbs and that households must pay high rents to live near town.
The report's most significant finding is that despite conventional wisdom, you can build middle-market housing. Many developers assume that middle-market housing won't “pencil out,” but the study found that 40% of all rental housing built during the 1990s was for the middle market.
In all, about 1.6 million new units were constructed in the 1990s. Most of that building occurred on the suburban fringes and is more likely to occur in fast-growing areas such as the Southwest and South.
Middle-market rentals also offer real estate firms solid returns with less risk than the high-end rental market. The Joint Center found that average operating margins for middle-market rentals are only slightly lower than those in the upper market, but middle-market rentals appear to weather economic downturns better.
This makes them less risky from a cash-flow perspective and may make them especially attractive to commercial mortgage-backed security (CMBS) issuers who are eager to reduce the vulnerability of commercial mortgage pools to business cycles.
A Study in Contrasts
Of course, all real estate markets are local. To find commonalities and differences in middle-market housing when looking at higher- and lower-cost cities, the study analyzed four markets — Boston, Los Angeles, Tampa and Minneapolis — in greater detail.
It found that half of the middle-market stock in Boston is more than 50 years old, with only 3% built since 1990. In Tampa, however, almost two-thirds of middle-market stock was built in the 1970s and 1980s. The statistics imply better new construction prospects in Tampa and rehabilitation opportunities in Boston. The same is true for Los Angeles, where one-quarter of the middle-market rentals are in single-family houses.
Nationally, 38% of middle-market renters have stayed in their homes for at least five years, but only one-quarter of Tampa's middle-market renters have done so — the lowest of the cities studied. The researchers speculate that this may be because Tampa has a higher share of younger households and greater job-related mobility.
According to Harvard, there will be 400,000 new renters annually through 2020, and some 160,000 of them will be middle-market renters. Serving this segment often takes more work than targeting the upscale market, but the potential makes it worth the effort.
The full report is available at www.nmhc.org/Content/ServeContent.cfm?IssueID=86&ContentItemID=3199 .
Douglas M. Bibby is president of the Washington, D.C.-based National Multi Housing Council.