When the housing market falters, the apartment market typically benefits from higher demand. But that hasn't been the case in 2007. Gains in the multifamily sector have been offset by stiff competition from an unprecedented number of unsold houses and condos, many of them made available for rent.

Apartment occupancy rates are expected to remain relatively flat in 2008, and there will be few substantial rent gains, analysts predict.

While the South and Southeast represent the country's fastest growing regions in terms of jobs and population, ironically they aren't necessarily the best markets in which to invest because of corresponding growth in the housing supply.

“We now have an inventory of single-family homes and condos that are vacant beyond anything we've had. This is an all-time record of vacant houses and condos for sale,” says Mark Obrinsky, chief economist at the National Multi-Housing Council, a trade organization based in Washington, D.C.

At the close of the third quarter, vacant housing units — including homes and condos for sale — totaled nearly 6 million, or 4.6% of all housing stock. By comparison, in 2002 there were 4.6 million empty units in the third quarter, accounting for 3.8% of all housing stock, says Obrinsky. “It's a pretty substantial jump.”

Florida apartment owners face particularly tough competition from unsold condo units after heavy speculation led to a collapse in the condo market.

The national vacancy rate is expected to climb in 2008. New York-based research firm Reis predicts that over the next five years, the vacancy rate will be 5.9%.

“I do think that the downturn in the owner housing market has a ways to go yet,” says Obrinsky. “I think we're going to see more foreclosures, and prices will remain soft.” If the single-family home market continues to experience more foreclosures, and more homes and condos become available for rent, that could cause a drop in apartment rents and increase the vacancy rate.

Watch for the curveball

With sharp increases in apartment construction unlikely in 2008, the multifamily market is expected to remain stable and benefit from the perceived risks of home ownership in the current climate.

“The one thing that could throw a curveball in this is if the economy should slip into a recession,” says Obrinsky. “I'm not predicting that could happen, but if it did all housing units would slip.”

According to the U.S. Commerce Department, despite the housing turbulence, GDP grew at 3.9% in the third quarter, up from 3.8% in the second quarter and a striking increase over the 0.6% GDP growth in the first quarter of this year. However, economists predict that GDP will fall over the next few quarters. Still, the National Association of Home Builders (NAHB), a trade group based in Washington, D.C., expects plummeting multifamily housing starts to stabilize in the first half of 2008 and show modest recovery in the second half.

Over most of the last decade, multifamily starts topped 329,000 annually, but 2007 and 2008 starts are likely to be closer to the 1995 level of 277,000, according to NAHB. In September, multifamily production declined 34.3% to a seasonally adjusted annual rate of 228,000.

NAHB notes that while prices have declined largely in response to the subprime crisis, over the last five years home prices in the nation's 20 largest metro markets appreciated more than 50%.

The credit crunch has dealt a severe blow to the commercial mortgage-backed securities market, prompting a sharp drop in loan originations and less favorable borrowing terms. Still, portfolio lenders, banks and life insurance companies are offering funds but with greater restraint.

Backing from both government-sponsored enterprises Fannie Mae and Freddie Mac has enabled many deals to proceed, an advantage not available in other commercial real estate sectors, such as office or retail.

Rents highest in Northeast

Many rental markets are healthy. Nationally, asking rents in the third quarter of 2007 rose 4.9% over the third quarter of 2006, according to Reis. Asking rents were highest in the Northeast, $1,427, about double the asking rents in the Southwest, where rents average $721, Reis reports. On the West Coast, third-quarter asking rents were $1,176.

San Francisco's high percentage of renters has protected the city from subprime problems, says Gerald Patrick Cox, a spokesman for RealFacts, which tracks housing trends. Many workers were priced out of homeownership and unaffected by foreclosure issues.

In these uncertain times, it may make sense to buy and hold an apartment property, Cox says. “If an investor's strategy is to buy and flip — I can't foretell, but it probably isn't the smartest move.”