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The apartment and for-sale housing markets usually compete with each other. Historically, the math has been simple and brutal: If the percentage of people who own homes goes up, then the percentage of people who rent goes down. Good news for housing sales often means bad news for the apartment sector, if the number of households that need homes stays stable.
But what’s happening today is different, according to the economists at the National Association of Realtors (NAR). “Rental demand and housing sales are rising at the same time,” says NAR spokesperson Walter Maloney.
As the first shutdown of the federal government since the 1990s continues, the Banking Committee of the U.S. Senate held a hearing on the reform of mortgage giants Fannie Mae and Freddie Mac that focused on multifamily lending.
“We all agree that the status quo in housing finance is not an option,” said Sen. Mike Crapo at the October 9 hearing.
However, despite the tumult in Washington, the Banking Committee hearing was almost bizarrely collegial. The Senators were focused on fine details. No one made long or angry speeches. There seems to be a growing consensus that Fannie and Freddie’s multifamily would be spun off as privately-owned businesses to issue bonds backed by apartment loans.
Make no mistake—developers are building a lot of new apartments. But demand is more than strong enough to absorb the new supply, according to the latest from leading apartment analysts.
“We are having a very stable recovery. Our fundamental look very positive, very strong over the next seven, eight, ten years,” says John Sebree, vice president and national director of the national multi housing group for Marcus & Millichap.
The apartments in the first wave of new construction are already opening their doors. Developers will finish an estimated 145,000 new units of multifamily housing this year. That’s well above the level new construction over the last few years. So far, demand for apartments is easily absorbing the new supply. The percentage of vacant apartments remains hovers at just 4.7 percent, according to Marcus & Millichap.
According to preliminary first quarter 2013 resultsfrom Reis, apartment sector fundamentals continued to improve, with vacancies dipping into the low four percent range. Asking and effective rents continued to increase, but there are some signs that improvements in fundamentals are decelerating somewhat.
The national vacancy rate fell by 20 basis points in the first quarter, dipping to 4.3 percent. Over the last four quarters, national vacancies have declined by 70 basis points, a far faster pace than any other sector in commercial real estate. The vacancy rate has now fallen by 370 basis points since the cyclical peak of 8.0 percent, observed right after the recession winded down in late 2009. By contrast, office sector vacancies have only fallen by 60 basis points since fundamentals began recovering five quarters ago.
The sector absorbed over 36,000 units in the first quarter, a relatively healthy rate comparable to the rise in occupied stock from one year ago (in the first quarter of 2012). Deliveries have remained modest at 13,706 units, representing roughly the same pace of inventory growth as previous first quarter periods over the last two years.
With a few exceptions, apartment developers shouldn’t worry too much about the building cranes looming over hot apartment markets—overall supply is in line with demand for rental housing, according to “The State of the Nation’s Housing 2013,” a report released by the Joint Center for Housing.
“So far, the indicators point to a healthy recovery,” according to the report. The Joint Center’s deep dive into recent housing data was full of good news this year—particularly for apartment experts. Demand for apartments is likely to continue to be strong and healing for-sale markets pose little threat to multifamily, according to the report. However, weak income growth will continue to put pressure on rental housing residents. And a handful of markets face some risk of oversupply.
The next time your property management software recommends raising the rent on multifamily lease renewals, you might want to think twice.
“Landlords may be reaching the limits of what they can charge for marginal rent increases,” says Victor Calanog, vice president of research and economics for Reis.
Your computer system may automatically push rents higher when your apartments fill up. But residents will have to find that extra money somewhere—or they will have to move out. In markets across the country, rents have been rising faster than incomes.
The combined cost of housing and transportation in the nation’s largest 25 metro areas have swelled by 44 percent since 2000 while household incomes have risen only 25 percent. That means that for every dollar household incomes have gone up, housing and transportation costs have risen by about $1.75, according to the Center for Housing Policy—the research affiliate of the National Housing Conference—and the Center for Neighborhood Technology.
In our last column on the multifamily sector, we noted that improvements in the apartment sector slowed a bit in the first quarter. Preliminary second quarter data from Reis indicates a decline in the rate of net absorption and a stalling of declines in vacancy. While this seems to show a continuation of this trend into the second quarter, the reality is more of a mixed bag.
Vacancy was unchanged during the first quarter at 4.3 percent. This marks the first time that the quarterly vacancy rate has not fallen since the first quarter of 2010. Over the last four quarters national vacancies have declined by 50 basis points, a bit slower than last quarter's year-over-year decline in vacancy of 70 basis points. However, this dynamic is somewhat to be expected and not necessarily indicative of a slowing market. As the market gets tighter and tighter, it becomes increasingly difficult for vacancy to continue falling at a high rate as vacant units, or at least palatable vacant units, disappear from the market.
The aforementioned stalling in vacancy decline is more a function of increasing supply than decreasing demand. On the demand side, the sector absorbed 31,973 units in the second quarter, about on par with absorption from one year ago during the second quarter of 2012 and down slightly from the 39,319 units that were absorbed during the first quarter of 2013. Year-to-date, the sector has absorbed more units in 2013 than were absorbed through this point in 2012.
The real estate analysts at the CoStar Group worry that the growth in multifamily development may be too much of a good thing.
“Apartment construction has been on a tear in certain markets,” CoStar says. “With the inventory growing at more than four or five times the national rate, vacancies will most likely increase.”
CoStar has picked out the apartment markets with the highest levels of construction currently underway compared the existing inventory of apartments. Raleigh, N.C., is at the top of the list, followed by San Antonio, Texas, and Austin, Texas. In all three of those cities, the number of apartments underway is more than 5 percent of the total existing inventory.
But CoStar worries the apartments now underway are just the beginning of an overbuilding boom.
Multifamily investors are finding lower prices and higher yields in secondary markets. “Markets that people gave up on are now markets that people are going back to,” says Walter Page, director of research for Property and Portfolio Research, a division of the CoStar Group. “In most primary markets the average price per sq.ft. is twice what it is secondary markets.”
CoStar now expects to see the lowest average returns on real estate investments in prime markets like New York City and Washington, D.C. The highest average returns will come from investments in secondary markets, including the East Bay near San Francisco; Raleigh, N.C.; Portland, Ore. and Austin, Texas, says Page.
Before the crash, investors didn’t get much of a boost to yield from buying properties in smaller markets. Cap rates for apartment properties in tertiary markets averaged about 7 percent in 2007, just a little higher than the average 6.5 percent cap rates in secondary markets and 6 percent cap rates in primary markets, according to John Sebree, vice president and national director of the national multi-housing group for Marcus & Millichap.
What makes an apartment market a “top” market?
Is it single-digit vacancy rates and double-digit rental rate growth? Can investors simply look at the most recent data from industry researcher Axiometrics Inc. and make their decisions based on numbers alone? If they do, they might end up investing in markets that are performing well today but lack any future growth prospects.
Or should investors take their cue from Wall Street and stick to the coastal markets—the so-called Sexy Six that regularly attract institutional investors? In doing so, investors might end up competing with every other investor and paying cap rates below 4 percent for assets that have little or no upside.
“You don’t want to confuse rent growth, occupancy or architectural attractiveness with the top markets for investments,” warns Jeffrey Friedman, chairman, president and CEO of Associated Estates Realty Corp., a Richmond Heights, Ohio–based apartment REIT with a portfolio of 52 properties containing 13,950 units in 10 states.
