Market growth is moderating, but long-term prospects are very favorable
By Patrick Duffy
While it’s certainly no secret that the multi-family sector has been on a roll over the past few years, there have been some recent signs that its growth trajectory will continue to moderate this year. Nonetheless, with an economic expansion in its seventh year and an average of one million new renter households being formed over the past five years, these economic tailwinds should continue to support this sector over the near term. The long-term prognosis is even better, with a recent study concluding a need for 4.6 million new apartments between now and 2030.
For now, overall tenant demand remains strong, especially as more millennials continue to form new households after being delayed due to the Great Recession and paying off student loan debt. Nationally, the homeownership rate fell to a 51-year low of 63 percent last year, and is expected to remain around this level for at least the rest of the year.
Construction of new apartments is also expected to peak this year, especially as over-supply in some high-growth markets is beginning to impact both vacancy rates and rent growth. Mindful of this trend, construction lenders are also being more discreet, critically assessing the experience of developers, double-checking projected returns while acknowledging lower growth in operating income. In addition, if government proposals for increased infrastructure spending see the light of day, this could mean increased competition for both the materials and labor required for more multi-family supply.
According to recent figures from brokerage Marcus & Millichap, most of the softening is beginning to occur for Class A buildings, both due to an increase in new product as well as historically weak absorption during the fourth quarter of 2016 being pushed into 2017. Nationally, this meant a large bump in Class A vacancy rates to over 6.5 percent. Yet instead of lowering asking rents to fill vacant units, many owners are betting that the strong spring and summer leasing season will mop up the excess supply.
For Class B properties, a slight rise in vacancies was often due to renters opting to make the leap to higher-quality apartments, especially in regions such as the South where the price difference between the two classes is the smallest. Not surprisingly, the vacancy rate for Class C properties remains the lowest due to the strong demand for affordable housing.
Both Axiometrics and Yardi Matrix—which regularly surveys apartment communities across the country each month—have shown a similar softening in both rent growth and occupancy rates. According to Axiometrics, although its surveyed properties had rebounded to the benchmark occupancy rate of 95 percent by May 2017, annual effective rent growth has stayed within a fairly narrow band of 2.0 to 2.2 percent over the past six months.
Yardi Matrix, however, showed an annual overall rental rate increase of 1.5 percent for the 12-month period ending in May 2017, down sharply from the 5.3 percent noted a year ago even though it reported an overall occupancy rate of 94.8 percent for April. As Marcus & Millichap similarly found, this is largely due to a temporary over-supply in Yardi’s “Lifestyle” class, which caters to households who prefer to rent versus owning, and has resulted in flat growth. Meanwhile, low supply and strong demand for “Renter by Necessity” units helped propel their average rents by 2.6 percent over the same time period.
Due to this softening, as well as higher borrowing costs and proposed changes to fiscal policy and the tax code—including a possible end to the popular 1031 tax exchange program—investors have recently pulled back. Preliminary estimates for first quarter 2017 sales suggest a decline of 15 to 20 percent from the same period of 2016, although greater clarity on these policy changes would certainly lead to a rebound in investor interest.
In the longer term, a combination of delayed marriages, an aging population, and continued legal immigration will continue to put increasing pressure on new apartment supply, but it’s not just millennials filling these units. It’s also Baby Boomers and other empty-nesters over 45 who accounted for over half of new renter households over the last decade in search of the flexibility and convenience of apartment living. With an annual projected demand of 325,000 new units per year through 2030 and an aging housing stock increasingly in need of renovations, there should be very favorable terms for well-financed investors, especially in high-cost and high-growth areas throughout the West and the South.
Patrick Duffy is a Principal with MetroIntelligence Real Estate Advisors and contributes to BuilderBytes. He may be reached at firstname.lastname@example.org or at 310-666-8288.