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Apartment Construction Boom Slowing Rent Increases as Market Shifts Into Expansion Phase

Wave of New Construction Expected to Peak Next Year, Pushing Up Vacancy and Increasing Competition for Renters Even as Conditions Continue To Favor Strong Demand for Apts.
December 10, 2014
At least 250,000 new apartment units are expected to hit the U.S. market in 2015, including 1,500 at Brookfield's Playa  Vista master development on  L.A.'s Westside.
At least 250,000 new apartment units are expected to hit the U.S. market in 2015, including 1,500 at Brookfield's Playa Vista master development on L.A.'s Westside.
With construction on new apartments back in full swing and vacancy rates beginning to trend upward, the robust rent increases enjoyed previously by landlords in most U.S. metro areas are expected to decelerate to below 2% in 2015 as the multifamily market shifts from full recovery into an expansion phase.

CoStar Group economists are forecasting that apartment vacancy rates will rise in 46 of the 54 top U.S. metros over the next four quarters due to the massive wave of current apartment deliveries and new apartment projects starting almost daily.

According to their most recent analysis, the U.S. apartment vacancy rate will rise from the current 4.1% to over 5% by the end of 2015. Although a significant trend shift, apartment vacancies are still expected to remain near 10-year lows across most of the nation, even with the addition of hundreds of thousands of new units.

Cycle's Apt. Construction Peak Extends to 2015

More than 220,000 new units were added during 2014 and another 250,000 units are projected for delivery in 2015, according to CoStar Portfolio Strategy's Francis Yuen, one of the presenters during the recent CoStar Third Quarter 2014 Multifamily Review and Outlook.

"At this point in the cycle, we’ve seen supply take hold almost everywhere," Yuen said. "Some late-recovery markets like Las Vegas aren’t yet seeing vacancy increases yet, but even there, developers are beginning to find opportunities."

Dallas, Washington, D.C. and Houston have each seen more than 10,000 units delivered over past four quarters, while apartment inventories in secondary markets like Charlotte and Raleigh have increased by nearly 5% as apartment construction fans out. Denver and Houston, each with upwards of 20,000 units under construction, will see record deliveries over the next two years, Yuen added.

Despite the expected impact on rents from all the new construction, because most of the new building is expensive luxury properties, analysts noted a widening affordability gap. In the Oakland/East Bay Area, for example, the average income has risen by about 15% to over $75,000 in the strengthening economy. However, rents have grown by a staggering 30% over the same period and now require more than 25% of annual income, Yuen said.

"Lack of affordability is certainly something we are beginning to see capping rent growth, especially at the high end of the market," Yuen said.

Year-over-year growth in effective rents, which has gradually decelerated since 2013, is expected to drift below 2% in tertiary and secondary as well as the top U.S. markets during 2015 and 2016.

The Return of Free Rent?

Meanwhile, concessions offered to induce renters, which in the past have increased quickly when supply accelerates, have so far remained below 3%. At this point in the cycle, concessions are primarily a factor in new projects struggling to lease up.

"We've been surprised by the low levels of concessions we're seeing today, given the large amount of new supply," said CoStar director of U.S. research, multifamily Luis Mejia, a co-presenter along with quantitative analyst Mark Hickey.

But with rent growth slowing further and more supply on the way, property income growth is also expected to finally slow down heading into 2015, which may prompt investors to buy more office buildings rather than apartments in search of higher yields, the analysts noted.

Net operating income (NOI) for apartments, which peaked at about 6% in mid-2012 and was the only major property type to show growth from 2010 to 2013, is now the only sector to show year-over-year income deceleration.

How much of an impact all the new apartments will have is still being debated. That's because demographics and sagging single-family homeownership rates continue to work to the advantage of the rental apartment market, one of the few sectors to benefit from the housing crash of the late 2000s.

As renters follow jobs to growing Sunbelt metros, roughly 67 million Americans are in the prime renting cohort between ages 20 and 34, about 7.5 million more than in 2000 -- numbers that will continue to tick upward in coming years.

Meanwhile, the rise in single-family home sales and prices has slowed in recent quarters and the average U.S. homeownership rate continues to drift downward, now standing at 64.4%.

"Renters are still facing economic ambiguity, and the speed at which they are coming into the rental market is still greater than the rate that they are becoming home buyers," Mejia said. "The economy is strong enough to push renters into the rental pool, but not strong enough to promote home ownership, a double benefit to the apartment market."

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