Current Lull In Multifamily Fundamentals Expected To Be Overtaken by Demographics, Jump In New Construction
The ongoing recovery of the U.S. apartment market is entering a new phase, one marked by an increasing level of permits and construction starts for multifamily development projects. The upwelling in new development is expected to increase supply across many markets starting in 2013 after years of almost zero growth.
The new phase follows the dramatic vacancy declines and strong apartment rent growth that has occurred in the tightest and more desirable coastal markets, and a rare moment of solid income growth even in vacancy-challenged markets.
The rising supply pipeline, coupled with the gradually improving market for single-family housing, is expected to help bring some equilibrium to an apartment market which experienced strong renter demand and plunging vacancies from late 2009 through middle to late 2011.
Demand has tapered off somewhat since last summer due to slower seasonal leasing -- and perhaps some sticker shock among tenants that have watched asking rents eclipse pre-recession highs in some supply-challenged metros, according to Michael Cohen , head of advisory services for CoStar Group’s economic and market forecasting company, Property and Portfolio Research (PPR).
Cohen, along with PPR’s new director of multifamily research Luis Mejia and senior real estate economist Erica Champion, made the observations during CoStar’s First Quarter 2012 Multifamily Review and Outlook.
"Vacancies have been slipping in the apartment sector for several years due in large part to favorable cyclical demand factors and little-to-no new supply," Cohen said. "But the next chapter in the apartment recovery is going to look pretty different, particularly on the supply front."
Overall, the national apartment vacancy rate has dropped by a precipitous 170 basis points through the first quarter of 2012 since peaking at 8.3% at the end of 2009, with the lion’s share of occupancy gains recorded during the six-quarter period between fourth-quarter 2009 and second-quarter 2011. That's equal to demand for about 270,000 additional units, two-thirds of them occupied in 2010 alone, the single strongest year for multifamily demand since 2005.
Rent Hikes Bring Sticker Shock
But demand has eased in the last six months, with the year-over-year vacancy closing the first quarter at 6.6%, down only 60 bps. Several tight coastal markets have already reached or are approaching pre-recession vacancy lows, however, and it’s likely the seasonally weaker pace of demand over the last two quarters will pick up over the rest of 2012, the analysts said.
Four of the top five rental markets that experienced the sharpest vacancy declines are fast-growing southern metros, led by Charlotte, Austin and Raleigh, NC. Detroit, with its surprising auto industry rally, ranked an impressive fourth place, followed by San Antonio. Apartment vacancies have not dropped as sharply in markets like Washington, D.C. and Seattle, where new supply is already starting to come on line.
The recovery has shifted away from the southern metros and toward West Coast markets in the last six months, much of it driven by strength in technology sector. Los Angeles was ranked first in the nation in the first quarter in year-over-year nominal demand growth with about 12,000 units, followed by Dallas, Chicago, New York and Houston.
Ranked by the percentage rise in demand growth, Richmond, VA, led all markets with a year-over-year gain of over 4%. Charlotte, Raleigh, San Antonio and Houston garnered the other top five spots.
Salt Lake City and the San Francisco Bay Area metros saw the largest declines in vacancy. But at least 30 of the top 54 U.S. metro areas have seen their vacancy rates increase at least slightly over the last six months.
"I’m not suggesting that’s indicative of the health or the trajectory of the market, but it’s not a straight line down in absolute vacancy improvement. There is a little bit of a lull," Cohen said.
Although job losses and the housing collapse are still fresh in the minds of 20-to-34-year-olds who make up the bulk of the renter base, and mortgage underwriting standards are stricter, the math is becoming more appealing for people deciding to buy a home or condominium over renting an apartment, Cohen said.
Those decisions are being influenced by spiking rents that have already pierced their pre-recession highs in such markets as San Jose, Oklahoma City, Denver, East Bay, San Francisco, Chicago, Portland and Pittsburgh.
Apartment Starts Ramping Up
While only 60,000 new apartment units are expected to be added this year, well below longterm average, construction starts and permitting activity are beginning to pick up from historical industry lows not seen since 1993.
"In advising our clients on market selection, we are starting to get calls with concerns about the rate of supply and net completions," Cohen said.
But developers who have delayed decisions to build are seeing the window close as capitalization rates reach record lows.
"2013 will be the first year we’ve seen deliveries above 100,000 units. We need to readjust our perspective on supply for Chapter Two (of the recovery). We haven’t seen 100,000 units come to market since 2009."
CoStar's outlook for supply is moderate through 2015, with between 100,000 and 130,000 units delivered per year, a rate expected to achieve equilibrium between supply and demand, Cohen said.
Homeowner Distress Continues To Help Apt. Investors
Meanwhile, apartment investors continue to reap benefits from the current weak housing market, with the flow of distressed homeowners-turned-renters still above average, while the flow of renters turning into buyers is still quite low, according to Mejia, who recently joined PPR as director of multifamily research.
A comparison of homeownership and foreclosure trends confirms that the homeownership rate could continue to decline -- possibly falling below 65% -- until the delinquencies and foreclosures that have plagued homeowners finally ease.
In the early 2000s, optimism about rising home prices and loose underwriting standards helped push the ownership rate up to almost 70%, leading to a price bubble that began to deflate in 2006, causing a surge in foreclosures and sending the homeownership rate tumbling.
"Apartment markets will continue to see additional demand while the foreclosure rate remains above pre-crisis levels and potential home buyers are cautious about committing to a purchase, even amid all-time low mortgage rates," Mejia said.
Mejia also pointed that as foreclosures remain elevated and renters mull their home-buying decisions, the ownership rate will likely continue to decline, although the extent of the decline depends on the length and strength of the housing recovery.