Renter Demand Holding Fast So Far As Apartment Supply Begins to Break

The tightening competition among apartment investors will yield both winners and losers during this next supply-driven phase in the multifamily market. The winning developers will likely be those that offer products that are new and different, capturing renters who have an expanding menu of housing options and amenities.

“We’re past the point at which simply picking a market that will lead to a successful strategy,” said Luis Mejia, CoStar Group director of U.S. research, multifamily at CoStar’s Midyear 2013 Multifamily Review and Outlook. Mejia was joined in the webinar presentation by real estate economist Francis Yuen and quantitative analyst Mark Hickey. “Due to the impending supply wave and increased investor interest in apartments, investors need to go beyond that and be able to identify opportunities within each market — regardless of whether it’s a mature, early recovery or late-recovery market — that put them in a position to compete.”

To avoid being swamped by the new offerings hitting the market, it’s important for developers to position their projects as new, different and better from an operational, technological or locational perspective — especially for higher-end projects competing for well-heeled renters in such markets as Silicon Valley and the Boston seaport area, Mejia said.

“Clients often ask us, ‘is the time to invest in multifamily over?’ The simple answer is ‘No, we don’t believe so,’” Yuen said. “However, it’s clear that after 2.5 years of fundamentals improvement and a more than 200-basis-point decrease in the U.S. vacancy rate to around 6%, the apartment market has grown far more competitive. The market has hit the pause button and is now going in the reverse direction.”

Chalk up a good part of the reversal to the feverish pace of new apartment construction in many markets. The total number of units delivered is now outpacing net absorption by tenants. Property & Portfolio Research Inc. (PPR), CoStar’s analytics and economic forecasting company, expects about 170,000 units to be delivered in 2013 in the top 54 markets that PPR analyzes — on track to more than double the amount delivered last year.

Make no mistake — apartment demand is still very strong and U.S. demographics are clearly in the sector’s favor. With more than 65 million Echo Boomers ages 20-34 now entering the prime renter cohort — more than at any time since the 1970s — savvy multifamily investors will continue to find opportunities in spite of new supply pressures.

The apartment market absorbed a net 130,000 units in 2012 and PPR is forecasting another 150,000 net units to be rented this year — highs that rival the peak of the previous up cycle. Even with the 40-basis-point rise in vacancy rates projected for this year, the market remains “exceptionally healthy,” Yuen said.

Nearly three-quarters of the 75,000 properties of 50 or more units tracked by CoStar, ranging from institutional-quality 5-Star luxury communities to lesser quality complexes, have a vacancy rate of 5% or less. Another 15% have vacancies of between 5% and 10%.

“Even the properties rated by CoStar at 3-Star and below, the Class C market, are tight,” Yuen said. “This is certainly making it harder for value-add investors who are looking to pick off under-leased assets- – there just aren’t that many of them.”

While these opportunities are harder to find, they’re still out there, particularly in housing bust/boom and employment recovery markets such as Las Vegas, which may yet see additional vacancy compression.

Many Echo Boomers are still living in their parents’ basement or with multiple roommates, but eventually they’ll get decent jobs and leave the nest. Markets benefiting from the growing technology and energy sectors such as Seattle, Austin, Denver and Houston are all seeing continued increases in both demand and absorption.

In fact, recent history has been very kind to the apartment sector, with 40 of the top 54 markets tracked by PPR experiencing vacancy declines over the last year. Developers who have been able to get to the construction phase early are seeing many of their projects lease up quickly.

Those later to the game may not see their leasing efforts go so smoothly, however, with the total number of multifamily starts and building permits reaching mid-2000s highs. The new inventory is following renters into the fast-growing Sunbelt metros. Year-over-year supply additions in Dallas and Houston lead all comers, with nearly 12,000 and 10,000 new units, respectively.

With costs to acquire existing properties in top coastal markets such as New York, Boston and Washington DC, reaching the stratosphere, investors and their developers are finding it much more attractive to build than buy.

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