Demand trends support apartments, but supply trends vary based on segment
Source: Institute for Real Estate Operating Companies
June 20, 2019
The apartment sector will be supported by strong demographics over the next decade, but the class A and class B segments have experienced diverging supply trends.
Demographics continue to be a significant demand driver for the apartment market, notes Daniel Walsh, CEO of Citymark Capital. The average renter is 32 years old, and the renter cohort is set to continue to increase over the next 10 years.
“The number of 18- to 34-year-olds will continue to grow for the next decade,” says Walsh.
He also points to rising student debt levels and delayed family formation as demographic tailwinds for the apartment market, keeping younger people renting rather than owning for longer. The U.S. homeownership rate fell to 64.2 percent in the first quarter, according to the U.S. Census Bureau. The rate hovered around 69 percent in the mid-2000s.
“People are not buying single-family homes at the pace they were 10 years ago,” says Robert Hart, president and CEO of TruAmerica Multifamily. The shrinkage of the homeownership segment has meant growth in the renter cohort, he explains.
The consumer side of the apartment market is still very robust, and will continue to be so for the next decade, as long as supply is kept in check, adds Hart. On the investment side, the apartment market has had a lot of capital, and a lot of liquidity, notes Hart, but that has pushed up asset valuations and pushed down yields.
“The financing side is super robust,” says Hart. He notes the agencies, insurance companies, banks and debt funds have been providing substantial liquidity.
The apartment market’s development pipeline remains active, but completions fell to 39,300 units in the first quarter — the lowest quarterly level in four years, according to CBRE Research. Construction starts and units under construction, however, remain elevated and indicate deliveries in 2019 and 2020 are likely to remain close to 2018 levels.
The apartment vacancy rate fell 20 basis points, year-over-year, to 4.6 percent in first quarter 2019, reports CBRE Research, and rents grew 3.0 percent, year-over-year. Investors have responded favorably — the 12 months through March 2019 saw multifamily transaction volume reach $175 billion, including $36.4 billion in the first quarter, according to Real Capital Analytics.
Coming out of the financial crisis 10 years ago, a dearth of capital meant new apartment supply was extremely limited. The past few years have seen a substantial catch-up of new apartment construction, with much of it concentrated in the class A, urban segment. Because of the high costs of land, labor and materials, it can be difficult to make development deals pencil out unless they are able to command premium rents. That also has meant an extremely limited supply of new class B and workforce apartments in infill locations, notes Citymark’s Walsh.
And that has meant a growing a bifurcation in the apartment market between class A and class B assets. Class B is currently characterized by a lack of supply, which is supporting rent growth, whereas class A has seen a lot of excess supply, which may take a while to absorb, says TruAmerica’s Hart. The higher end has seen concessions and less durable cash flows.
Workforce housing — the class B sector — functions very differently than class A, says Hart. “There’s a huge disconnect between the class A and class B sectors, especially in markets such as Seattle, San Francisco, Los Angeles,” he says.
Walsh believes the apartment market — especially the value-add, class B segment — will be well-positioned in a recessionary environment. As opportunities for homeownership become scarcer, that can support the apartment rental market.