By Doug M. Poutasse
Doug Poutasse is an executive v.p. at Bentall Kennedy.
The markets experiencing the strongest apartment construction this cycle are also the ones experiencing the strongest job growth. In most cases, developers are delivering new units in locations where renters want to live primarily highly amenitized, walkable, urban cores and sub-urban transportation nodes in areas with high concentrations of employment in growth industries such as technology, healthcare and energy.
This development activity is creating a virtuous circle of growth as firms expand in areas with growing ranks of skilled workers, and more residents migrate to these areas due to lifestyle considerations and the availability of both jobs and housing. In markets with stronger economies, if a housing shortage emerges, both household formation and job creation are disrupted.
We believe that rising concerns that the U.S. might be in a multifamily construction bubble are over done National apartment occupancy and rents have continue to climb. The reality is that most of new construction will only partially satisfy the pent up demand for housing that exists in high growth locations that have been undersupplying housing for years.
Denver, Houston, San Francisco and Seattle are among the more active markets for multifamily construction starts; however, strong job growth and healthy income gains have led to improving apartment market fundamentals. According to Axiometrics, all four of these markets had rent growth in excess of 5% during the year ending May 2014. Some markets are showing the effects of new supply. Austin and Raleigh, for example, are seeing the most rapid growth of new apartment units in at least a generation, to the point where developers appear to be outpacing each MSAs exceptional job growth. Still, demand growth in these two markets surpasses that of all other major markets, and rents continue to rise, at least for the moment.
Data show that in perennially tight housing markets such as Boston, New York and San Francisco, household growth can lag behind population growth. This is particularly true during recessions, as high housing costs discourage household formation. However, this effect is also evident during periods of economic expansion, as markets such as these often struggle with housing shortages, due to the high costs of development, limited ready to go land sites and long construction and development periods. An interesting paradox is that one of the constraints on economic growth in high cost markets such as these is the lack of housing supply, which limits both population growth and new household formation.
These growth constraints are less evident in higher vacancy and easy to build markets such as Raleigh and Austin. In markets such as these demand tends to expand more rapidly during periods of economic expansion. Despite these exceptions, however, housing shortages have largely become a national issue. National housing construction took a hiatus for a few years during the recession. Multifamily starts in the U.S. have been running at an annual pace of about 327,000 over the past year, compared to a fairly consistent pace of about 340,000 units during 200207. During 200911 multifamily starts fell to just 134,000 units per year, which was, by far, the slowest pace of the past 50 years. Exacerbating this lack of housing was an even greater drop in single family construction. Today apartment vacancy is at its lowest level since the early 2000s, and cyclical and structural demographic factors should create growth in apartment renting households for the next decade or so.
Sources: U.S. Census Bureau, Moodys Analytics
Renters driving new household creation
Most recent growth in new households has come from the renter market. U.S. Census data indicate that between the fourth quarter of 2007 and the first quarter of 2014 there has been a 1.4 million decrease in households that own, versus a 4.4 million increase in households that rent a nearly 16% rise in just over six years. Undoubtedly, much of this divergence was cyclical as millions of households were displaced from their homes due to foreclosure and short-sales. However, other factors that are more structural, have also impacted these trends. These forces suggest that there has been a longer term shift in housing tenure preferences. They include younger people delaying marriage, rising desirability of urban living amongst the Millennials, an increase in baby boomers seeking second and primary homes in the city, and a host of other factors.
Although year-over-year employment growth since the beginning of 2012 has averaged almost 2.3 million jobs, nearly matching the robust pace of 200506, the homeownership rate has continued to slip, falling from 66% at the end of 2011 to 65% in the first quarter of 2014. This is the lowest rate recorded since mid-1995 and is a far cry from the 69% peak in 2006. The coming of age of the Millennials as a key apartment demand driver, immigration trends pushing the percentage of the foreign-born population to levels reminiscent of the 1920s, and chaning preferences due to lifestyle, household composition and mobility considerations have all helped drive this shift.
Over time, as economic conditions improve to a point where households once again have the confidence and equity to buy homes, and the number of Millennials choosing homeownership rises as they age and begin to raise their own families, we will see homeownership take back some of the ground it lost during the recession. However, homeownership rates are likely to remain well below the peak range of nearly 70% range. In fact, over the next few years apartment demand is likely to continue to rapidly rise, as pent up demand is unlocked by stronger economic conditions combined with newly available supply. A major driver of this growth in demand will be from younger college-educated adults who have previously chosen to live at home with their parents until their economic prospects significantly improved.
|Renters Driving New Household Creation|
Sources: U.S. Census Bureau, Moodys Analytics, Bentall Kennedy Reserch
Employment and apartment markets are not created equal
This more permanent shift will be particularly evident in the burgeoning urban cores and sub-urban transportation and employment nodes of major U.S. cities where quality housing, employment opportunities, and an attractive lifestyle are all within close proximity. The economic fortunes of these cores have been quite different from the nation overall. While the U.S. has only just now returned to its pre-recession peak employment levels, areas such as Boston, San Francisco, and Seattle have expanded well beyond their previous peaks. This outperformance has occurred due to these areas superior educational infrastructure and achievement, abundance of healthcare research and employment, and large and innovative technology sectors.
Equally important, however, is that these areas have managed to attract the types of highly-educated and innovative white collar workers that firms are looking to hire. The ability of geographic areas to provide the labor force that is the lifeblood of economic growth will be paramount to them attracting new firms and encouraging existing firms to expand. Attractive housing options are a crucial component of this formula. To a large degree, these two forces share a symbiotic relationship that is hard to disrupt, absent dramatic overbuilding, severely inflated pricing, a national recession or some other exogenous shock.
Millennials have shown an affinity for urban living and frequently possess the skills to thrive in sectors of the economy that are driving the recovery. Numerous studies show that Millennials accumulate fewer physical possessions and are less likely to own cars than previous generations. Cultural shifts towards delayed marriage and lower birth rates give this generation more freedom to live where they want. Further, younger age cohorts have always demonstrated a higher propensity to rent, and Millennials will be no different. The most recent Emerging Trends report found that 38 percent of Millennials expect their next move to be to multi-family housing, compared to 29 percent of the U.S. population as a whole.
Employers looking to attract these workers will benefit from proximity to desirable urban neighborhoods that are ideally within walking distance. In the absence of this proximity, employers will need effective and frequent public transportation to attract these Millennial workers. Absent effective public transportation, firms can take the more expensive approach of shuttling workers from dense urban centers to nearby suburban campuses, such as Google has done in San Francisco. However, this will only work for large employers in metros with a history and a willingness to develop fully amenitized suburban campuses with access and proximity to major technology hubs.
Gen Y is not the only group driving the strength of the apartment market. The wave of mortgage foreclosures combined with home value declines over the past six years to undercut the notion of a house as the ultimate retirement plan. This has caused a number of Baby Boomers to gravitate toward apartments. A report from Harvards Joint Center for Housing Studies noted that the strongest net growth of renter households over the past decade was in older households. Among 4554 year-olds, [the rate of] growth in the number of renters was more than three times that of total households. Many of these older workers are choosing urban neighborhoods for some of the same reasons that younger workers are: easier work commutes, proximity to amenities and availability of mass transit. However, Baby Boomers are less likely than Millennials to move to a new city without a job waiting for them.
|Housing Starts Have Leveled Out, Combined Activity |
Remains Well Below Historical Highs
Source: U.S. Census Bureau
When apartment supply lags, does job creation lag too?
The risk of a shortfall in housing supply should be of greater concern to long term investors than any short term supply hiccup created as new properties in lease-up compete for tenants. If workers cant find housing or low availability pushes rents to levels that younger renters cant afford, long term economic prospects will be limited. We may be seeing this phenomenon start to play out in San Francisco, where geographic and human constraints on apartment supply have led to an acute housing shortage and dramatic increases in rents are displacing long-term residents.
The highest construction levels for urban rentals, in at least a generation, have caused many to fear an oversupply problem. While a few markets will suffer from oversupply that is worrisome, we believe that many markets, especially knowledge based-cities with housing shortages, will fare well through-out this construction stage. In such supply-constrained, knowledge-based markets, the pace of new development has helped fuel job growth, leading to a greater demand for housing units. Cities must have new apartment supply at prices that are affordable to young professionals in order to drive job growth. This becomes a virtuous cycle.
Healthy demand certainly doesnt mean every new apartment development or existing property investment will be a winner. It does mean, however, that many markets that have a dynamic employment base and face an acute shortage of housing can absorb significantly higher than expected numbers of new units. Investors looking for solid yields and stable returns will be well-served by targeting multifamily investments in such locations for long-term investment. While they may risk potentially becoming discouraged by short-term softness that could occur in rents as new projects come online, over the mid- to long-term, investment returns should be compelling.