Apartment investors are ending 2019 on a high note and closing the books on what has been an incredible decade of strong performance. Yet the extended bull run also has some wondering just how long those good times will last.
So far, concerns about any market overheating due to the concentration of development in the high-end Class A sector have largely proved to be unfounded. Despite a steady stream of new supply over the past several years, vacancies remain near historic lows and data shows still healthy absorption and rent growth. According to Yardi Matrix, more than 320,000 new units were absorbed through November, marking the sixth straight year that absorption topped 250,000 units.
A combination of factors is contributing to that sustained performance. Certainly, the apartment sector has been lifted by economic expansion that has brought steady job growth and new household formation. Additionally, there is a deep renter pool of people across age and demographic groups that are renting either by necessity or by choice. The usual sweet spot for renters is individuals between the ages of 20-34. Yet aging Millennials are in no hurry to buy that house in the suburbs even as the leading edge of Gen Z begins entering the renter market.
Some experts point to a housing shortage in general with new supply in both rentals and starter homes that are not keeping up with demand. For many, home ownership is less attractive – and less affordable. In fact, the typical home remains a “financial stretch” for average wage earners, according to ATTOM Data Solutions. The firm’s 2019 U.S. Home Affordability Report found that median home prices were unaffordable for average wage earners in 71% of the 486 counties analyzed. In addition, home prices are less affordable than historic averages in nearly half (49%) of location markets. ATTOM also noted that average U.S. home prices rose 9% year-over-year in the fourth quarter of 2019.
Investors continue to like the data and the demand drivers behind apartments. (People have to live somewhere.) GlobeStreet cited a recent Capital One survey that found 74% of multifamily professionals expect to be active buyers in 2020. Yet there is still some lingering wariness that, at some point, the music will stop. Rent growth, although strong, has slowed to 3.1%, according to Yardi. In addition, there are some soft spots emerging in local markets. One market on the weaker end is San Jose with relatively flat rent growth of 0.1%, while San Francisco and Houston are both below the national average at 1.4%. Another market to watch is Seattle. The metro posted sharply negative rent growth in the past few months of 2019 due to the large load of new supply delivered to the market.
Given the abundant capital still targeting the sector and the late stage of the cycle, investors and developers don’t have a lot of room for error in decision making. According to Marcus & Millichap, apartment values are up 51% compared to the peak of the last cycle. Not surprising, capital is following growth to markets that are generating good job and population growth. At the same time, they also are balancing demand drivers with what’s ahead in supply pipelines. Research from Marcus & Millichap shows pressure on supply in markets such as Charlotte, Nashville, Orlando, Austin and Salt Lake City, while Yardi noted Seattle, Charlotte and Denver as the top three markets that have seen the biggest increase in completions as a percentage of total stock in the past year.
|Market||Completions as % of Total Stock*||YOY Rent Growth||Occupancy as of Oct 2019|
Data Source: Yardi Matrix. As of Nov 2019 unless otherwise noted.
Investors continue to rate apartments as one of their top two preferred property types along with industrial. Yet looking forward to 2020, both short-term and long-term secular trends are likely to impact investment strategies. Apartments are not one-size-fits-all. There are a lot of nuances at play in local levels that drive demand for the location, type, size, amenity package and price renters are willing to pay. All of that rolls into strategy as investors weigh decisions on issues such as choosing suburban versus urban locations, or how much is too much to pay for workforce or value-add assets.
Investors are keeping a close eye on how new legislation around rent controls could impact returns. Oregon, California and New York have already passed rent control legislation and there are another six stages that have introduced rent control legislation. In addition, they are watching to see how alternatives such as mixed-income project, micro units or single-family rentals fit into the overall housing picture, either as investment opportunities – or as added competition. As the search for investment opportunities remains in high gear, changing market dynamics and potential late-cycle risks ahead highlight the importance of conducting thorough market analysis and due diligence.