I just read this report by Gleb Nechayev, VP and Senior Economist of the CBRE Econometric Advisors. A lot of you have been following my progress with Monica Main’s Apartment Cash Flow System so I thought you would be interested to read this too.
The new year promises to be a better one for the apartment sector. With the U.S. economy expected to show some improvement in 2010, our outlook for multi-housing is cautiously optimistic. Rental demand should strengthen due to a more robust overall household formation and declining homeownership rate. With completions of new multi-housing product dropping sharply from the current pace, most markets are likely to see moderate improvement in occupancy and less severe effective rent declines in 2010, with additional momentum in 2011.
While the worst of the job losses are behind us, aftershocks such as rising unemployment and foreclosure rates, are still a concern for the economy. Today’s record overhang of vacant year-round housing still poses tangible risk to home prices and rents in many markets. In this respect, the national apartment market will remain in uncharted waters in terms of vacancy rates until the broader housing market shows convincing signs of recovery. In general, areas with stable employment bases, limited supply overhang, and declining affordability of owning should fare better in terms of apartment rate and revenue growth. Even in submarkets, however, property performance can vary widely depending on product type, condition, amenities, and street location.
Demand Trends
After a steep loss in apartment demand by the consumer over the first year of the depression, 2009 is on track for a positive net absorption. Property managers are offering incentives to attract and retain renters even in markets that are doing relatively well, possibly in anticipation of traditionally weak year-end leasing and uncertain early months of [this] year. It is encouraging to see that renters are taking advantage of these discounts as evidenced by improving net absorption. As the economy continues to improve and housing becomes less affordable, these concessions will dissipate and allow for effective rent growth to resume after 2010.
[my note: I'm pretty sure that means to BUY an apartment building NOW!]
More…
The total rental demand (i.e., including 1 to 4 unit family housing) continues to expand at near-record pace. This recent growth is a result of overall household formation and changes in homeownership rate, with the latter contributing the most. Over the five year period ending mid-2009, about 3.5 million households were added to the national rental pool, including in excess of a million households [in 2008]. With foreclosures still on the rise and home mortgage lending more stringent, homeownership is likely to continue falling from its current rate of 67.4% to about 66.0% by the end of [2010], boosting growth in rental households even further — perhaps by as much as a million above the long-term trend of 350,000 to 400,000 per year.
Such record expansion in total rental demand provides a timely cushion for apartment occupancy — without it, the impact of record job losses on property performance would be much more negative. While declining homeownership does create a near-term tail-wind for apartments, it is important that foreclosures begin to taper off [this] year allowing home prices to stabilize and start recovering. A prolonged slump can lead to a tangible loss in apartments’ market share to other forms of housing. Conversely, stead or rising home sales and prices will make ownership less affordable, which would support increased rental demand over time, especially given the favorable age demographics.
Even in the environment of rapidly growing total rental demand, apartment properties will have to complete aggressively to retain existing tenants and attract new ones, especially those of good quality. There is evidence that markets with higher total vacancy rates also tend to see higher apartment rates. Not surprisingly, single-family prices and rents in such areas are also generally more affordable — another factor limiting apartment rent growth.
Supply Trends
One factor that should help ease competitive pressures on apartments next year is a minor reduction in new multi-housing supply. Judging by the number of projects which started in 2009, completions of properties with five or more units are expected to drop from the current annual pace of 250,000 units to about half that figure in 2010. Market-rate apartments will comprise fewer than 70,000 units nationally — less than half the average level of the prior twenty years and a new historical low for this segment.
The exact timing of deliveries does vary, however, and many projects are often deferred during recessions. There are still over 50,000 apartment units which started in 2008, whose current status is unclear. If construction for most of these projects was deferred rather than abandoned, the actual completions in 2010 could be significantly higher than expected.
Given today’s record-high apartment vacancy and depressed rents, however, completions are still likely to drop below historically low levels last seen in the aftermath of the real estate burst of the early 1990s. Moreover, a slow recovery in fundamentals along with highly constrained residential construction lending (at least for the moment) would limit the subsequent recovery in total multi-housing completions, keeping them at very low annual levels of about 100,000 units over the next few years. Some argue that a combination of record low new supply and pent-up rental demand would create conditions for above-average rent increases, or “spikes,” in 2011 to 2013 nationwide.
In our view, such a case can be made in markets with low housing affordability, high barrier to development, and sharp declines in apartment rent and revenues this this year and next.
2010 Outlook
The near-term outlook for apartment rents and revenues calls for a gradual recovery from the record declines experienced in 2009. Positive net absorption expected in 2010 should bring the national vacancy rate to 7.0%, or about 100 basis points below the peak. While the vacancy rate level will remain over 150 basis points above the long-term average next year, demand momentum is expected to curb further spread of rent discounts and concessions for new leases resulting in progressively smaller effective rent declines. Since the roots of this recession are in housing, however, cumulative peak-to-trough loss in apartment rents and revenues nationally will be more severe than after the 2001 recession and more comparable to those sustained in the early 1990s. After the 2001 recession, apartment performance benefited from rapidly rising home prices and massive rent-to-own conversions. It is just the opposite situation now: there is a record inventory of vacant single-family homes and condominiums, falling home prices, and own-to-rent conversions.
Employment trends aside, housing affordability is a key factor affecting apartments in this cycle and contributing to wider differentiation in rent growth across markets, submarkets, and product types. Variation in performance, already much wider than it has been historically, will likely widen even more as markets adjust to new economic realities. For the first time in over a decade apartment owners and managers have to operate in the environment when the primium to buy a median-priced single-family home or a condominium is much smaller relative to rents.
Declining homeownership rates and rising propensity to rent does boost aggregate rental demand but employment and household growth are more important for apartments. With fewer workers and households and reduced incomes, potential apartments demand cannot be realized, especially in locations with an over-supply of vacant single-family homes and condominiums for rent and for sale.
There are some signs, however, that home prices are stabilizing. The recent decline in sale duration for single-family homes indicates that markets are functioning as expected. A plunge in new house completions helped keep for-sale inventory at bay, and low prices attracted more buyers, including investors. It it important to look behind this facade, however, to see that much of the recent improvement is accounted for by Arizona, California, Florida, and Nevada — states whose housing busts were common among the triggers for the financial crisis and the national recession.
While home sales are indeed leveling out, these steep job losses of late-2008 and early-2009 have affected regular borrowers and foreclosures on fixed-rate mortgages now drive much of the distress. In California, Florida, and Nevada, current unemployment rates are not only well above the national average, they are also above their own historical peaks. Labor markets in these states must improve quickly ot they will risk facing new negative impacts from housing that can have national implications once again.
Stabilization and subsequent recovery in the labor market and home prices are both key to the multi-housing outlook. Judging by the current conditions, a tangible improvement in fundamentals is unlikely to begin for another year or so. We don’t expect “heaven in 2011″ either, but the road to a real recovery in apartment rents and revenues should clear by then.
