State of the National Apartment Market
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Doug Bibby, President, National Multi Housing Council gives a keynote address at Massey Knakal Multifamily Summit (GreenPearl Events).
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State of the National Apartment Market
- 1. September 2010 State of the Apartment Market
- 2. 1 2.1% Excl. Growth in Private Inventories 1.2% Excl. Growth in Private Inventories 1.0% Excl. Growth in Private Inventories
- 3. Inflation Not a Threat Yet
- 4. Jobs Lost in Recessions As Share of Peak 2007 excluding temporary Census jobs
- 5. NMHC Market Tightness Index
- 6. Still Too Many Vacant Housing Units
- 7. Housing Inventory Remains High (Months’ Supply of Existing Homes)
- 8. Young Adults Living at Home Trend Suggests Significant Pent-Up Demand
- 12. Echo Boomers and Millennials A Continuing Stream of Young People Source: National Center for Health Statistics.
- 13. Immigration Set a New Record In the First Decade of the 21 st Century
- 19. Supply Trends Period Starts, Annual Average Completions, Annual Average 1999 – 2008 297,000 278,000 2009 97,000 259,000 2010 (est.) 85,000 135,000
- 20. Multifamily Mortgage Credit Extended, 2008Q1 – 2010Q1 Source: Federal Reserve Board; NMHC.
- 21. Bank Lending Not Back To Normal
- 22. U.S. Quarterly Apartment Transactions
- 23. National Apartment Price and Cap Rates
Editor's Notes
- I’ve been invited today to talk to you about the state of the apartment industry. I would sum it up thusly…tides are rising, but the waters remain choppy. As has been the case in past economic downturns, apartments are one of the first commercial real estate sectors to emerge from the recession. Transaction volume is beginning to increase, capital markets are beginning to thaw, and rental demand is rebounding. That said, there is still a long way to go until we have a robust recovery. But once strong job growth returns, the apartment industry is on the cusp of what many say will be the best operating environments in 30 years. Before we get to current market conditions, it’s useful to take a big picture look at the general economy.
- Real GDP growth rose to 5.0% in 2009 Q4, but taking out the inventory cycle effect (which is now over), the economy has only been growing at an average rate of less than 1.5% over the last three quarters.
- Despite concerns about a possible inflationary spiral, the data show no signs of rising prices. And with the 10-year Treasury yield at a low 2.55%, the markets clearly aren’t expecting a pickup in inflation any time soon.
- New jobs are the biggest driver of apartment occupancy and the “Great Recession” was by far the worst in the post-WWII era for job losses. Excluding the temporary Census 2010 jobs, very little employment has been regained since the apparent start of the apparent recovery in the second half of 2009. But there has been some nominal improvement since the beginning of the year. Private employers have been adding an average of 95,000 jobs a month through August. This revived hiring has been enough to stimulate demand for apartments. And importantly, employment for people 20 to 29 years old – a key renter group -- rose in May and June for the first time since the end of 2007. Even though we’re not creating a lot of jobs, it’s enough to make people feel secure enough to “unbundle” their households - young people are moving out of their parents’ basements and families living with relatives are moving out on their own.
- In fact the rebound in demand has exceeded expectations. Some 46,000 apartments were absorbed in the second quarter of 2010, the highest level of net absorptions in 10 years. NMHC’s Quarterly Survey of Apartment Market Conditions reflects the widespread improvement in the demand for apartment residences this year.
- But there are still too many vacant housing units of all types still out there. At 6.4 million, the inventory is about 2 million above the “normal” level. As long as this excess inventory is out there, it will remain to be seen whether the apartment market recovery is sustainable at the current pace.
- While the for-sale market got a temporary boost from the costly (and wasteful) Home Buyer Tax Credit program, the months’ supply of inventory of both single-family and condo units are far above normal levels. We expect that the excess supply in the for-sale market will remain for another couple of years and will hold back rent growth for 2010 and probably 2011.
- But once job growth resumes , there is a lot of pent-up demand out there, mostly from young adults. Fully 29.4% of young adults (aged 18-34) are living with their parents. That’s an all-time high and represents 2.75 million more than there were in 2001. While some of this may reflect long-term cultural changes, surely some of it represents pent-up demand for household formation. The average share living at home from 1983-1995 (before the housing bubble set in) was 27.4%. Returning to that level would bring an additional 1.4 million young adults (most of whom would surely be renting) into the housing market.
- There are many reasons to be bullish about apartments going forward. I’ll touch on a few of the most important. But overall, we believe that the recession and shifting demographics will swell the ranks of renters over the next five years.
- First is population growth in general. Unlike most industrialized nations, the U.S. population is growing. In fact, our population is expected to increase 33 percent by 2030 to 376 million. That’s 94 million more people than there were in 2000. To accommodate that growth, we will need 60 million new housing units.
- Downsizing baby boomers are another factor driving future rental demand. At 78 million strong, even if just a very small percentage of baby boomers migrate to rental housing, that creates tremendous new demand for apartments. And we are already seeing signs that once they are empty nesters, this group is increasingly opting to trade in their suburban houses for apartments and condos in vibrant live/work/play downtown neighborhoods. According to Census data, 75 percent of all seniors will change housing type between ages 65 and 80. And they are more likely to rent after the move than own. We see that 20% were renters before they moved, but 59% rent after they move.
- Another even more powerful force for rental demand are the Echo Boomers, children of the Baby Boomers. They will either match or exceed the Baby Boomers and so will be at least 78 million at peak. In fact, by 2015, there will be 67 million people aged 20-34—the prime years for renting. And we have reason to believe that this generation of young people will rent for longer than earlier generations. Not only have they seen first-hand that owning is not a can’t-miss investment, they’ve also learned through the recession that they need to be more mobile to respond to fast-shifting economic opportunities and not be burdened by needing to get out from under a house. Those experiences will likely keep them in apartments for longer, so they can be flexible and follow job opportunities.
- Immigration is also important for future rental demand because immigrants rent for a long time after arriving in the U.S. 71% of immigrants who have been here for less than ten years rent, and a full 82% of those here for five years or less rent. Even after the 9/11 attacks, which caused speculation that immigration would be restricted, legal immigration set a record in the first decade of the 21 st century. Like the echo boomers, tomorrow’s immigrants are likely to rent longer than their predecessors because the aftermath of the housing crisis—especially tighter credit and larger downpayment requirements—will make it harder for them to buy a house.
- Perhaps the biggest force at work here, though, is a dramatic change in what constitutes the "typical" American household. For generations, married couples with children dominated our housing markets and they caused the suburbs to grow explosively. But now they are less than 22% of households. And that number is falling. By 2030, nearly three-quarters of our households will be childless.
- In fact, between 2000 and 2040, fully 86% of our household growth will be households without children. That’s a profound change that has serious implications for the kind of housing we need. Our future society will be dominated by single people, unrelated people living together, couples without children and empty nesters. These households are much more likely to choose the flexibility, convenience and superior locations offered by rental housing.
- That’s the demographic picture, but there’s another important factor here and that’s our changing attitudes about homeownership as a result of the housing bubble. In many ways, the housing crisis has freed people up to question the conventional wisdom that they “have to buy a house” to pursue the American Dream. According to a 2009 survey by the National Foundation for Credit Counseling, almost half of American adults no longer believe that owning a house is a realistic way to build wealth. 1 People are starting to realize that when you add up all of the potential liabilities of homeownership—maintenance and repairs; insurance costs; rising property taxes; and potential price drops—renting is a smarter choice. As people come to understand that housing is shelter, not an investment, they are being freed up to choose the housing that best suits their lifestyle, and for millions that is an apartment.
- So with these new attitudes will come lower homeownership rates, and greater demand for rental housing.
- What do all these changes mean in practical terms? They mean a shift toward rental housing that has yet to be fully appreciated by either policymakers or even the housing industry. Between 2008 and 2015, nearly two-thirds of new households formed will be renters. That’s 6 million new renter households. According to Professor Arthur “Chris” Nelson, Director of Metropolitan Research at the University of Utah, to meet emerging housing demands, half of all new homes built between now and 2030 will have to be rental units.
- The obvious question then is – are we building what we need for the future? And the short answer is no. New apartment construction set an all-time post-World War II low in 2009 at 97,000 new starts. 2010’s construction levels are predicted to be even lower. To put it in perspective, we’ll need deliveries of an estimated 300,000 units annually on average to meet expected demand. Yet we are only building 85,000 this year. At the current rates of starts and completions, we’re not even building enough to replace the units that are lost every year to old age. Ironically, most casual observers look at the huge oversupply of vacant single-family houses we currently have because of the foreclosure crisis, and assume that the U.S. has a housing glut. We do indeed have a glut of single-family houses, but on the apartment side we are heading toward a shortage as early as 2012. The shortage of affordable rental units is particularly acute. The Harvard Joint Center for Housing Studies estimates a 3 million unit shortage nationwide .
- Of course, we can’t begin to bridge the supply gap until the capital markets fully recover and at this point, it’s clear that the financial sector has not returned to normal. Since the onset of the financial meltdown, virtually all private mortgage lenders left the market. Fully 8 out of 10 apartment loans issued in the first six months of 2010 had some form of government credit behind them – either FHA or GSE. The FHA is expected to insure $15-$20 billion in multifamily mortgages during FY 2010. Before the financial crisis, they averaged approximately $2-$3 billion. For deals submitted after October 1, however, FHA has tightened its underwriting requirements to require more documentation and more equity. They are also going to be more strict on how loan proceeds are managed during the development and construction phase of construction/permanent loans. On the non-government front, life insurance companies are returning to the market, and there is some activity in private-label CMBS. But it’s nowhere near pre-crisis levels.
- Bank lending is also not back to normal. Banks are still holding back on construction lending and they continue their “extend and pretend” strategies for underwater commercial real estate mortgages on their books. Earlier in the year, there was some hope that banks would begin to refinance maturing debt on a 5-year term, but that optimism is now largely diminished. What loans are being made are being done on a much more conservative basis, with lenders requiring 75 percent loan-to-value based on historical income results.
- The lack of fully functioning capital markets continues to have an impact on apartment property sales, although there are signs of improvement. Through the first half of the year, there were just under $10 billion in sales, split almost equally between the first and second quarter. This is an increase of approximately 70 percent over the same period in 2009, but as this chart shows, transactions still remain well below the frenzied pace of mid-decade. REITS and other large institutional investors are the most active buyers in the market and we expect the pace to pick up as more debt and equity sources come off the sidelines.
- Cap rates appear to have already topped out and started to edge down once again. Price per apartment unit (admittedly volatile) appears to be moving up as well. Multifamily saw price declines of nearly 30% from Q1 2008 to Q4 2009, with an estimated additional 10% this year. Even though deal velocity fell 40% between Q4 2009 and Q1 2010, national median sales price has climbed 6% to $74,900/unit in the first half of 2010. Cap rate compression is occurring in primary markets, because of all the capital from private investors, REITs, pension funds and life companies competing for limited inventory. As we’ve all heard, the wave of expected “distressed assets” has failed to materialize because of the banks “extend and pretend” strategies. Buyer demand is targeted at Class A assets in first-tier markets. This has driven the overall increase year-to-date. In the first six months of 2010, Class A properties traded at $97,600/unit, up 14% from last year. Prices fell in lower-tier markets, with Class B down 6% and Class C falling 23% from last year.
- In the end, it all comes back to the capital markets. One of our priorities this year was the enormous Dodd-Frank financial regulatory reform measure that was enacted in July. Overall, we expect the law to have mixed results for apartments and commercial real estate in general. Reform means added regulation and disclosure requirements that will increase transaction costs for loans and hedging activities that may be passed on to borrowers. It may even result in changes in underwriting. While there are many unknowns, one thing is certain—the Dodd-Frank bill is extensive and complicated. One measure of it’s complexity is the fact that it directs federal agencies to issue nearly 200 rules to implement it. By contrast, the far-reaching Sarbanes-Oxley law had only 16 rulemakings. While the bill focuses largely on banking, mortgage and consumer protection, NMHC and our partners on Capitol Hill secured several important changes to the bill which should mitigate its impact on the industry. Among the things we avoided: Onerous Risk Retention Requirements The measure imposes new "skin in the game" requirements, but allows regulators to let B-piece investors satisfy them. This should help avoid significant increases in pricing and retain much of the current structure of CMBS. The SEC is studying what levels of risk should be retained and how, but it is unlikely that we will see the proposed 5-10 percent levels that will apply to other securities offerings.. Material Ratings Changes for CMBS Assets As originally drafted, the bill would have required specifically identifying CMBS with a special identification, which would have acted as a potential red flag on issuances and could have affected pricing and trading. Costly "End-User" Derivatives Regulations Commercial real estate owners who use derivatives to hedge interest rate risks are exempted from costly fee and registration requirements. Of course, the devil is definitely in the details with this particular piece of legislation given the importance of the rulemaking process. And the risk retention requirements and the derivatives provisions are among the areas where regulators will have the greatest influence. So we'll continue to closely follow the process to ensure that the rules don't materially change lawmakers' intent.
- Without a doubt, however, the biggest threat to the industry is GSE reform. Ultimately, the outcome is highly dependent on politics as there is a sharp division along party lines on the issue. Democrats support a continued role for the government in the housing finance system while Republicans want to eliminate the GSEs –and any federal guarantee for mortgage credit – entirely. Sadly, even though the GSEs’ multifamily programs did not contribute to the housing meltdown, they are now at risk of potentially onerous changes as a collateral victim of single-family market excesses. We have mounted an all-out campaign to educate policymakers that a federally backed secondary market is absolutely critical to the sector’s health and our ability to continue to meet the nation’s growing demand for rental housing. In meetings with both the Administration and Congress, we are explaining to them that history has made it clear that while private capital should dominate a reconfigured system, the private market simply cannot meet 100% of the apartment industry’s capital needs. Now that financial regulatory reform is complete, the GSEs have become a priority. The White House held a high-level, invitation-only conference on the topic on August 17. And I'm happy to report that our efforts are making a difference. A common theme in the panel discussions was that this discussion should not be just about ownership, it's also about rental housing. And a number of panelists reiterated our call for a more balanced housing policy. The Administration has to outline its blueprint for reform by January 31 thanks to a provision in the Dodd-Frank bill, but the transition to a new housing finance system will likely take years. Expected Republican gains in the November elections could further delay the prospect of legislation and meaningful reform. That doesn’t mean there won't be a lot of activity and political theater, though.
- In addition to housing finance reform, our expert team of lobbyists is working dozens of other issues that threaten to derail the sector’s recovery. Among the top priorities are carried interest, unrealistic green building mandates, card check legislation and tax law changes. Other than carried interest and taxes, Congress has run out of time to deal with most of these. Congress reconvened on September 13 for a short work session before adjourning to campaign. Both parties are gearing up for major battles this fall on a long list of unfinished business, including the looming expiration of the Bush tax cuts, a small business lending bill and a tax “extenders” measure that would be paid for, in large part, by a dramatic tax hike on real estate partnership “carried interest.” This year’s high-stakes congressional elections could produce a significantly changed political landscape, which will have an enormous impact on our legislative work. And it remains to be seen whether the Democrats will convene a post-election lame-duck session to try and tackle some last items before the new Congress convenes.
- So what does all of this mean? Going forward, the near-term outlook for the apartment industry is likely to be tied to the pace of job growth. Over the longer term, positive demographic trends are likely to keep the demand for apartments growing. And in between, we need to navigate our way through an increasingly partisan political environment that likely holds the future of our capital availability in its grips.