The Future of Multifamily Housing
Seniors, Lifestyle, and Low- and Moderate-Income Renters Will Drive Demand for Apartment Stock.
The U.S. multifamily housing market has benefited from the most stable supply-and-demand fundamentals of any property type for the past several years. As a result, at a time when many property markets, particularly the office and hotel markets, were overbuilt and suffering from falling rents and negative returns, apartments were posting strong rental growth and gains in values. Since 1990, average apartment rents have moved up at an annual rate of 5 percent and sales prices have escalated 4.5 percent per year on average. Yields have averaged 10 percent since 1993, making apartments the market leader for the first half of the 1990s.
However, some of the dynamics that helped propel the apartment market have begun to change. Having led the property recovery, the multifamily housing market is further along the current property cycle than any other property sector and is showing the characteristics of a maturing asset class. These characteristics include rising new construction, slowing rent, and income-based value escalation. Apartment sales prices continue to rise as investor demand bids up prices in a number of markets. Other recovering property types, particularly suburban office and hotels, have captured a large share of investment dollars recently by offering higher short-term gains in rents and values.
Of most concern to apartment owners and investors is the construction activity that was up 43 percent in 1996 compared to 1993. However, the 160,000 units of multifamily housing projected to start this year throughout the nation constitute 25 percent of the total units built in 1985, the last peak in multifamily construction. At the same time, absorption of new units has slowed. In 1994, 82 percent of all new units delivered were absorbed within the first three months of availability. The three-month absorption rate of new units fell to 72 percent in 1996. Absorption levels for the six-month period after delivery followed a similar pattern. In 1996, 87 percent of all units were absorbed in this time frame, compared with 94 percent in 1994.
Several markets, including Denver, Phoenix, Las Vegas, Dallas, Atlanta, and Austin, Texas, have experienced particularly high levels of construction and now are under tight observation for potential overbuilding. The vacancy rate of some of these markets has edged up slightly. However, this movement in vacancy generally has been limited to newly constructed higher-end units; class B rents and vacancies have not been affected to any significant degree. These markets also have appeared high on various job and population-growth rankings for the past several years and have absorbed the new supply for the most part. While the short-term supply-and-demand balance may get tilted in specific markets, no broad-based evidence indicates a downturn in the long-range outlook for the multifamily market. In fact, supply and demand are expected to stay more or less in balance. While the returns and value escalation may not be as rapid in the future, the general stability of multifamily real estate investments will continue to attract investors.
Nationally, multifamily vacancies have been dropping and have remained the lowest of all property types. The national vacancy rate is projected to stay at less than 6 percent in 1997, despite continuing construction activity. Another sign of strength for apartment properties in relation to the other major property sectors is reflected in its low delinquency rates. According to the American Council of Life Insurance, only 0.48 percent of apartment property loans are delinquent, down from 1.5 percent a year ago and 3.5 percent in 1993. The overall delinquency rate for all property types stands at 1.8 percent.
The U.S. population continues to grow at a moderate rate, with a total of 62 million residents added since 1970. By 2001, the United States will have added 12 million people to its population base. The nation's population will climb by an estimated 45 million residents during the next two decades thereafter. At the same time, total households have grown by 57.5 percent, or 36.5 million, since 1970. Household growth in the 1990s is projected to total 12.7 million, or 13.8 percent.
Falling household density has been a contributing force behind the growth in household formation rates. In 1970, households averaged 3.2 people in the United States, compared with an average of 2.6 people in 1996. During the recovery from the 1990-91 recession, low interest rates and weak home price elevations helped increase U.S. home ownership rates. Since 1993, ownership has risen from 63.9 percent of households to more than 65 percent.
While this trend implies a negative effect on renter demand, the impact likely will be short term. Interest rates have been moving up again in response to consistent economic activity and show no evidence of falling soon. In the last 35 years, the U.S. home ownership rate has stayed virtually unchanged, despite short-lived movement.
Low- and Moderate-Income Renters
Households with annual incomes of less than $25,000 comprise 61 percent of all apartment renters, according to the U.S. Bureau of the Census. Low- and moderate-income households rely on older class B and C properties to accommodate their housing needs.
Foreign immigrants in particular represent a sizable segment of the low- and moderate-income households. According to the U.S. Immigration and Naturalization Service, the annual average number of foreign immigrants entering the U.S. legally has averaged 800,000 since 1990, up from 700,000 in the 1980s and 410,000 in the 1970s, placing a high level of new-renter demand on low- and moderate-income housing. The long-term outlook for immigration patterns is difficult to predict due to several measures designed to curtail the inflow of foreign immigration into the United States.
However, demand for affordable housing is likely to remain high, keeping the issue of government involvement in specialized financing for affordable apartment projects on the front burner. Easing the restrictions on pension fund investments in apartments, mortgage insurance programs provided by the Federal Housing Administration (FHA), the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac) are aiming to create new financing alternatives for this sector.
Young renters (18 to 34 year olds) and older renters (65 years and older) will have an influential role in the future apartment supply-and-demand balance. The population of younger renters has fallen from 67.3 million in 1980 to about 65 million today. By 2001, the number of U.S. residents in this category is expected to fall to 64.1 million. Over this 20-year span, this segment will have fallen from 30 percent of the population to 23 percent. The drop in this segment is more than offset by the rise in older and lifestyle renters (who have an annual income of more than $50,000) on a national scale.
For the younger renter, the key benefit of apartment living is affordability. In many markets such as San Francisco, San Jose, California, and Chicago, where apartment rents are among the highest, low affordability has become a serious issue even for apartment renters. Apartment rents average $1,200 in San Francisco, $1,140 in San Jose, and $850 in Chicago.
The number of affluent individuals and families that choose apartment community living over single-family home ownership also is growing. Frequently referred to as lifestyle renters, these individuals and families make up another growing segment of the rental market. According to the Census Bureau, 13 percent of apartment renters have household incomes exceeding $50,000 and fall into the lifestyle-renter category, a segment expected to continue growing at a modest but steady rate over the next two decades.
New apartment design and construction has changed in response to the fastest-growing segments of renters-seniors and lifestyle renters. Characteristics such as higher ceilings, garages, upscale appliances, advanced alarm systems, expanded club houses, business centers, and multiple phone lines for in-home offices are becoming common in new construction projects. More new communities also are offering extended landscaping and gardens, elaborate exercise facilities with more variety, after-school programs for children, and organized social activities.
Proximity to shopping, public transportation, and job centers also has become a vital factor in securing new development sites. Higher-end properties and facilities naturally have created pressure on retaining higher-end property management, maintenance, and tenant services.
As a result, larger units are built to accommodate expanded features and needs. The average size of new units constructed in 1996 was 1,075 square feet, compared with 880 square feet in 1985. Approximately 55 percent of all units built in 1996 had at least two bedrooms, and 13 percent had at least three bedrooms. Correspondingly, 38 percent of all units command rents of at least $750 per month. Average monthly rents for 19 percent of all new units built range from $650 to $749. The high-end luxury apartment properties have the highest short-term risk since only a small portion of the U.S. population can afford the higher rents.
The widely publicized aging of the U.S. population is a significant trend for multifamily housing rental demand. In 1970, 20 million U.S. residents were over the age of 65-9 percent of the total population base. By 2001, an estimated 45.5 million residents will be in this category, comprising 16.4 percent of the U.S. population. According to the U.S. Census, the shift toward an aging population will accelerate rapidly after 2010, and by 2050, 21 percent of the U.S. population-or 80 million residents-will be 65 or older.
The spectrum of senior resident multifamily living ranges from complete independent living in an apartment community to full-service facilities that offer health-care assistance to seniors. The first group, frequently referred to as "empty nesters," are lifestyle renters by choice that seek the ease of apartment living, look to eliminate home maintenance issues, and take advantage of community-style amenities and general living conveniences that apartment communities offer. The other incentive for this rental category is the freedom to use home equity created over the years for other purposes.
Seniors that require living assistance and health care also are a strong consumer group. According to a recent survey by the American Association of Retired Persons, 69 percent of seniors who need care prefer living in a facility compared to living with family or friends. Developers are responding to this fast-growing segment of renters by accommodating various in-unit and community needs. Assisted-living developments offer services including meals, personal care, housekeeping, transportation, shopping, and household chores. These facilities have an average of 77 units, most of which have one or two bedrooms, a dining room, and a full kitchen. Most of these properties also offer common areas for social gatherings and activities. Developers are shifting more toward assisted-living construction to retain tenants previously occupying independent units. At the other end of the spectrum are licensed nursing facilities, which offer round-the-clock medical and personal care for residents with chronic medical conditions.
Apartment Investment Trends
Investor appetite for apartment properties has remained strong throughout the 1990s. As the market supply has tightened and demand has increased, improving cash flows and prospects for growing operating income have captured investors' attention. In the early '90s, when most property types were suffering from the economic downturn and over-building, apartment properties were posting a strong comeback and therefore became the most sought-after property type among investors.
Public market financing and equity funding for apartments have been increasing in the past several years. In addition to lowering the cost of capital, public market development funding has helped keep new construction in check by requiring significant equity investments on behalf of developers. Many apartment real estate investment trusts (REITs) were active in 1993 and 1994, positioning themselves to take advantage of a strong market. In these two years alone, apartment REIT initial public offerings totaled $2.9 billion. In 1995 and 1996, there was very little IPO activity; however, secondary offerings totaled $3.8 billion.
Although apartments have passed the peak of value appreciation on an aggregate basis, low vacancies and strong cash flows will continue to attract institutional and private investors.
Aside from temporary gyrations in the supply-and-demand balance in specific markets, long-term demand for multifamily housing will remain robust for the next two decades. Class B and C properties, many of which offer upgrade potential, will become increasingly important to investors.