Instant Multifamily Development Boom
November 27th, 2013 by Diane Moore
Concerns about overbuilding in the multifamily sector are not new. But based on the number of new developments springing up from all key markets, it looks like developers aren’t worried. Construction activity is still high compared to 2009 levels, and it appears that there are no signs of slowing down.
But should developers be threatened by a possible market saturation? This article discusses the myth surrounding the multifamily sector and the truth behind it.
Are We in the Apartment Bubble?
Industry experts have conflicting views over the country’s multi-family sector. For some, overbuilding is on its way. For others, they don’t think it will happen anytime soon.
What has led to talks of an apartment overbuilding?
One of the reasons is the influx of cheap money from the federal reserve. An article published at Forbes.com states that the Feds guaranteed a total of $71 billion multifamily loans from 2008 to 2010.
According to the Irving Housing Blog, an over-abundance of capital will flood the apartment or multifamily sector. As a result of this, many deals will be underwritten, and positive assumptions will be held on rental growth and future cap rates.
Because of this capital growth, many developers will rush to develop apartment complexes even in markets that don’t need them. But the bottom line is, deals that are underwritten today may not perform well as expected. Projected growth rates will not be achieved, and resale prices at liquidation will not be obtained.
In 2012, Bloomberg reports that Seattle and other key cities are aggressively constructing new apartment complexes. The key driver behind this is the growth in jobs as fueled by employers such as Amazon, Boeing, and Nordstrom Inc. But some experts worry about a bubble, stating the uncertainty of job growth across the country. Although these are all valid concerns, reputable organizations say there is no threat of apartment overbuilding.
In fact, as early as January this year at the NMHC Apartment Strategies Conference, experts say that the multifamily market is in no danger of another bubble. This is backed by research from Jones Lang LaSalle. The research shows that the market across the United States is robust, and it will continue to be so until 2016.
In another research by the Urban Land Institute, the market is shown to open newer opportunities as a consequence of pent-up demand from the previous years. PwC also says that the multi-family sector is one of the emerging trends to watch out in 2014. Among the key cities, San Francisco topped PwC’s list of markets with high investor confidence.
Dispelling the Myth: Why Should There be No Cause for Alarm?
CEO of Rentlytics Inc. Justin Alanis mentioned an important point about the concerns on multifamily overbuilding – that real estate development is cyclical.
First, it goes through a series of accelerated growth, high vacancies, declining rent, and lower prices. Then, it goes through lower vacancies which leads to rental increase. Right now, Justin says, the economy is improving, and the multifamily sector is gaining momentum.
Here are the top reasons why it’s too soon to worry about an apartment bubble or overbuilding.
1. New multifamily construction is lower than national annual averages
One of the organizations that have given an early warning about multifamily overbuilding is the CoStar Group. CoStar cited that multifamily construction levels are far ahead than other sectors. In fact, new construction of multifamily complexes totaled 1.6% of the total inventory. The group says that this is way higher than the other sectors such as office (0.8%) and retail (0.6%).
However, the National Real Estate Investor says that a decade before the housing crash, there were around 132,000 apartments being finished every year. During that 10-year period, the total apartment inventory every year was 1.4%.
National Real Estate Investors also pointed out that most of the markets with the highest levels of construction are not Tier 1 cities. Unlike big markets such as San Francisco, these smaller cities have all the right reasons for some experts to be worried. First, smaller markets have low barriers to development. In these cities, it can take developers to pursue a project at a shorter time as compared to bigger cities. Secondly, these small cities cannot sustain overbuilding.
According to the Commercial Property Management, markets that are at most risk of over-development include:
2. FHFA’s plans to re-structure financing terms will most likely lead to an under-financed market, not a bubble
Last year, a proposal was announced on the restructuring of debt and loan terms of GSEs (government-sponsored enterprises). In the proposal, GSEs’ role in the multifamily financing will be significantly reduced. The FHFA (Federal Housing Finance Agency) will instead encourage debts and loans from the private sector.
Mark Bergen, a contributor at Forbes, says that a private sector will not necessarily bring about a bubble. However, if the FHFA’s plan will take effect soon, this will limit business activity.
For one, private lenders do not have the same public mission so there is a big tendency that they cannot support affordable development. For instance, GSEs was able to help New York City Housing Development Corporation since 1985 to finance apartment complexes in low-income neighborhoods.
Also, many housing finance agencies are strongly dependent on GSEs. In Washington alone, it can be observed that the GSEs and HFAs have been working together to develop nearly 17,000 affordable units.
3. Strong demand will remain in place
There are at least three reasons to validate this — the impact of the recession, the changing preferences of Generation Y, and the surge in immigrants.
The recession has changed the way the consumers look over the homeownership. During the housing crash, many individuals under 35 were still under their parents’ protective wing, according to the National Real Estate Investor.
When these individuals had the means to finally be independent, some will buy a home of their own. Majority of them, however, will prefer to rent apartments. Those who would rent have mostly learned from their parents’ experience — that owning is risky. Besides, banks have tightened their policies to lend only to the safest borrowers.
Next, members of Generation Y are more inclined to rent because of three reasons. The first one is the trends in urbanization. Instead of owning a house in the suburbs, the younger generation will opt to rent to get close to shops, services, and places of entertainment. Their high college debt is also one factor. Also, they want to get close to their workplaces.
Demands will also come from immigrants and their children. They may find housing too expensive, so renting is a viable option.
According to international director of Jones Lang LaSalle’s Multifamily Capital Markets, Jubeen Vaghefi, there is still a lackluster supply to fill the strong demand for apartments. Vaghefi says that this year, deliveries are 12% below historical levels.
4. Most of the plans to develop 1.4 million apartment units are still just plans
According to the National Multi Housing Council, many developers are still on the initial stages of their development plans. From buying developable land up to getting building permits ,the process can last up to 7 years (or even more) before a project is actually finished.
This is especially true for markets with high barriers to entry. One of these barriers is the tighter terms imposed by lending institutions. These days, lenders are looking for a highly responsible borrower who can financially support a project. Some of the things these lenders look for are an existing well-funded operation and a guarantee of support (from partners).
5. Developable sites are getting tougher to find
There are fears of overbuilding in the Dallas-Forth Worth market. But one good point to remember is that it is getting more and more difficult to find affordable sites in downtown areas. Many of the multifamily renters prefer to live in key cities in the country. If this demand is not met, the result is not overbuilding but an excess in demand.
California Multifamily Development Boom
Just like any market whose multifamily sector shows no signs of slowing down, California is not spared of concerns over apartment overbuilding. Fortunately, the facts contradict the myths.
1. California residents are changing housing demands
It has already been established that the younger generation is looking forward to a life in an urban setting. Surprisingly, even the retiring baby boomers in California would want this, too. In 2009, a survey conducted by Robert Charles Lesser and Co. revealed that 75% of the retiring respondents said that they want to live in a mixed-use community. They don’t want to be in a home for seniors, and they prefer to live in an urban setting.
This only means one thing – that the baby boomer generation and Generation Y’s preference to live in an urbanized neighborhood is augmenting demands for apartments.
If it’s not about their preferences, the choice to rent rather than to buy a home is fueled by a weak job market. To save on costs, renters want to live in areas closer to their workplace, services, and public transportation.
2. California supply lags behind the annual average need
The housing sector in California is essential to its economy. Unfortunately, housing permits for both single- and multifamily reveal that there is a significant decrease in new constructions as compared to pre-recession levels.
Multi-family permits in 2009 through 2012 are growing in number, but they are still not enough to fill the rising demands.
According to the Construction Industry Research Board / California Homebuilding Foundation, multifamily permits in 2009 reached a record low at 11,000. Last year, it was 32,000. In 2004, permits issued for multifamily complexes totaled 62,000. In 2007, it was 56,000. Clearly, these numbers do not reveal a case of apartment overbuilding.
3. Three in four overcrowded households are renters
During the recession, many California residents lost their homes to foreclosure. As a result, these families are forced to find a place to rent. Those who can’t afford multifamily units live with their relatives or share an overcrowded home with friends.
According to the Department of Housing and Community Development, this is not new for the state. In fact, this was experienced in the 1990s when a decline in new construction led to a rise in overcrowding. Census revealed that there were 1.7 million overcrowded households in 2000.
In 2010, the American Community Survey said that in four overcrowded households, three were renters. The good news is that these renters see themselves living on their own as soon as they can get back on their feet. These means that there is a pent-up demand for both the residential and multifamily sector. Even the California Building Industry Association thinks a new renter culture is sweeping California.
According to the New York Times, 260,000 apartment units are scheduled for construction this year. Some experts have already sent early warnings about a possible overbuilding. But despite these concerns, reputable organizations are stating that the multifamily sector is strong. Industry pros say that the multifamily sector has important sources of demands that can support its way to recovery. Most of these sources are from the younger generation.
In California, the demand is fueled mostly by the lackluster supply of affordable multifamily units. Since the recession, most people are still living in overcrowded quarters. Clearly, the multifamily market is not going anytime soon. Trends and analysis reports are optimistic that no matter how slow, the real estate market is on its way to recovery. If there is anything to worry about, it is how the multifamily sector can keep up with growing demands.
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