May 09, 2017

Multifamily: It's All About the Fundamentals

Steve Guggenmos
Steve Guggenmos, VP Multifamily Research and Modeling

Despite recent reports about softness in a few very high-cost markets, multifamily continues to be robust, as indicated by steadily rising rents in most markets.

Our view of the multifamily market still holds as covered in depth in our 2017 Outlook. Rents will continue to increase because they are principally driven by two factors: a change in demographics which favors rental housing and a persistent gap in new housing production since the 2008 housing crisis.

Let’s take them one at a time.

Unprecedented Strong Demand

The nation’s rental housing supply is effectively surrounded by the country’s two largest generational cohorts: an estimated 75.4 million Millennials (born between 1980 and 2000) and 74.9 million Baby Boomers (1946 and 1964).  Both groups are now entering the rental market in increasing numbers as Millennials start new households and Baby Boomers look to downsize from their current homes and perhaps lighten their responsibilities for maintenance and repairs.

New renter households have increased by 9 million in the past 10 years – the largest decade increase on record. Growth in renter-occupied households as of the first quarter of 2017 remains strong, up 365,000 year-over-year.

Household Formations

The Joint Center for Housing Studies conservatively estimates the country will likely add 4.7 million renters between 2015-2025; or roughly 50% of the prior decade’s growth. By comparison, the country had been averaging 3.8 million new renter households every ten years going back to 1978. In addition to simple demographics, there also appears to be a growing preference for rentals among consumers. For example, the number of renters who say they plan to rent their next home rose from 55 percent to 59 percent since September 2016, according to the latest Freddie Mac renter research.

Too Little Supply

Unfortunately, a supply gap that widened after the 2008 housing crisis shows little sign of narrowing. In fact, as the charts below show, the country is experiencing an annual shortfall of approximately 400,000 housing units even when taking single-family starts into account.

Completed Units

This limited new supply has resulted in historically low and flat vacancy rates over the past several years. So even though recent vacancy rates are up slightly from these low levels in many metros, the magnitude is small. As a matter of fact, national vacancy rates didn’t budge in the first quarter of 2017, remaining flat at 4.3 percent, as reported by REIS, Inc. Despite higher levels of new supply entering the market each year, the vacancy rate has remained relatively flat since the end of 2013.

Another concern is the type of multifamily property being built today. Most of it is luxury, Class A property that typically charge higher rents needed to cover costs like land, materials, and construction. Some isolated markets are admittedly becoming oversaturated in Class A supply. But regardless in most markets, the overall supply is simply not expanding fast enough to meet the nation’s growing demand for rental housing.

So, Rents Are Rising

Over the past four years, rents, nationally, rose an average of 4.5 percent annually. So far this year, rents have been rising at a more modest rate of 3 percent annually well above the target inflation rate of 2 percent. In markets and submarkets with the most supply, it will take time to absorb the new units and rents may take some time to adjust. But given the demand in the market and too little supply, forecasters are universally predicting national rents will growth at 2% or more in the 2018-2020 period.

Bottom line: While the strength of local markets will continue to vary, we expect overall multifamily demand to continue growing, as evidenced by rising rents and flat vacancy rates. Consequently, the multifamily market, as a whole, is unlikely to experience a major decline, provided the national economy continues at a similar pace as in the past few years.

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