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Looking Back - The Perfect Storm Creates Strong 2014 Multi-Housing Market

Tuesday, January 13, 2015

The national apartment market was surprisingly strong in 2014, as a perfect storm of job growth, increased demand, a bevy of new supply and falling home-ownership rates combined to lift effective rent growth to 4.5 percent for the year and occupancy near 95 percent.

So strong was 2014 that Axiometrics, deemed it “The Year of the Apartment Market.” Quarterly effective rent growth increased each quarter from its corresponding 2013 period, and annual effective rent growth increased 173 basis points (bps) in 2014 from the year-end 2013 rate of 2.8 percent.

It was the second quarter, historically the strongest quarter of the year, that demonstrated how special 2014 was. After a first quarter hindered by cold, snowy weather and attendant construction and relocation delays, the second quarter of 2014 was the national apartment market’s strongest since the third quarter of 2000, according to Axiometrics.

Quarter-over-quarter effective rent growth was 2.7 percent, and occupancy hit 95 percent for the first time since early 2001. The March-May period was one of the strongest three-month periods in 20 years of Axiometrics reporting. Occupancy stayed above 95 percent in the third quarter, but decreased slightly to 94.8 percent at year-end.

Market Absorbing New Product

Capitalization Rate Forecast

One of the big questions going into 2014 was whether the market would absorb the 300,000-plus new apartment units that would come to market during the year. The occupancy and rent-growth numbers answer that question: They were absorbed, and then some. Axiometrics’ supply/demand model shows total absorption outpaced new supply by 50,000 units in 2014. The forecast, though, is that the demand will be met by the second quarter of 2015, when new supply will outpace absorption.

Absorption was also helped by the growing desire to delay home ownership and rent by choice. The home-ownership rate of 64.3 percent in the third quarter of 2014 was the lowest since 1995, according to the U.S. Census Bureau. Though many mortgage lenders are beginning to loosen up their credit standards, home prices continue to rise out of the range of many first-time buyers.

More apartment units were scheduled to be delivered in 2014, but completion of many projects was pushed back to 2015 because of construction delays, resulting primarily from a shortage of construction workers and increasing cost of some materials.

The concern of oversupply was unfounded because, in reality, development was catching up to demand. New apartment construction was almost non-existent in the first stages of recovery from the Great Recession, which did cause a surge in effective rent growth nationwide and in several major metros in late 2010 and early 2011. As strong as 2014 was, some markets have yet to overcome those peaks of four years ago, though they’re getting close.

Employment Outlook Better

But now that the economy has added jobs – U.S. job growth will likely be around 2 percent when the final 2014 numbers are released – millennials that make up the foundation of apartment renters were able to move out of their parents’ homes or separate roommates, dividing one renter household into two.

The unemployment rate has dipped below 6 percent, and employers added about 2.8 million jobs nationwide, though many of those were part-time. Strong sectors nationally included professional and business services; trade; transportation and utilities; health care; hospitality and manufacturing.

Though there is a shortage of construction workers, plenty of construction jobs were added. The problem is that many workers qualified for construction work are taking higher-paying, more permanent jobs in other manual-labor fields.

The technology boom is continuing, with information and technology providing the job-growth engine in strong apartment markets such as San Jose, Austin, Charlotte and Raleigh. Manufacturing is fueling the boom in Denver, while construction is a major driver in Dallas and Houston.

Job growth is expected to continue as the economy grows in 2015, but the recent drop in oil prices could have a significant effect on the job market in several metros should West Texas Intermediate Crude remain below $60 per barrel.

Though economies in Houston and other large oil-industry-heavy metros are more diversified than they were during the oil bust of the 1980s, oil and gas still plays a large role in many employment sectors in those areas. Smaller markets near the nation’s major shales – such as Odessa, Texas; Williston, North Dakota; and East Stroudsburg, Pennsylvania – could suffer major setbacks.

West, South Dominate

Though many metropolitan areas in the Northeast and Midwest emerged during 2014, there can be no doubt that the South and West provided the electricity behind the national apartment market’s powerful year. A look at the top 25 major metro areas in terms of annual effective rent growth tells the story:

Annual 2014 Effective Rent GrowthAll but one of those metros – Hartford – lie outside an L-shaped area west of the Rocky Mountains and south of Interstate 40. Four of the top five metros are in Northern California, and five of the top 25 are in Florida.

The Oakland Metropolitan Division might be the story of the year. With 12.6 percent effective rent growth in 2014, the East Bay area leads all major markets … and has for most of the year. Even though Oakland has lower job growth than Bay Area neighbors San Francisco and San Jose, the average rent is $450-$900 lower. That’s worth the hour commute. Oakland landlords are also able to push rents higher because new supply is not as prevalent in the San Francisco and San Jose markets.

Though Texas, Denver and Bay Area metros have been among the strongest markets since the start of the recovery, late-blooming markets such as Atlanta, Las Vegas, Sacramento and San Diego have come out of the darkness to achieve annual rent growth above 5 percent.

Northeastern metros such as Hartford, New York and Philadelphia also are gaining strength, while Boston is moving forward in bits and pieces. Washington, D.C. emerged from negative territory, and effective rent growth is expected to maintain positive ground. Apartment markets in the Rust Belt remain steady but far below the national average, though Chicago is showing real signs of life.

The Investment Picture

While Fannie Mae and Freddie Mac still have a good share of the apartment lending market at about 30 percent, other lenders have been gaining influence as construction has increased and the outlook for apartment fundamentals becomes increasingly positive.

Standard banks loosened restrictions on credit and now control 56 percent of the lending market. CMBS and life insurance companies are gaining share, as well. Foreign investors, particularly from China and Russia, have also expressed serious interest in U.S. properties.

Some 6,784 apartment properties were sold from the third quarter of 2013 to the third quarter of 2014 for a total value of $102.3 billion, according to Real Capital Analytics. Investors also are looking at properties other than the high-end, Class A variety. Some Class A owners are not ready to give up their rental income. In response, investors could gravitate to high-quality Class B properties, which are less expensive, more available and could offer better return on investment, especially if those investors put some capital into upgrades.

Investors could consider Class C assets, especially those in good shape and located near employment centers. Though Class C can be a somewhat riskier product type, investors might be willing to assume some extra risk in their search for higher yield.

Lending should remain steady in 2015, a survey from Chandan Economics and the Real Estate Lenders Association found that lenders aren’t necessarily anticipating a lot of growth in apartment lending volume, mainly because they want to diversify into other types of commercial real estate. Even with this, capital is available, rent growth and occupancy are still strong and for many investors, apartment investments are making sense.

In Conclusion

The apartment market had an unexpected strong year in 2014, and Axiometrics forecasts continued strength in 2015, though rent growth should moderate somewhat while remaining robust. As job growth continues and new construction tapers off near the end of the year, developers, owners and investors will find apartments still among the top-performing commercial real estate sectors.

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