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Jan. 14, 2011

SPECIAL REPORT: Apartment Construction Is Inadequate to Meet Growing Demand

By Keat Foong, Executive Editor

Orlando, Fla.–The supply of apartments is falling seriously short of what is required to meet the increasing demand generated by renters in a slowly recovering economy, according to the National Association of Home Builders (NAHB).

“My message to you today is very simple,” said Sharon Dworkin Bell, senior vice president of multifamily at NAHB, at a press conference at NAHB’s International Builders Show (IBS) this week in Orlando, Fla. “Although the economy is recovering, it is recovering very slowly. We are seeing a great deal of demand, but because of the serious lack of debt and equity capital, although we are building more, it is not enough. And because we are not creating enough supply,” there will be a shortage of multifamily rental housing. As a result, apartments will become even more expensive.

Speakers at a press conference and at educational sessions say that although there may be some evidence construction financing is thawing to a limited extent, with the exception of FHA-insured financing the flow of money is still for the most part being limited to the top sponsors–stronger and larger developers–and trophy properties in primary markets.

Although there are “billions and billions of dollars chasing cash-flowing deals” on the acquisitions side, the traditional construction lenders, the national banks, have not resumed their normal levels of lending, and only the local and regional banks are providing capital, notes Jay Jacobson, national partner for acquisition and investment for Wood Partners.

NAHB Chief Economist David Crowe projects that 2011 will be a better year for multifamily construction. NAHB is forecasting construction of 133,000 multifamily units in 2011, representing a 16 percent increase over 2010. (About 45,000-50,000 units of the 2011 starts are composed of affordable housing, and 20,000 units of  condominiums.) Multifamily construction is expected to register at 114,000 units in 2010, on par with 2009 levels. Crowe attributes the low levels of multifamily construction in part to difficulty obtaining financing especially for smaller developers.

Although multifamily starts are forecasted to be higher in 2011, they are nevertheless much lower than the 250,000 to 300,000 additional units per year that would be required to meet demand: About 100,000 units of new multifamily housing per year are needed just to keep up with the loss of housing through obsolescence and disasters. In addition, the industry has yet to compensate for the past two years’ extremely low volume of multifamily development. “On a net basis, there is virtually no new supply of units,” observes Bill McLaughlin, executive vice president of the REIT Avalon Bay Company.

Apartment markets began to see strong improvements starting at the beginning of 2010, as a result of increasing demand meeting limited supply. Jacobson reports that, without exception, fundamentals are strong across Wood Partners’ portfolio nationwide. He says Wood Partners’ average apartment occupancy is currently 96.5 percent. New developments are leasing well ahead of pro forma, and rents are increasing at an average 4 percent, with some markets trending to 7 to 8 percent. Even the company’s Miami portfolio is showing revenue growth of 6 percent and very high occupancy levels. “I have been in the business 25 years, and I have never seen such pent-up demand and stability in the apartment markets,” says Jacobson.

In the affordable housing sector, the demand for housing is even stronger. “We cannot find a bad market. Everywhere we build, demand is growing bigger every year,” says tax credit housing developer Robert Greer, president of Michaels Development Company, in an educational session at IBS. Greer says whether a property is in the South, East or West, in every project his company develops, there will be 800 applications for every 100 units of two- to four-bedroom housing available. “The demand is simply growing beyond the ability of affordable housing developers to [meet]. Without more investors to provide equity, it is very difficult for us to satisfy that demand.” To overcome the falloff in equity investors during the recession, Michaels Development created its own Low Income Housing Tax Credit syndication company and directly approaches banks needing CRA credits for investment funds.

There may be even greater demand for apartments coming down the pike, as the Echo Boomers are on the cusp of household formation. Crowe suggests there is a pent-up one to two million unformed households that have delayed formation and that are waiting to be created. Given the population level, household growth should normally be 1 to 1.25 percent a year, but there has been only 0.5 percent growth in households, Crowe calculates. Many of these populations are young adults living with their parents, and they may move out of their parents’ homes once the jobs picture improves.

NAHB projects that job growth may now be finally sustainable and will reach a “decent level” of 200,000 to 250,000 per month by the end of 2012. That is presumably when demand for rentals will become even more intense. However, even if banks return to the market today, developers may not produce apartments in time to meet the demands of the much stronger market. “We would love to build more,” says McGlaughlin. However, in Avalon Bay’s classically supply-constrained coastal markets, it takes more time to get developments off the ground. “Even if we start today, we will not deliver the units in 2012, 2013, when demand heats up.” In effect, a severe apartment shortage in 2012 and 2013, at least in some markets, could be assured.

“There is a huge supply of end users coming” to the market, agrees Jacobson. Jacobson says what scares him the most is that the continuing dearth of jobs may constrain many people’s ability in the future to pay for housing–either rentals or homes.

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