Apartments Lead the Commercial Real Estate Pack in Recovery

Dees Stribling, Contributing Editor

New York–Apartment properties have been the first kind of commercial real estate to show signs of genuine recovery this year, and the outlook is even better, according to the latest Apartment Outlook report released this week by property investment specialist Marcus & Millichap. The future looks good for apartments mainly because demographic trends (and some economic trends) are pointing toward increased demand for rental housing.

“Improvements were broad-based,” the report asserts, referring to how apartment performance “turned the corner” during the second quarter of 2010. “Seventy percent of all major U.S. apartment markets recorded occupancy gains. As 2010 progresses, more pent-up demand for apartments will be released, particularly among the estimated 2.2 million young adults who have moved back with their parents since 2005.”

If in fact the economy continues to recover in 2011, demographic shifts will support a longer-term surge in renter demand that will eventually drive rent growth, Marcus & Millichap also predicts. Because apartment development has slowed drastically in many markets, by 2012 or 2013, there might be a shortage of apartments nationwide, thus driving rents to above historic averages.

During 2Q10, the average U.S. vacancy rate for apartments was 7.8 percent, down 20 basis points from the previous quarter, notes the report. About 46,000 units were absorbed, which represented the strongest demand for apartments in nearly 10 years. Demand has been pent up for some time as the severity of the recession forced young adults to delay household formation and displaced homeowners were obliged to double up with other family members rather than move to apartments. Even the modest recovery of 2010 has helped change that dynamic, and now more people want to move into their own place—which usually means apartments.

In a trend that bodes well for longer-term apartment demand, the report says, “tight lending and high down payment requirements preclude many renters from purchasing homes; as of mid-2010, just 8 percent of residential mortgages originated allowed for down payments of less than 10 percent, compared to 29 percent in 2007.” There’s no indication that lenders will suddenly (or even gradually) loosen up their new-normal lending standards, and that will effectively keep a cap on the U.S. homeownership rate to the benefit of apartments.

At the same time, developers delivered 29,200 apartment units nationwide in the second quarter, up slightly from the previous quarter but down 18 percent from the same period in 2009. Few banks want to lend on apartment development these days. Many of the projects completed through the first half of this year were started ahead of the downturn in renter demand, with a more dramatic slowdown in deliveries anticipated later. Fewer than 30,000 units will come online during the second half of 2010, the report notes.