Best Bet for Building: Small Units in an Urban Location

If the numbers don’t lie, then what to build now should become obvious to developers very soon. There appears to be a serious rental shortage in the making, to the tune of half-a-million units, according to several architects who specialize in the rental market. The greatest demand will come from Baby Boomers and their progeny—the emerging Renter Nation.

Ironically, both groups also want the same thing in a rental community: cool, contemporary urban apartments that are smart-sized and affordable.

“The statistics are staggering,” says Mark Humphreys, chief executive officer of Humphreys & Partners Architects L.P. “To say I am excited by these trends would be a huge understatement.”

As one of the largest apartment architects in the nation, Humphreys studies national and local demographics as closely as the savviest of developers. He predicts a ‘perfect storm’ that will arrive over the next couple of years and positively affect the rental industry through 2020.

First up are the Echo Boomers, who represent a potentially huge market for the apartment sector. According to the U.S. Department of Labor, almost 3 million Echo Boomers graduated from high school in 2009. This is the largest high school graduating class in U.S. history. Of these, a whopping 70 percent were enrolled in college last year.

In terms of available units, the rental market is ill-equipped to handle the potential demand as the Echo Boomers enter the market. Statistics show that fewer than 45,000 market-rate rental units have been built in each of the last two years. Normal demand is about 300,000 units per year, and the U.S. retires about 100,000 rental units a year due to obsolescence or conversion.

On top of that, homeownership has dropped to a low of 60-63 percent, with a loss of nearly 7 million homes. Baby Boomers are looking to downsize, and a rental community may be their best option.

“As jobs start to come back, the economics say that the rental market will not only improve, it will explode,” says Manny Gonzalez, AIA, LEED AP and the senior partner with KTGY Group Inc., Architecture and Planning.

“As the huge number of people in their early 20s enter the prime rental age, the Baby Boom Echo will become the Renter Nation. And that bodes well for the rental industry.”

What to build—and where

The old adage, “location, location, location,” holds true for both the Baby and Echo Boomers. But instead of the right suburb and school district, these renters want to be in the center of the action.

“This means entertainment, dining, easy transit and an active lifestyle,” says Gonzalez. “The important amenities aren’t what are inside the communities; it’s what’s outside the communities.”

Gonzalez is confident that to be a part of this new urban fabric, Boomers and Echos are willing to accept smaller-sized units with a reduced amenity package, because the amenity is the location.

“Both of these groups want cool, contemporary design,” adds Gonzalez. “The Echo Boomers don’t want to live in something old and dated; they want it to be fresh and vibrant. And the Boomers feel the same way. They don’t want to live in the senior community they helped move their grandmother into years ago.”

Already, Humphreys sees a “big increase” in occupancy and rental growth in Florida, California, Texas, D.C., the Carolinas, Minnesota and several other smaller states. “Everyone’s market study is coming out better than their pro forma, and that never happens to developers,” says Humphreys. “Amazingly, this is happening even before we see job growth.”

As the economy climbs out of a protracted recession, jobs will have a huge impact on the rental market, observes Gonzalez. “New product should be cost-effective and offer attractive rents, but as the job market recovers, there will be some pressure on rental rates.”

In the meantime, U.S. occupancy has improved by about 2 percent since bottoming out in 2009, according to Greg Willett, vice president of sales, research & analysis at MPF Research. The nation’s annual change in effective rents also turned positive (1.2 percent) in the third quarter of 2010.

However, in markets like Las Vegas, where the positive demographics have moved south and west, the economy must improve and the population shift must slow down before rentals pick up. As of mid-2010, Las Vegas led the nation with a -6.9 percent annual rent change, according to MPF.

“The [national] trends are temporarily suspended here,” says David Baird, national director multifamily at Sperry Van Ness in Las Vegas. “For the present, households in select markets have combined or downsized due to job loss or pay cuts. However, as the ‘shadow’ inventory of homes is absorbed, the percentage of home-owning public will shrink with a move to rental.”

As if to prove his point, REITs are picking up on these trends and are bullish on development. Baird, who is also southwest region leader for Sperry’s Asset Recovery Team, notes that AvalonBay Communities has made a move into Las Vegas—a city that had been abandoned by REITs over the last 10 years.

Smaller and sexier

In California, Wade Killefer, founding partner of Santa Monica-based Killefer Flammang Architects, confirms the trend toward smaller, more cost-effective apartments of 400-500 square feet. “The market around here has really taken to the idea,” he says. “And developers are still getting premium rents on a per-square-foot basis.”

Killefer, who is an expert in adaptive reuse, is working with one developer to convert a “big box” appliance store into mini-loft apartments.  “My first apartment was 200 square feet; people haven’t gotten that much bigger,” Killefer quips. “Where we were getting 50 units on a piece of property, we are now getting 100. The numbers just work so much better.”

Indeed, developers are taking advantage of new building code changes and the shift toward a 50/50 ratio of one- and two-bedroom units (as opposed to the old 30/60/10 of one/two/three bedroom mix). This has allowed architects to create urban-feel, three-story walk-ups that replace the breezeway program that has been the staple of rental units for decades.

Like Killefer, Gonzalez has replaced the typical 25 dwelling units/per acre (DU/AC) designs with much more efficient 40 DU/AC layouts.

“We are finding ways to make smaller units ‘live large’ by creating open plans,” says Gonzalez. “But people still have lots of stuff! You need to be creative in the ways you handle that stuff.”

Killefer finds that there is ample storage space in the garage, and he uses high ceilings so renters can stack their things vertically.

The solution for Humphrey’s firm has been its e-Urban and e-Max designs, both of which are HUD 221(d)4 financing approved. The company’s e-Urban design debuted in 2007 in response to higher construction costs. These units were more efficient and affordable to build and sold well, with approximately 100 projects breaking ground in the last four years.

Humphrey’s e-Max design was introduced in 2009 and is a direct response to the Echo Boomer trend. “I have three Echo Boomers at home or in college. We Boomers have to realize there is a paradigm shift taking place, and some of our children’s needs and wants are different from ours.”

The e-Max pushes rental unit building efficiency to 87 percent, with floor plans as compact as 360 square feet. “We also have move-up units (640-750 square feet) already on the ground and leased,” says Humphreys.

The e-Max puts Echo Boomers downtown at a price point they can afford. At about $2 per square foot for the renter—with 62-70 surface parked units per acre—the developer enjoys a greater number of rentals, which makes the product even more affordable.

This level of efficiency is possible by cutting hallway space up to 50 percent and limiting circulation areas, which drastically cuts operating costs.

Killefer Flammang recently put two projects into entitlement that include 115 rental apartments to replace 40 failed condos. Despite the downsizing, a swimming pool and café still remain part of the deal for residents.

These projects can also be considered “green” thanks to their efficiencies. Humphrey’s firm is also including 220-volt charging stations for electric cars in some locations. Power and/or conduit are run to parking spaces closest to the building. This gives electric car owners a preferred parking space, while the owner gets revenue from the charging stations.

Killefer is also seeing some interest in prefab apartments. However, he acknowledges that much of the industry is still too conservative to fully embrace prefab construction.

Gonzalez suggests that developers keep a sharp eye on demographics, as current designs won’t become stabilized communities for two or three years. “There are still large numbers of Echo Boomers entering colleges, so the rental market should be strong for several years. If the job market heats up, some may become first-time homebuyers. But aging Boomers will still be looking for contemporary urban apartments.”