In every economic downturn, there are both losers and winners. The current recession–or, more optimistically, the recently ended one–has been devastating for many of the nation’s homeowners, forced out of their homes by job loss, foreclosure or both.
The beneficiary of this distress has been the multifamily industry as a whole, particularly owners of cautiously leveraged assets in early-recovering markets and savvy developers who lightened up on new construction early in the downturn. As construction financing nearly evaporated in 2008 and 2009, multifamily housing starts plummeted. Now, however, as the economy begins to recover, a tremendous gap between multifamily housing demand and supply has emerged. This shortfall has created a compelling investment opportunity that is likely to persist for the next several years.
Changing demographics, lifestyles and economic trends are colliding to drive demand for rental housing in the United States. A primary legacy of the recession is a pent-up demand for living accommodations. Driven from their homes by foreclosure, many individuals and families have “doubled up” or moved in with relatives. These individuals are eager to live on their own, but are likely precluded from buying new homes due to credit problems and/or tighter lending standards. They will have no choice but to rent.
Population growth also favors the multifamily market. Recent trends suggest annual population growth of about 1.1 percent, or 3.4 million people per year, including 1.1 million legal immigrants. Even though the rate of household formation has fallen significantly over the past two years due to the recession, gross demand for new housing units in the United States is expected to increase by 1.5 million per year for the next several years.
Gross population growth figures do not tell the whole story of the nation’s changing demographics. About half of the population falls into two large age groups: 76 million (in 2010) baby boomers, aged 46 through 64, account for about 25 percent of the U.S. population, while about 77 million Generation Y or Echo Boomers, aged 15-32, account for another 25 percent. Analysis of demand across all age cohorts indicates that 20- to 30-year-olds are more likely to rent, by a considerable margin, than any other age group.
The supply of new multifamily residences is likely to be highly limited for the next several years. From 1959 through 2008, annual multifamily housing starts ranged from a low of approximately 200,000 to a high of approximately 1 million residences, averaging about 350,000 starts per year. In 2009, starts fell precipitously to about 97,000 units and rebounded only slightly in 2010 to approximately 107,000 units.
Lack of financing is a major factor driving this shortfall. Domestic banks, the traditional source of construction finance, are focusing on resolving problem loans and are hesitant to underwrite new construction. Lending for multifamily and commercial real estate peaked in the third quarter of 2008, and has declined by 25 percent since. While the construction loan market is beginning to improve, banks are requiring significantly more equity from developers than they have in the past. This funding gap provides a significant opportunity for joint venture equity providers.
A similar opportunity exists for the renovation and rehabilitation of multifamily communities. While Fannie Mae and Freddie Mac continue to provide attractive permanent debt for property acquisitions, funding the physical improvement of communities remains more complicated. The easiest way for an owner to accomplish a substantial property renovation is to form a joint venture to fund the improvements.
Even when apartment construction returns to pre-recession levels, the total inventory of apartments will fall short of demand. At the average pace of apartment construction over the last decade–about 276,000 units annually–this demand shortage could require over 10 years to satisfy. Thus it is highly unlikely that the multifamily sector will become overbuilt any time soon. Meeting the demands and desires of millions of new apartment dwellers will continue to provide investors with solid returns on an absolute basis and also in comparison with other property types, now and well into the future.