Developers simply cannot build enough new luxury apartments to meet existing demand, contributing to double-digit rent increases in many U.S. markets.
This despite the fact that developers are on track to complete more luxury apartments in 2022 than they have in decades, but tenants are expected to fill them, even if rents continue to rise. Economists – so far – also don’t worry that developers will eventually build more apartments than current demand requires. Instead, they worry about how long the US economy will continue to run so warmly, creating new households and new housing demand.
“Rent growth will not slow significantly until demand cools and vacancy increases, which will happen if and when affordability becomes a headwind or the labor market stumbles. “said Jay Parsons, vice president and head of economics and industry at RealPage, based in Richardson, Texas. “The worst-case scenario is a slowing labor market that causes wages to stagnate, while other consumer spending continues to rise.”
Not building enough apartments for an overheated economy
Even as developers opened hundreds of thousands of new apartments in 2021, vacancy rates continued to fall and rents continued to inflate.
“The shortage of luxury apartments has become particularly acute over the past year,” says John Sebree, senior vice president and country manager of Marcus & Millichap’s Multi Housing division, working in the company’s offices. in Chicago.
According to Marcus & Millichap, only 3.0% of Class A luxury apartments were vacant at the end of March 2022. This is the lowest luxury vacancy rate since Marcus & Millichap began counting in 2000. It is also 180 basis points lower than the vacancy rate at the end of 2019, before the coronavirus pandemic.
Developers are building apartments as fast as they can – they plan to open 400,000 new apartments in 2022 – a record number, according to Marcus & Millichap.
But the vacancy rate should continue to fall anyway. According to Marcus & Millichap, only 2.4% of apartments overall are likely to be vacant at the end of 2022. That’s the lowest metric in more than two decades.
“We’re not building enough multifamily housing nationally,” according to data firm CoStar, headquartered in Washington, D.C.
Developers continued to build new apartments even during the pandemic, but not enough to keep pace with household formation. The rising cost of land and building materials continues to hold back developers, according to Moody’s.
Additionally, homebuilders have built fewer single-family homes in the past decade than in the past 50 years, according to Ermengarde Jabir, an economist at Moody’s Analytics who specializes in commercial real estate. And a significant minority of single-family homes purchased and built are for the single-family rental market rather than homeowners.
“I don’t see any type of product coming close to being overbuilt,” says Paula Munger, assistant vice president of research and industry analysis at the National Apartment Association.
The demand for apartments has been increasing for a long time, especially for the more expensive luxury apartments. The number of “four- and five-star” units occupied has increased by 2.6 million units or 127% since the start of 2010, according to CoStar, which uses “four-star” and “five-star” to refer to Class A . Properties.
Demand is expected to continue to grow rapidly for all types of housing, including apartments, as long as the United States continues to rapidly create new jobs. So far in 2022, the US economy has added an average of 518,000 per month to the number of people in employment. This came as a surprise given the tight labor market conditions, according to CoStar. The percentage of workers who say they are unemployed and looking for work has remained below 4%.
Many of these newly employed people are likely to use their wages to form new households, moving out of their parents’ basements or leaving roommates behind. And every new household will need a place to live.
“Tenant income continues to rise and leases continue to fill quickly,” Parsons says. “The pool of demand from high-income tenants for new luxury apartments has proven to be far deeper than even the most optimistic developer could have imagined.”
Net apartment demand was 75% higher than its previous peak in the 30 years that RealPage has collected apartment data.
“If someone had modeled and predicted such a number through 2021, they would have been laughed out of the room,” Parsons says. “When you look at this type of demand combined with huge increases in renter household incomes at market rates and a severe housing shortage, the growth in rents is not that surprising.”
The surprises of the future
The biggest potential challenge that could hurt apartment investment would be problems with the broader US economy…such as inflation and the federal response to combat it.
“Inflation has been the biggest surprise for economists over the past 18 months,” says Sebree. Prices were expected to rise as the pandemic came to an end and federal stimulus measures such as low interest rates continued. “The continued severity of price increases has defied most expectations.”
The Federal Reserve now plans to raise its benchmark interest rates seven times in 2022, its most aggressive moves in decades. “These policies have important implications for interest rates and the economy as a whole,” Sebree says.
Other factors could also weaken demand for apartments. “The ongoing conflict in Ukraine, new variants of COVID (whose impacts vary widely from country to country) and persistent inflation are all real threats to the economy,” says NAA’s Munger. “If the Fed manages to get inflation under control without causing a recession, that will be a very pleasant surprise.”