The Outlook for Apartment Development

Posted by Title Source

For 2017, the outlook for apartment development appears favorable, but far from certain. Vacancies remain low, demand remains high, construction is picking up, and a new Republican administration appears ready to take on so-called “burdensome” regulations in the industry. Yet, challenges remain. Long-persistent constraints on developers are still in play, but is that enough to lessen growth? Here’s a deeper dive into the state of apartment development and surrounding issues at present.

title-source_apartment-complex-1The Role of Housing Policy

With a new administration taking office in January, changes are likely for governmental housing policy. In August, then-candidate Donald J. Trump told a gathering of the National Association of Home Builders (NAHB) that one of the biggest issues facing the industry was overregulation.

More recently, President-elect Trump appointed Dr. Ben Carson as Secretary of the Department of Housing and Urban Development (HUD). In a July 2015 op-ed, Carson, then himself running for office, touched on “government-engineered” attempts to regulate housing policy, and the negative, unintended consequences such policies could produce.

Now following the announcement of Carson’s appointment to HUD, housing industry leaders have signaled their support. In a joint statement, the National Multifamily Housing Council (NMHC) and the National Apartment Association (NAA) congratulated the new administration’s pick of Carson as HUD Secretary, saying they looked forward to working with the new administration on housing. “We are optimistic that with the new administration and Dr. Carson, we can develop a balanced housing policy that recognizes the importance of a strong housing market for both rental and homeownership,” the industry groups affirmed.

While opinions diverged on the future of HUD under Carson, Republican lawmakers appeared focused on regulation reforms. “I look forward to supporting Dr. Carson’s nomination and working together to roll back government regulations impeding economic growth,” said Sen. Chuck Grassley, R-Iowa, in a statement after meeting with Carson. “HUD needs to get the biggest bang for the buck.”

Construction Costs, Capital Costs, Rent Affordability

No matter what early policy shift lays in store, supply-side constraints, namely the cost of construction, the cost of capital, and issues surrounding rent affordability, are likely to persist.

Costs of construction for one firm have reportedly increased 65 percent since 2010. Once again, several factors play a role here. First, an ongoing skilled-labor shortage across numerous disciplines means that such jobs come with an added premium. In fact, a new Associated General Contractors of America survey found 73 percent of construction firms hope to hire in 2017 — and 73 percent of construction firms say they’re having difficulty finding qualified workers. Putting aside a lack of skilled workers for new positions, existing wages are also increasing. A recent JLL report forecasts a three percent wage increase by March 2017. Changes to the building code also factor into higher construction costs.

Capital to build apartments is also getting more expensive. Lending is said to have tightened as credit risk retention rules make construction lending a less desirable product for banks. Multi-Housing News reports that many banks were only willing to loan about half the cost of construction. In November, loan-to-cost ratios even fell as low as 45 percent.

Rent affordability is yet another supply-side constraint on the development of new apartments. The lack of available market-rate apartments in growing centers of commerce leads most directly to a lack of low- and moderate-income apartments in those areas. As developers look to build new projects, regulations, incentives, and local politics become yet another constraint. Increasing the share of affordable units can make things go smoother, but in some cases, stringent local requirements affect the feasibility of projects.

title-source_construction-truckVacancies, Demand, and Construction Trends

Nevertheless, 2016 has been a good year for apartment development, and most experts agree development is likely to remain “robust” and 2017 will be a “strong year.”

Overall apartment vacancies nationally were still quite low in the third quarter, at 4.4 percent, and on the level with vacancy rates a year prior. That’s despite a report last month that the absorption rate, apartments rented out within three months of completion, fell in the second quarter to 58 percent. A year prior, the absorption rate stood at 66 percent, and that was for a larger pool of new apartment completions. However, Scotsman Guide points out that new luxury apartments coming on board in major markets like Manhattan distort the overall picture of a still historically low vacancy rate.

Research from RentCafe in August revealed strong demand in nearly all major markets across the country. Over 1,400 large-scale apartment development projects were said to be underway at the time, and the industry was on target to deliver approximately 320,000 new units in 2016 — a more than 50-percent increase over 2015 apartment completions.

The U.S. economic engines of Houston, Dallas, New York, Los Angeles, and Washington, D.C., were expected to deliver the most units. Houston topped the list, with a forecast of nearly 26,000 new apartment homes spread across 95 developments. New York and Los Angeles were close behind, with expectations of 20,000 new units each in 2016.

All those completions did have some effect, slowing rent growth from 6.3 percent in 2014 to an estimated growth of 4.4 percent by the end of 2016. However, the national average rent is still near an all-time high at $1,213 as of June 2016.

Owing to the potential for federal policy changes, strong demand, rising rents, and confidence from both industry experts and private business, construction starts are forecast to grow by five percent in 2017 to $713 billion, according to Dodge Data & Analytics. However, multifamily is forecast to remain flat in dollars and dip two percent in terms of units after the high completion rate of 2016.

This isn’t so much a bad thing as it is a return to normal levels, according to Nick Fitzpatrick, an analyst with Axiometrics. According to Fitzpatrick, rent growth has been “exceptional” the last few years and vacancies have been at historic lows. “We think that 2017 will be a bit of a down year and then into 2018 and 2019 we expect rent growth to come back,” Fitzpatrick told Scotsman Guide. “We do expect healthy growth in the apartment market, partly because we do expect to see supply ramp down a little bit.”

Considering all the factors, 2017 looks like it will be a good year for apartment development, even if it does fall short by some measures. Longer term, rental growth, housing demand, and potentially a more favorable regulatory environment could make for even better years in 2018 and 2019.