Multifamily, class B in particular, has been one of the best performing asset classes over the past decade. Demand has outpaced supply, leading to sustained rent growth and significant investor interest. As of March 2019, the average apartment vacancy rate was near all-time lows at roughly 6.5%.
While the demand drivers for apartments is somewhat obvious, I want to dig into the statistics/fundamentals in more depth.
It’s important to first understand the size of the market. There are 120M households in the U.S. totaling 317M total people. Of the total households, roughly 43M are renter-occupied (36%) and $77M are owner-occupied (64%).
Of the 43M renter households, about 19M (38.7M people) live in apartment communities of 5-units or greater. Taking it one step further, according to REIS, Class A rental properties represent approximately 45% of the total apartment inventory in the U.S., while Class B/C properties represented 55%. So of the 19M households, roughly 10.5M live in Class B/C apartment communities.
This is the space Atlas plays in, and what I’ll be referencing throughout this post.
Understanding the demand for multifamily all starts with homeownership. The homeownership rate topped out at roughly 70% in 2005, dipped to as low as 63% in
There’s a narrative surrounding homeownership that young people (Millennials) no longer want to own homes and instead prefer to rent. While there may be some truth to that, it’s misleading and largely untrue. Young people in general still want to own their own home, but they’re buying homes later in life and spending more time in the renter pool. The sheer size of the Millennial generation (73 million Americans aged 18 to 34), who are just now beginning to buy homes, led to the decrease and recent uptick in the homeownership rate.
The reduction of the homeownership rate from 70% in 2005 to 65% today added roughly 8.4M households to the renter pool. That massive growth in demand has fueled the high average occupancies and strong rent growth the apartment sector experienced over the course of the recovery. The chart below shows the cumulative increase in renter households since 2006.
Young professionals remaining in the renter pool is primarily driving the demand for Class A luxury communities in urban areas (Class B demand is
Renters of Class B communities are primarily renters by necessity, not renters by choice. They cannot afford to buy homes today. Home prices have increased drastically, banks have maintained stringent lending requirements, and young people are burdened by student loan debt, making it difficult for lower and middle-income residents to qualify for mortgages. Households earning less than $50,000 have a homeownership rate of 45% versus 80% for those making more than $50,000. Families who can afford to buy eventually do, while the rest of the population will remain renters.
Of the 19M households who rent apartments in communities of 5 units or more, over 60% make less than $50k. That means 60% of the total household renter pool (12M) are largely restricted to class B and C communities based on the typical resident qualification standards (3x the monthly rent).
Home prices relative to rents are also increasing, making homeownership less attractive and even more unattainable for lower-income individuals.
Housing costs have skyrocketed and now in more than half the counties, it’s cheaper to rent than buy. 24% of U.S. Households (about 29M) spend more than 50% of their annual income on housing.
For more context, here is the household income distribution for a solid B+ apartment community owned by Atlas with average rents of approximately $1,200 per month.
Millennials still want to own homes. Annual sales to first-time homebuyers is on the rise, increasing steadily since the lows in 2011.
Further supporting that trend, lower-priced homes are appreciating at a faster pace than other segments of the single-family market.
This shift back toward homeownership will be an ongoing headwind for the apartment market, primarily class A apartments. However, Class B is buffered from this trend, as residents are unable to purchase homes today.
Early in the recovery, the strong rent growth was driven by the increase in demand, but also by the lack of new supply. Annual production averaged 331,000 units from 1995 to 2003, increased to just over 400,000 in the previous peak, and came to a halt from 2009 to 2014. Due to the limited new construction, there was significant pent-up demand through the early part of the recovery.
Supply has ballooned recently, up to nearly 600,000 in 2018. However, according to the National Association of Home Builders (NAHB), multifamily development starts are expected to fall from their 2018 levels to roughly 350,000 units in 2019.
The total number of units under construction in large buildings (50 units or greater) is the highest its been since the 1970s.
With construction and labor costs skyrocketing, and land prices near all-time highs, the all-in basis for new projects has increased substantially. Over the last three years alone, construction costs have risen more than 30% in many markets, dramatically above inflation.
To make projects pencil, developers must underwrite aggressive rents aimed at a small segment of the high-end renter market.
Class B supply (characterized by communities built from 1960 – 2000) is shrinking as properties age and become obsolete. Supply of class B communities decreased by 2% from 2005 to 2015.
Understanding Millennials and Baby Boomers
There are 73M Americans aged 18 to 34. Members of the largest generation have delayed marriage and having kids, and stayed in the renter pool longer.
On the fertility side, U.S. births are lower by 500K annually from their pre-recession peak, a figure more amazing given that the number of women aged 25-34 is higher by roughly 2.5M.
With the declining fertility rate, population growth in the U.S. will be fueled by immigration. By 2024, immigration will surpass internal population growth (births) for the first time (more on this below).
There are 23M 18-34-year-olds who live with their parents or relatives and will eventually enter the renter pool. While the older Millennials are increasingly moving into homeownership, the younger Millennials are beginning to move out of their parents’ basement and into rentals.
Over 50% of kids 18-24 live with their parents. This significant pent-up demand will drive Class A multifamily performance over the next several years.
In addition to the Millennials, many Baby Boomers (born between 1946 and 1964) are ditching the suburban home for a low-maintenance apartment in walkable locations.
By 2030, more than 20% of U.S. residents are projected to be age 65 or older, compared with 13% in 2010 (before any of the baby boomers turned 65) and 9.8% in 1970. And in 2050, there will be 84M people age 65 and older, almost double the 43M seniors in 2012.
Today, just 8% of the renter population is 65 years or older. As our country gets older, and Baby Boomers seek to downsize, the demand for quality rentals should remain strong.
These fundamentals are what many developers will point to as they construct new projects today.
With fertility rates turning negative, population growth in the U.S. will be led by immigration. More than 1 million immigrants arrive in the U.S. each year. In 2016, the top country of origin for new immigrants coming into the U.S. was India, with 126,000 people, followed by Mexico (124,000), China (121,000) and Cuba (41,000).
The U.S. foreign-born population reached a record 43.7 million in 2016. Immigrants today account for 13.5% of the U.S. population, nearly triple the share (4.7%) in 1970.
Looking forward, immigrants and their descendants are projected to account for 88% U.S. population growth through 2065, assuming current immigration trends continue. In addition to new arrivals, U.S. births to immigrant parents will be important to future U.S. growth. In 2016, the percentage of women giving birth in the past year was higher among immigrants (7.4%) than among the U.S. born (5.9%). While U.S.-born women gave birth to over 3 million children that year, immigrant women gave birth to more than 750,000.
It’s safe to say that immigration will play a huge role in future apartment demand.
Economy Today / U.S. Migration Trends
Given the strength of the current economy, apartment demand should remain strong over the near-term as it’s fueled by population and job growth.
The unemployment rate was 3.9% at the end of 2018 and estimated job growth for 2019 is 2.6 million jobs. Supported by the low unemployment rate, the U.S. Census Bureau reported 2.3 million new households were formed in 2018.
The trend of migration out of expensive (and often very big) cities is being felt across the U.S. and is especially evident among millennials. A Brookings Institute study tracking millennial migration from 2004 to 2017 showed New York, Los Angeles, Chicago, Boston, Philadelphia, Miami and Washington D.C. as some of the biggest losers and Portland, Phoenix, Las Vegas, Sacramento, Dallas, Austin and Nashville as some of the biggest gainers, reflecting a trend towards smaller, more affordable cities.
According to their data for 2018, Utah ranked #1 in net gains followed by Texas, Florida and South Carolina.
Other Stats Impacting Multifamily Today
According to the Mortgage Bankers Association, unregulated higher leverage, higher-priced private debt funds placed $67 billion in mortgage loans in the U.S. in 2018, up from $52 billion in 2017 and $32 billion in 2016. This trend is a bit concerning, with over-leverage being the most substantial risk in multifamily investing.
Contrast this with the $70 billion loaned by Fannie Mae and Freddie Mac on apartment loans for 2018 (the agencies are capped at the same number for 2019). The numbers on a deal may not work with bank leverage at 60%, but they suddenly make sense with private, high priced money at 80% leverage.
Despite strong growth, overpaying for properties while putting on high leverage can be a recipe for disaster. Apartment pricing is significantly above its previous peak.
At Atlas, we continue to be bullish well-located Class B value-add apartments which we expect to experience sustained demand and outsized rent growth over the long-term.
To summarize the state of the multifamily industry today:
- New construction is near all-time highs but is expected to taper off.
- Then new construction is primarily in the Class A luxury space due to land and construction costs.
- The Class B supply is flat or shrinking.
- Construction costs are up 30% over the past 3 years alone.
- Older Millennials (30-35) who put off marriage and having kids until later in life are buying homes. The desire to own a suburban home hasn’t changed and the homeownership rate is ticking back up.
- Younger Millennials (18-24) living with their parents will eventually move out and enter the renter pool, keeping demand for class A product strong.
- Housing costs have gone up significantly and it’s cheaper to rent than buy in most markets.
- There’s a housing affordability issue, keeping most lower and middle-income earners in the renter pool. This is partly driving the demand for high-quality Class B product.
- Fertility rates are down and population growth in the U.S. is being driven by immigration. Immigrants today account for 13.5% of the U.S. population (44M individuals).
- Immigrants and their descendants are projected to account for 88% U.S. population growth through 2065
- Most new immigrants rent for the first few years but aspire to own single-family homes.
So there you have it. Which key stats or fundamentals impacting the multifamily industry would you add to this list?