Although the single-family housing recovery has been slow, the multifamily sector continues to be red hot. Single-family construction has yet to pass the halfway mark back to normal but by mid-2014 multifamily building had surpassed the long term trend of 340,000 units a year established in the 1990s and the first half of the 2000s.
Apartments are hot because of two driving trends: demographics and finance.
Demographics drive housing demand; more people mean more households, and that means more homes. Current demographic trends are heavy with the age group most likely to change from dependent living, e.g., living with parents, to independent living, e.g., renting or owning a home. Members of the Millennial Generation (also known as Echo Boomers) are in the prime household formation ages, and there are more of them than the baby boomer generation.
But two things differentiate the echo boomers from the baby boom generation. First, the echo boomers are forming households at about half the expected rate. Second, those who do go out on their own are overwhelmingly choosing renting over buying. As a result, the ranks of renters have swelled by 2.3 million since 2011, or almost 800,000 per year. Rental completions are running at less than half that rate, which has driven down vacancy rates from double digits to less than 8 percent, and real rents are rising about 1 percentage point faster per year than all other prices.
This is also driving multifamily production because mortgage lenders tightened their underwriting standards significantly in the wake of the recession. As a result, large numbers of potential first time home buyers cannot qualify for a mortgage and have turned to renting. Historically, about 40% of existing homes are sold to first time home buyers, mostly between the ages of 25 and 34, and about 30% of new homes are sold to first time buyers. Those percentages are down to 30 and 16%, respectively, meaning a loss of at least 800,000 home sales in 2014.
The tighter underwriting standards affect younger buyers because their credit has not been well established. They are also more likely to have student debt, and they entered the job market either during the recession or the subsequent slow recovery. Young buyers suffer the double whammy of lower starting incomes leading to little or no savings at the same time mortgage qualification standards are ratcheting up.
Congress and regulators have overreacted to the financial collapse by denying credit to potential home buyers with good, but not perfect, credit. Younger adults just starting out are the most affected by the mortgage credit pendulum swinging from too loose to too tight.
An added demographic trend that is difficult to separate from the financial and economic environment is that younger adults prefer urban living. The surge in apartment construction has been particularly strong in large metropolitan areas. As a result, the top 25 metropolitan areas increased their share of US multifamily construction from 42% in 2009 to 60% in 2013; the larger the metro area, the greater the gain.
As the home building industry catches up to the new and higher level of demand, the speed of growth should decrease and multifamily construction should level off at 370,000 to 380,000 per year. That level of activity is sustainable for at least the next two to three years.
Beyond that three-year time horizon, rental demand will cool a bit and sustainable production levels will be in the 350,000 to 360,000 range as Millennials get their financial feet on the ground, more rational underwriting standards return to the system, and the older members of the generation return to more normal levels of marriage and child rearing.
Kevin Kelly is the National Association of Home Builders’ 2014 chairman of the board.