Oversupply of Rentals Weighs on Multifamily Housing Activity
Feeling the fallout from the ongoing correction to the 2003 to 2005 housing boom, the near-term outlook for multifamily activity is “rather weak,” according to a new forecast report from NAHB economists.
While condominiums — which rose to an abnormally high share of the multifamily market at the height of the boom — are being hit the hardest, market-rate rentals also face tougher going as the supply of available units is bloated by for-sale properties that, at least until conditions improve, are being put up for rent.
“After a decade of unusual stability in the production of multifamily housing, multifamily housing starts are poised to fall sharply in 2007,” according to the NAHB report. “Over the last decade, multifamily housing starts have not fallen below 329,000 starts. This year and next year, multifamily starts are likely to be close to 1995’s level of 277,000 starts.”
On a seasonally adjusted annual basis, multifamily production averaged 292,000 units during the first half of 2007, and it is expected to slow somewhat further during the balance of the year. An uptick in rental starts later this year or early next year won’t be enough to offset a decline in starts of multifamily units for sale.
A Condo Glut
With the homeownership rate slipping from its 69.2% peak in the second and fourth quarters of 2004 to 68.4% in this year’s second quarter as the result of the overall housing downturn and problems in the subprime mortgage market, the number of prospective renters is now on the rise. However, the supply of rentals has been increasing at an even faster pace and vacancy rates have been rising because of a recent movement back to building market-rate rental units, conversions back from condos to rental apartments and an increase in single-family rentals, the economists report.
From an abnormally high 45% share of multifamily starts in 2006, condominiums are now headed back to their traditional range of 20% to 25% and were already down to a 39% share during the first quarter of this year.
Even though it has been clear for some time that home buyer demand has weakened, the economists add, multifamily condo projects require a relatively long lead time. And even as condo production has declined, condo starts still exceed completions, “suggesting that a large number of units will be coming on the for-sale market during the coming year — adding to the supply glut and encouraging more conversions to the rental market.”
High Rental Vacancy Rates
The rental vacancy rate among structures with five or more units has been high in recent years, reaching 12% in 2004 but dropping to 9.5% during the fourth quarter of 2005. “However, more recently it has moved back up, partly due to increased supply from conversions of condos to rental units. In addition, some would-be sellers have decided to rent their units while they wait for a bounce back in the market to produce a price they are willing to accept,” the study says.
As of the second quarter of this year, the five or more rental vacancy rate stood at 10.1%.
The unprecedented overall rental vacancy rates in recent years partly reflect increases in the number of vacant single-family homes for rent. Single-family rentals account for more than 30% of all rental housing, and in the fourth quarter of 2005, the vacancy rate for these properties actually exceeded the multifamily rental vacancy rate for the first time ever.
“The current high vacancy rate for single-family rentals is most likely due to excess supply from individuals who originally purchased a house with hopes of quickly selling it for a profit and now find they must either sell at a loss or rent the property until the housing market rebounds,” according to the report.
“Many of these novice landlords may be exacerbating the excess supply problem by asking for too high a rent. Rather than ask a reasonable market rate, this group often asks for a rental rate that covers mortgage payment, insurance and taxes, an amount which may be above the market clearing rent. Presumably, the discipline of the market will eventually sort this out."
Recasting Condos as Rentals
Despite high vacancy rates, rents have been rising: “In 2006, rents rose faster than overall inflation and probably will continue to do so in future years as well.” Along with oversupply problems, this has resulted in some condo projects being recast as apartment projects, but the strategy is not risk-free.
Condo units tend to be larger and more upscale than most apartments and “even if converted into luxury apartments, a limited market, it may be difficult to extract sufficient rents to pay for the cost of the project. At best, the project may have to be sold at a discount to attract a buyer, leaving the project’s backers with below-normal returns or even losses.”