Unsold Home Inventory Casts Shadow on Apartments
Looking at the depth of the current housing slump, attendees at NAHB’s Multifamily Pillars of the Industry Conference in Colorado Springs, Colo. on April 1-3 heard that conditions in their sector were holding up relatively well — even as an oversupply of unsold inventory and a weak national economy are having some negative impact on demand.
The multifamily industry has “a lot to struggle through but is doing better than single-family,” said Bernard Markstein, NAHB’s director of forecasting and senior economist. And the downturn, he said, is likely to last until housing prices stabilize and home mortgage lenders return in full force, which is “a problem for everyone.”
While multifamily starts are experiencing some softening, it is not as bad as the sharp decline that occurred in the early 1990s following a period of overbuilding stimulated by tax benefits, he said.
NAHB is currently forecasting 298,000 multifamily starts this year, down from 306,000 in 2007 and 338,000 in 2006 — with apartments for rent edging up as condominiums trail down. Next year’s forecast projects 315,000 units.
Multifamily production “has been worse,” Markstein said. “This has been a pretty good period of stability, but too much high-end and too many condos were built. The problem is in the mix, not overbuilding.”
At the height of the housing boom, condo starts rose to half of multifamily output, compared to a “normal” share of about 25%, he said. The share has now declined to roughly 30%. There is currently a 12-month supply of condos and coops on the market, compared to the five- to six-month average that is considered healthy.
‘Darker Before the Dawn’
Describing 2008 as a period that will be “darker before the dawn” for the multifamily industry, Ron Witten, president of Witten Advisors LLC in Dallas, said that “there are challenges before us, but they are not fatal.”
The fundamentals for multifamily remain good, Witten reported. National occupancy rates averaged 94.4% in last year’s fourth quarter, almost unchanged from a 94.6% rate for the same period of 2006; and rent increases for 2007 averaged about 3% compared to just above 4% in 2006.
The good news for the industry is that the homeownership rate has declined to pre-boom levels as mortgage lending standards have tightened significantly, generating more demand for rentals. However, “not everyone who rents, rents apartments,” he said: 45% are renting apartments but 30% are renting single-family homes.
Consequently, the absorption of rental apartments has been weakening, and that trend is being exacerbated by sluggish job growth “that feels like zero.”
Multifamily developers now find themselves competing with an oversupply of single-family housing that remains near cyclical highs, and “everyone outside of the rental apartment business has built too much housing,” Witten said.
Of finished single-family homes now up for sale, 2.5% are sitting empty, compared to 1% in a healthy market; 10% of single-family rentals are vacant, compared to 5% normally; and 9% of the homes in 5+ condo buildings are empty.
At the end of last year, there were 1.2 million unoccupied homes on the market, led by almost 700,000 single-family homes, and followed by 299,000 single-family rentals, 166,000 rentals in buildings with 2+ homes and 100,000 condos, “not a huge amount compared to single-family.”
The inventories are being adjusted, with for-sale completions running at the annual rate of 1.2 million at the end of last year but skidding to a 700,000 pace in 2009, “adding less to the problem,” he said, and enabling the market to work through the excess inventory more rapidly.
Demand Returning in 2009
For the short haul, Witten voiced pessimism about home prices, which he predicted will tumble 27% from the peak to the trough of the housing cycle. Prices are about halfway there already, he said, and will keep falling in 2008 although at a slower pace by year’s end.
“What house prices are doing correlates to how much you can raise your rents,” he said, and “home buying is quickly becoming more affordable.” Rental increases should now be dipping closer to 2%, he said.
Witten said that multifamily rental starts are down to an annual pace of about 175,000 today, compared to a peak of 275,000 to 280,000 in the late 1990s.
On the plus side for new production, hard construction costs, including land, are now rising at a 3% annual rate, down from 12% to 15% during boom times, Witten said, and he calculated that land values have dropped an average 20% in the last 12 months.
On the negative side, 80% of banks have tightened up on construction lending, compared to about 60% of them during the credit crunch of the early 1990s.
Looking at net completions, Witten said that only 100,000 units are being added a year to a stock of 20 million units. And when demand comes back in mid-2009, it won’t take long to catch up with supply, exceeding it by the end of the year.
For the 12 months ending through the fourth quarter of 2007, rents in 42 markets tracked by Witten Advisors increased most rapidly in: San Jose, Calif., 9.3%; San Francisco, 9.1%; Seattle, 8.7%; Salt Lake City, 8.6%; Portland, Ore., 6.3%; Oakland, Calif., 5.7%; Austin, Texas, 4.8%; Los Angeles, 4.5%; and Raleigh, N.C., 4.1%.
Rent increases were smallest, and actually declined, in: Detroit, down 0.1%; Fort Lauderdale, Fla., 0.5%; Orlando, 1.3%; West Palm Beach, Fla., 1.4%; and Tampa, Fla., 1.8%.
Noting that “the housing oversupply is not evenly spread across the country,” Witten’s research found that in the fourth quarter of 2007 Detroit alone was responsible for 7% of it; followed by Houston and Atlanta, each above 5%; Chicago and Tampa, each a bit above 4%; Riverside and Sacramento, Calif. and Orlando, above 3%; and San Diego and San Antonio, between 2% and 3%.
Florida accounted for 13% of the nation’s excess housing supply; California, 12%; and Texas 10%.
Production Is Down
Participating in a panel discussion of market trends and their strategies for today’s changing environment moderated by Leonard Wood, founder of Wood Partners, executives from the for-rent and for-sale segments of the industry indicated that they were primarily lying low during the current period, easing up on production, getting back to basics and aiming at remaining as profitable as possible.
“I haven’t talked to anyone that hasn’t talked about doing away with a proposed deal in one market or another,” said Steve Patterson, president of ZOM, a merchant builder largely in markets in Washington, D.C., Florida and Texas.
While it remains more affordable to rent than to own, he said, “if prices do fall 30%, then the differential goes away.” Patterson said that he had expected the gap to be closed by rent increases, which haven’t turned out to be substantial enough.
Rent and occupancy rates are down in every major market in Florida, he said, because of the “shadow market” of unsold inventory and, as a result, state residents are “getting more space and amenities at a lower price.” Condo and home owners are on the losing side of that proposition and “may ultimately have to take a 30% hit on price.”
Patterson said that his company has sold aggressively to extricate itself from deals gone sour, “but we didn’t sell deals below replacement costs,” especially on high-rise building with a shelf life of 100 years, a strategy other panelists reported taking as well.
In favorable developments for the market, Patterson said he expected land prices to go down and underlying demographic demand to go up, especially among members of Generation Y, who are in their 20s, pointing to a return to good times by 2010.
Not Much Turnover
Constance Moore, president and CEO of BRE Properties, whose portfolio includes 25,000 units worth $1.6 billion primarily in California, noted that the mortgage credit crunch and unaffordable housing prices are helping her business on the operational side. During the boom, 12% to 17% of her residents were moving out to buy homes, but today that isn’t a factor and there isn’t much turnover.
Moore also observed sharp market differences on the West Coast, with the San Francisco Bay area and Seattle “on fire,” but Phoenix and Orange County and the Inland Empire in California “trailing,” because they are most affected by the single-family glut.
“With costs outstripping rents, we have to be careful about what we start,” she said. Her company is “saying no” to a lot of new deals and she expects hard-hit markets to be “still treading water” next year.
Challenging Capital Markets
Bryce Blair, chairman and CEO of AvalonBay Communities, also blamed the unsold housing inventory for disappointing conditions across the country in general, with some markets doing noticeably better, or worse, than others.
“We’ll start $1 billion this year,” Blair said, “but we could have started $1.5 billion; because of capital availability concerns [we won't]." The capital markets pose the biggest uncertainty for his business this year, he said, with an impact on values and the ability to sell assets.
At a time when “you have to think about when to pull the trigger on construction starts,” Blair said he has purchased five “busted” condo deals in recent months, and with the economy weak and production down, “it’s a good time to look at opportunities.”
Construction borrowing, per se, has not been a problem, Blair reported, but banks have been “rationing” capital in their lines of credit, capital is being cut back and it is becoming more expensive.
W. Dean Henry, president of Legacy Partners, said that he has $800 million in deals under construction for 2008-2009, but “the pipeline looks empty in 2010-2011,” and that is when he anticipates seeing less production. Where production isn’t getting financed, equity sources, in some cases, are the problem. He said that he has had no problem with banks.
Henry said that his company bought five sites on Wilshire Boulevard in Los Angeles five years ago, with an eye on getting back in the condo business, and then decided to sell them at three to five times what they cost, without ever building anything on them.
Business on properties converted to condos has slowed dramatically, he said. Townhouses selling for $500,000 in a golf course community in the Bay Area were bringing out 150 people a week he said. Now weekly traffic is down to 20, and only eight units have been sold in the past six months. “Fortunately, the debt has been paid off, so we are waiting to get equity and looking to just get the money back,” he said.
Even in today’s bearish market, however, Henry voiced enthusiasm for condo hotels, which have been an instant hit in San Francisco and other markets and have shown rapid price appreciation.