MultiFamily Market Outlook - December 31, 1969

Quarterly Update: Rents Up, Condo Absorption Surprisingly Strong

Rental demand fundamentals remained solid in the last quarter (Q4'06), according to the most recent data released from the Census Bureau. Although some rental demand indicators are a bit weak, asking rents are up substantially and growth in the number of renter households remains strong, which bodes well for rental markets in the future. And condo absorption rates, while declining somewhat, still outpaced rental absorption rates for the quarter.

Rental Vacancies Remain Low

The vacancy rate for buildings with 5 or more units stood at 10.1% for the three months ending December 2006, down from 10.4% during the third quarter of 2006, but up from 9.5% during the fourth quarter of 2005. The vacancy rate for all rental properties (of which 30% are single-family homes) stood at 9.8% in the fourth quarter of 2006, down slightly from 9.9% in the previous quarter and up from 9.6% during the fourth quarter of 2005 (Figure 1). 

Quarterly vacancy rates are not seasonally adjusted. Source: U.S. Census Bureau, Housing Vacancies and Homeownership

Regionally, the highest vacancy rate was found in the South, at 12.4% in the fourth quarter, up from 11.9% in the previous quarter and up from 11.4% recorded a year ago. The West reported a vacancy rate of 7.0% in the fourth quarter of this year, up from 6.5% in the third quarter and unchanged from 12 months ago.  Those rates reflect the fact that new multifamily construction has been most active in the South and West.

Vacancies in the Northeast came in at 6.5% for the period September-December, down from 7.7% during the June-September quarter of 2006, and down slightly from 6.7% 12 months ago. Meanwhile, the Midwest weighed in with a vacancy rate of 11.9%, down seven-tenths of a percentage point from the third quarter and down four-tenths of a percentage point from what it was a year ago.
      
National absorption rates for new, unfurnished rental apartments¹ fell from 67% in the third quarter to 59% for units completed in the fourth quarter of 2005. While this is up slightly up from the 58% absorption rate recorded in the fourth quarter of 2004, it is the third-lowest rate recorded since the start of 2003 (Figure 2).

Absorption rates are for structures with five or more housing units that are privately financed, nonsubsidized, and unfurnished. The results are presented for units completed during the indicated quarter.  The quarterly rates are not seasonally adjusted. Source: U.S. Census Bureau, Survey of Market Absorption

Regionally, the Northeast and the West both had the highest absorption rates at 65%, while the South and Midwest both reported absorption rates of 55%. Moreover, the absorption rate fell by 17 percentage points in the Northeast between the third and fourth quarters, while the rate in the South declined by 14 percentage points, with the Midwest rate declining by 11 percentage points.  In the West—the only area to experience any rise in the absorption rate—the rate rose by three percentage points.   

New Households Spur Rental Demand
       
The formation of new households is another key indicator of the overall demand for multifamily housing. And while multifamily household formation (including both rental and condo) has risen in every quarter since the start of 2004 (Figure 3), it still is 200,000 below its recent high of 34.4 million recorded during the first quarter of 2006. This trend suggests that the rate of multifamily household formation may be slowing, but is still well above the recent cyclical lows registered during 2004.  

Source: U.S. Census Bureau, Housing Vacancies and Homeownership

This general growth in households helps explain the first sustained increase in renter households since the first quarter of 1995—more than 10 years ago. At that time, the number of such households was about 35.5 million, and it now stands at 34.2 million—up handsomely from 33.7 million a year ago, but down slightly from 34.2 million in the second quarter of 2006. The number of renter households now is at its fourth-highest reading since the start of fourth quarter of 2002—and up from a low of 33.1 million during the last two quarters of 2004. Newly-formed households tend to be renters rather than owners.          

Asking Rents Are Healthy, even Record-Setting

Median asking rents were $974 for rental units completed during the fourth quarter of 2005. Although that is down from the record asking price of $1,025 during the second quarter of 2004, it is the third-highest reading ever recorded, and it is $47 higher than in the previous quarter. This strongly suggests general improvement in this market. Regionally, the Northeast and the West continue to have the highest median asking rents with the median asking rent in the North at more than $1,150, and in the West at $1,088.  These two high-priced regions are followed by the South, with a median asking rent of $885, and the Midwest, at $750. Although rents are clearly highest on both coasts, median asking rent in the Midwest is near its all-time high, and the median asking rent in the South is within $81 of its highest quarterly reading ever.   

Perhaps not surprisingly, asking rents for existing apartments also have been improving, and are at or near all-time highs (Figure 4).

Quarterly asking rents for vacant units are not seasonally adjusted. Source: U.S. Census Bureau, Housing Vacancies and Homeownership

For all existing units, the median asking rent was $700 during the fourth quarter of 2006, which is $61 higher than in the previous quarter and $107 more than a year ago. Moreover, this is the highest median asking rent for existing apartments ever recorded. During the fourth quarter, the Northeast had the highest median asking rent at $825, followed closely by the West at $805. In the South the median asking rent was $632, while in the Midwest it was $574. In all areas except for the Midwest, median asking rents are at their highest levels ever.             

Because asking rent data on new apartments are volatile from quarter to quarter and can change directions rather quickly, we have constructed a four-quarter moving average and have calculated rents based on the moving averages. These data show that at present, rents are within $32 of their all-time high. While some of the increase is due to local economic conditions, some of the increase may be attributed to changes in the characteristics of the multifamily rental units being produced. New units completed in 2005 were slightly larger than their 2004 counterparts. Median square footage rose from the record level of 1,105 square feet in 2004 to 1,143 square feet in 2005, and to 1,154 square feet during the third quarter of 2006. Similarly, the share of new units completed in 2005 with 2 or more bedrooms rose by four percentage points, to 67%, and the share with two or more bathrooms also edged up, from 49% to 54%.  

The Condo Market Holds Its Own

In the third quarter of 2005, absorption rates for new condominiums and cooperatives² generally declined but once again tended to be higher than for rental units; a relationship that has held consistently since 1999, with the exception of the third quarter of 2004. Nationally, the condominium absorption rate was 68% in the fourth quarter of 2005, down from a more robust 75% in the third quarter of 2005. The highest absorption rate reported was 77% in the West, followed by the South at 71%. The Northeast was next at 61%, and the Midwest reported an absorption rate of just 49% during the second quarter of 2005. While 49% is very low, it is important to remember that quarterly absorption numbers are volatile and that the completion of just one large project can dramatically alter the results, especially for areas in which condo construction is not prevalent.  It will be interesting to see the results for the Midwest unfold over the next several quarters as condo construction and conversion activity rises in second- and third-tier markets.

Over the past several years, condominium production overall has increased dramatically. There were 71,000 multifamily condos/coops started in 2001 and 2002, 87,000 in 2003, 120,000 in 2004 and a stunning 150,000 in 2005³,  in large part because a record 51,000 condos were begun in the third quarter of 2005.  Despite anecdotal evidence to the contrary, construction activity in this sector appears to be heating up in 2006. During the first quarter of 2006 we saw 39,000 condos started, while 42,000 were started in the second quarter, and a very solid 38,000 were started in the third quarter of last year. Although condo starts have retreated slightly from the all time quarterly highs of 2005, on a year-over-year basis there appears to be little, if any, evidence of a decline so far. Given the relative weakness in condo prices and strength in rents, an important question that can’t be answered by the federal government’s statistics is: How many new projects might be converted from condos to rental units somewhere along the way--reversing  the trend most industry analysts believe was occurring a couple of years ago?

Sales of existing condominiums and cooperatives, meanwhile, have been steadily cooling from the torrid pace exhibited during the second and third quarters of 2005. For all of 2005, there were 896,000 existing condos/coops sold—a 9% improvement over 2004, which was itself up about 12% from the previous year. However, last year’s 803,000 sales of existing condos represented a decline of about 10% from 2005. Perhaps more importantly, sales fell by between 5% and 14% in 2006 across the four Census regions. The largest decline (14%) was recorded in the West, followed closely by the South (13%) while the Northeast (10%) and the Midwest (5%) suffered milder declines. The two regions with the sharpest declines collectively accounted for almost 42% of existing condo/coop sales in 2006.       

In December of 2006, existing condos sold at a seasonally adjusted annual rate of 777,000, a 12% decline from December 2005 and a 17% decline from the June 2005 peak. Further evidence of the weakening demand for condos can be seen by looking at rates of appreciation. Median condo resale prices spurted by 18%, 17%, and 14% in 2003, 2004, and 2005 respectively, bringing them to levels of $168,500, $197,100, and $223,900 for those three years. However, during 2006, median condo resale prices declined by about 1% to $221,800, and are almost 5% below the all-time high of $231,800 set in June 2005.

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 ¹ Defined as what percentage of privately financed, nonsubsidized, unfernished units in buildings with five or more units are rented wihting 90 days of completion.

² Defined as what percentage of privately financed, nonsubsidized, unfurnished units in buildings with five or more units are sold within 90 days of completion.

³ All condominium price and quantity information come from National Association of Realtors monthly surveys.  

Year Ends with a Surge in Multifamily Starts

In December, housing starts in buildings with five or more units surged by 30%. The Census Bureau's (seasonally adjusted annual) five-plus starts rate came in at 350,000, up more than 30% from November's 268,000. The rate of permit issuance, which can be an indicator of future construction activity, also increased substantially. Five-plus permits were issued at a seasonally adjusted annual rate of 353,000 in December, up 17% from the previous month.

Source: U.S. Census Bureau; NAHB Economics Group

As always, it's advisable to keep things in perspective and avoid reading too much into a single month-to-month change. On a year-over-year basis, the five-plus starts rate was up less than 4% in December, and the five-plus permit rate was actually down year over year. Over the past six months, the industry has recorded four extremely week five-plus starts rates (around 250,000), one that was about average (September's 302,000), and one very strong number in December. The industry is unlikely to sustain a  rate of production as high as 350,000 for long, just as it was unlikely to sustain a rate as low as the 250,000 seen in much of the last half of 2006. NAHB's estimate of a long-run sustainable trend is slightly under 300,000 five-plus units started per year. The NAHB forecast calls for a total of 265,000 five-plus starts in 2007, followed by 288,000 in 2008.

Real Rents Remain High, with Slight Year-End Drop

In the final month of 2006, real rents retreated very slightly from the record high they reached in November, according to the latest Consumer Price Index (CPI) data.

While the overall CPI increased at a seasonally adjusted annual rate of 6.7%, the residential rent component of the CPI narrowly missed keeping pace, increasing at an annual rate of 5.9%. In nominal terms, the strength in residential rents has been quite consistent, with the annual rate of increase staying above 4% for seven consecutive months. Because overall inflation was somewhat higher than this in December, however, the real rent index (which adjusts rent changes for overall inflation) dropped, but only by a tiny tenth of a point—from 109.4 to 109.3.

This still is the second-highest number recorded since 1981, the point at which consistent data series become available to compute the real rent index. The index first reached the 109 mark in October 2006.

A Steady Economy, with Low Inflation, Low Interest Rates

In general, the U.S. economy is performing well, with growth in real Gross Domestic Product (GDP) holding up in recent quarters even though the housing production component of GDP has contracted substantially. The economy did not even skate close to a recession in 2006, and the probability of an economic downturn is not high over the 2007-2008 forecast period. The labor market has been resilient. Although the downswing in housing production undoubtedly caused job losses in residential construction during 2006, overall job growth was solid during the year, and NAHB is expecting solid job growth in 2007 as well. While the labor market was performing relatively well, core consumer price inflation (excluding food and energy) moved well above the Federal Reserve's "tolerance zones" during 2006. However, core inflation rates began to recede as 2006 drew to a close (at least on a year-over-year basis).

The slowdown in core inflation actually had been projected by the Federal Reserve, and this Fed projection is an integral part of NAHB's economic forecast for 2007 and 2008. The Fed held monetary policy steady at both the January and February meetings of the Federal Open Market Committee (FOMC). Indeed, the Fed has held its federal funds target rate at 5.25% since mid-2006. NAHB expects the Fed to maintain this funds rate target until the late-June FOMC meeting, and for the Fed to cut the rate by a quarter point at that time—primarily in order to keep the "real" rate from rising as core inflation recedes. Meanwhile, long-term rates firmed up in January, as incoming data on the economy were surprisingly strong. 

Even so, long-term rates remain quite low on an historical basis, as well as significantly below the recent high points reached in mid-2006. Despite the recent firming of long-term rates, the Treasury yield curve still is inverted across much of its range, and that may not be sustainable for much longer. NAHB's economic forecast calls for an essentially flat yield curve by late 2007 (at least from short term rates out to the 10-year Treasury), as short-term rates recede and long-term rates move up from their current levels.

Multifamily Stocks Again Show Record Performance

During the month of January, the Multifamily Stock Index (MFSI) jumped by 328 points, or a shade more than 9%—its fourth-biggest monthly rise ever. With this huge increase, the MFSI finds itself at at yet another all-time high—its eighth in the past 12 months—and is more than 35% higher than it was last tyear at this time. During the past month, the value of the S&P 500 with dividends reinvested jumped by 1.5% and, as a result, it now finds itself almost 15% above where it was one year ago.

Because the MFSI rose by about six times a much as the S&P 500 with dividends during the month of January, the performance gap—or percentage difference—between the two indexes jumped from 169% last month to 190% in January, its highest reading ever. Despite the very strong 91% rise in the S&P 500 since its recent low set in October 2002, the MFSI has risen a staggering 170% during the same 52-month time period.  In addition, the MFSI continues to dramatically outperform the S&P 500 over longer time periods including the past five, six and seven years. Since December 1998, the MFSI has risen by a whopping 285% while the S&P 500 with dividends reinvested has gained a meager 33%.

                 ¹ For initial article discussing the MFSI in detail see NAHB Multifamily Market Outlook, January 2002.            ² Percent difference is defined as (MFSI minus S&P 500 with dividends)/S&P 500 with dividends

During the month of January, the price-to-earnings ratio (P/E) of the MFSI strengthened and now stands at 21.94 while the dividend yield, defined as the total cash dividend payments divided by the current stock price, and which moves in the opposite direction eased to 3.09%. The MFSI is an index of 23 publicly traded US headquartered firms, including 19 REITs, principally involved in multifamily ownership and management.