It’s no secret that the housing market is very hot at the moment and as a result, becoming increasingly more expensive. There is a pretty simple explanation for this and anyone who has taken an Economics 101 class can identify that the crux of the problem is tied to the concept of “Supply and Demand”.  A confluence of factors is contributing to a shortage of supply of rental housing and an increase in demand in most markets around the country which is driving prices up. In this article, we will investigate what is contributing to the supply constraints and demand drivers as well as discuss what this climate means for investors.

The Law of "Supply and Demand" is one of the simplest yet most powerful economic drivers for any market. Whether it’s for avocados, rare artwork or rental housing, low supply and high demand will create higher prices. Let’s take a look at the supply vs demand relationship in the U.S. rental housing market. According to the National Multifamily Housing Council, as of the end of 2017 approximately, 43 million households out of the total of 118 million were renter-occupied. In addition, over the past 5 years, an average of 1 million new renter households were formed each year, which constitutes an all-time record.

Why is demand so high? Aside from population growth, the housing dynamics are changing in this country with the Baby Boomer and Millennial generations leading the way and exhibiting significantly different behavior than their predecessors. A study done by Hoyt Advisory Group, commissioned by the National Apartment Association and the National Multifamily Housing Council paints the picture for us. Over 75 Million people between the ages of 18-34 are entering the housing market, most of which are renters. In addition, Millennials are delaying larger life events such as marriage and children, which tend to be the largest two drivers of home ownership. Today only 19% of households were married couples with children as compared to 44% of households in 1960. However, renting is no longer just relegated to the younger generation. Many Baby Boomers and retirees are selling single-family homes and opting for the convenience and flexibility of rental apartments. More than half of the net increase of renter households over the past 10 years have come from people over the age of 45.

So we’ve established that demand is high, but how does that compare to the supply? To meet the increasing demand, it’s anticipated that we will need to add 4.6 million housing units by 2030, which equates to roughly 383,000 units per year on average. According to data from REIS we had a record year of supply in 2017 as approximately 220,000 new units were added. So, despite a record number of units added, we’re still 43% off the required pace of 383,000 per year for supply and demand to equalize by 2030. We have discussed how high construction costs are leading to an oversupply of luxury or Class A apartment buildings in a recent blog article: Why Are So Many Luxury Apartments Being Built? Since the majority of the new units produced are luxury apartments, the supply constraints for affordable housing units are exacerbated further. Of the 220,000 units added last year, approximately 200,000 or 91% were Class A luxury multi-families which command the highest rents.

Most of the current and anticipated demand is coming from low and middle-income households, which need affordable and workforce housing.  In most cases, this demographic cannot afford the new Class A properties that are built. This creates a significant demand for B & C class properties and present opportunities for investments in those particular multifamily assets.

What does this climate mean for investors? For those that are investing in Class A, high-end luxury apartments, they should be cognizant of the fact that demand could subside in the event of a market contraction. While the demand for apartments as a whole is considerably outpacing supply, it is not as clear as to how much longer the demand for brand new high rent apartments will continue. If the market flattens, Class A multi-family will be one of the first asset classes within real estate to soften. We’re already noticing a slowdown in Class A profitability as construction costs continue to rise and competition by the number of luxury units being added strengthens.

In contrast, Class B and C properties present interesting opportunities for investors despite being near the top in the real estate market cycle. These assets tend to be more resilient in a down market than their newer more expensive counterparts. As we mentioned before, only 9% of the new units added last year were not considered Class A. However, the vast majority of rental demand comes from low and middle-income households. Given the massive shortage of affordable housing supply, Class B & C properties are positioned to continue to remain in the highest demand.  If the market flattens or turns, owners of B and C properties benefit from lower vacancy rates as previous Class A tenants trickle down seeking more affordable housing options.

While no one can be certain how fast supply or demand will increase over the next decade. It is clear that we have come out of the previous recession with demand outpacing supply, despite significant increases in units being added in more recent years. The supply that does exist is lopsided heavily in favor of higher-priced luxury rentals in city centers. In this climate, opportunities exist for investors to add value to more aging rental housing stock and take advantage of its more affordable price points and resilient position.

Did you like this blog post? If so, please feel free to share it using the social media buttons below!