Apartment Market Trends: Is Current Construction Volume Manageable?

MPF Research showed 162,000 apartment units under construction at the end of 2nd quarter across the nation’s 100 largest metros. (We’re pretty hard-nosed in the criteria required to count a project in the under construction category. By our definition, construction of the building has to be in process, with plumbing going in or foundations being poured. Site preparation work doesn’t put the property in the under construction segment.)

Given it takes about a year and a half from the initiation of construction to completion of the final units for a typical property in most markets, the volume of product underway means we’ll be delivering new supply at an annual pace of about 108,000 units annually in the nation’s key locales through late 2013.

With completions in the top 100 markets averaging about 151,000 units per year over the course of the past two decades, you could argue that what’s coming out of the ground right now represents an undersupply of nearly a third, since it’s still notably below the long-term norm.

But is just over 150,000 units per year in core markets really the right target figure to have right now?

Certainly there are factors that suggest apartment demand will come in at levels higher than general economic growth expectations would suggest during the near term. Strong population increases are occurring among young adults, who tend to be apartment renters. And the loss of apartment renters to purchase is running below normal. (We’re assuming that somewhat-smaller-than-usual loss to purchase will be the big-picture story for this housing cycle, but keep in mind that the apartment base does contain a layer of residents who are qualified buyers, but they’ve delayed purchase until they feel secure in their jobs and confident that home prices have bottomed.)

Taking into consideration that apartments are capturing a disproportionately large share of total housing demand, then, might seem to support apartment construction at near-normal levels, despite the lackluster state of the overall economy.

But keep reading, ‘cause here’s where we pull a John Roberts on you and come to a conclusion that’s different from what we’ve thus far led you to believe.

From our perspective at MPF Research, the additional factor that gets ignored in the debate on whether total construction remains manageable reflects that some metros normally tending to account for a huge block of all deliveries actually don’t need a lot of additional stock right now. We shouldn’t be building at rates anywhere close to the historical averages across the state of Florida or in Atlanta, Phoenix and Las Vegas, given the still excessive total housing availability found in those locations. Likewise, spots like the Inland Empire, Tucson, Sacramento, Reno, and Fresno, while not big players on the national scene, currently don’t need product completions at their historical norms.

Combined, those still-struggling locations have accounted for a whopping 28 percent of the apartment additions that have come on stream across the top 100 metros during the past two decades, though they comprise just 11 percent of the stock under construction right now.

If you assume that not-fully-recovered metros can support niche-justified completions at about a quarter of the normal building pace seen in those locations, appropriate total deliveries in the top 100 markets come down to about 120,000 units annually, not 150,000 or so apartments.

At a target level of some 120,000 deliveries annually in the top 100 markets, what’s under construction now leaves only a little room for starts to continue on their upward trendline without starting to do some damage to occupancy and rent growth fundamentals. Maybe we can bump up activity by roughly another 10 percent, rather than a third, and still be in good shape.

Next up in the second part of this examination of future supply: If you buy the argument that we’re getting relatively close to the right amount of product underway, will planned product that’s not yet truly under construction push us over the top?

And in the third part of the series, we’ll examine the metros and individual neighborhoods perhaps most in danger of seeing deliveries outstrip absorption capacity in the short term.

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