Quarterly Stats Show Weak Market for Multifamily
by Rose Gutierrez
While 2002 was a great year for the single-family market, multifamily housing didn't fare nearly as well. In spite of rising household formation rates, which usually bode well for multifamily, the market was beset by rising vacancy rates and falling absorption rates.

Despite recovering slightly in 2002 from the stagnation of 2001, the US economy remained fundamentally weak last year, with the stock market – especially the manufacturing and high-tech sectors – failing to recover lost ground.  Amid the uncertainty, residential real estate emerged as one of the most appealing alternative vehicles of investment, driving both new and existing home sales to record highs in 2002.  The modest increase in multifamily permits in 2002 occurred despite the deterioration shown in the sector’s demand fundamentals.  Vacancies in apartment buildings with 5+ units in the first three quarters of 2002 were the highest in more than 10 years, while the rate of absorption of newly completed units slowed dramatically.  Even though the formation rate for new households accelerated, creating a large increase in the number of renter households, that failed to stem the deterioration in rental absorption. It’s likely, however, that the rising number of rental households encouraged builders to continue starting new units.  Meanwhile, the number of homeowners is on the rise, shown by a rise in the rate of homeownership in the fourth quarter of 2002.

Condo Starts Especially Strong

Compared to 2001, multifamily starts in 2002 rose in all Census regions except for the West, where 79,000 units were produced – 10.2% fewer than the 88,000 units built in 2001.  In the Northeast, 41,000 apartments were started last year, 3,000 more than in 2001.  The Midwest and South regions also saw robust growth in multifamily construction last year, growing 18.0% and 7.7%, up to 72,000 and 153,000 units, respectively.

Production of multifamily condo and co-op units in both the second and third quarters of 2002 reached 20,000 units – a level not seen since the third quarter of 2000.  In the first three quarters of last year combined, a total of 57,000 condos and co-ops were started, which was 5.6% more than the 54,000 started in the first three quarters of 2001.  The total number of condo and co-op units started in 2001 was 71,000.  Data for the full year 2002 have not been reported yet.

Unlike rental apartments, condominiums finished in the second quarter of  2002 saw their 3-month absorption rate shoot up to 87%, up from 71% the previous quarter, and substantially higher than the rate posted in any quarter of  2001 (Figure 1).  Although the median asking price for new condos remained the same overall at $188,300, it was up in every area reported by the Census Bureau except for central cities and the Northeast Census region, where the median is the highest price recorded in the Survey of Market Absorption ($300,000+), and non-metro areas (Table 1).

Weak Demand Pushes Vacancy Rate to 10-Year High

Continuing deterioration in key market fundamentals indicates that weakness in demand for multifamily rental housing has deepened.  Data for the first three quarters of 2002 on the rental vacancy rate, for example, show it rising to an average of 8.9%, compared to 8.3% in the first three quarters of 2001.  Although this measure includes single-family rentals, most of the increase is due to rising vacancies in multifamily units.  In fact, structures with 5 or more units in the first three quarters of 2002 posted an average rental vacancy rate of 10.5%, up from 9.5% in the corresponding period of 2001 – the highest first-three-quarter average since 1988.

The latest data available on apartment absorption show no less distress in multifamily demand.  For rental apartments completed in the first six months of 2002, the average 3-month absorption rate was only 61%, compared to the 65% rate posted in the first half of 2001 and the 73% of the first half of 2000.  The first half of last year, in fact, saw the lowest absorption rate for that period since the inception of the series in 1972.
 
Meanwhile, the lowest mortgage rates since the mid 1960s have contributed to an apparent explosion in household formation, despite higher unemployment. While that has sent the homeownership rate up, it also has resulted in significant gains in the number of renter households.  The year-over-year pace of net household formation was 1.8 million in the year ended in September 2002, compared to 1.0 million in the year ended in September 2001.  The last time net household formation was this strong was in late 1993.

Since new households are more likely to rent than to own at first, the surge in net new households is directly tied to the large increase posted by the number of renter households in 2002.  In the third and fourth quarters of 2002, for example, there were 729,000 and 163,000 more renters, respectively, than in the corresponding periods a year earlier (Figure 2).  Relatively inexpensive financing served to drive the rate of homeownership to a new record in the last quarter of 2002 – up to a seasonally adjusted 68.2% (from the 67.8% posted in last year’s third quarter).  In 2002, the average share of households who owned their homes rose to 67.9%, up from the 67.8% recorded in 2001.

The median asking rent for new apartments completed in the first half of 2002 was $928. That was 5.4% higher than the $881 median rent recorded for apartments completed in the first two quarters of 2001, even though a greater share of those completed in the first half of 2002 had fewer than two bedrooms.

Some Local Markets Thrive, but Most Remain Weak

Table 2 (click here) shows a number of variables measuring multifamily supply and demand in 35 metropolitan areas across the United States.  Data comparing the all-items Consumer Price Index (CPI) and the rent-only sub-index provide evidence that rents were outpacing overall consumer prices in 2002 in all metropolitan areas reported.  Thus, in all 27 metros (reflected in Table a) for which data are available, rent increases between the first half of 2001 and the corresponding period in 2002 significantly exceeded overall growth in prices.  In 2001, this had been the case in only 23 of those metros, with Dallas, Detroit, Honolulu, and Pittsburgh being the exceptions. Year-over-year net increases in rent in 2002 have surpassed 6.0% in only three areas:  Boston, San Diego and Washington DC.  San Diego, in particular, posted a dramatic 9.1% jump in residential rents between the first half of 2002 and a year earlier, while the overall CPI grew by only 2.9% in the same period.

A steady demand for apartments in the Houston area (after two years of restrained output) allowed for continued rent increases as well as strong gains in construction (multifamily permits) in 2002.  Houston saw rents grow by 2.9% in 2000, by 3.9% in 2001, and by 4.4% between the first half of 2001 and that of 2002.  A 3-month apartment absorption rate that rose from 60% in 2000 to 65% in 2001 – remaining at that level for the year which ended in June 2002 – and a rental vacancy rate that dropped slightly between 2001 and the first three quarters of 2002, led multifamily production to increase significantly in Houston last year.  That city’s multifamily permits rose an impressive 71% in 2002 – reaching 28.8% of all permits issued there last year.

Denver, on the other hand, has been weathering a serious slowdown in multifamily demand. In 2001, the 3-month absorption rate for apartments dropped to 66% from 77% a year earlier, while rental vacancy rates rose from 4.6% in 2000 to 6.0% in 2001.  Amid all this, the pace of rent increases slowed to 5.8% in 2001 (from 6.4% a year earlier), yet multifamily permits rose by 8.5% in 2001.   Multifamily production in 2002, however, dropped a steep 41.1%, as partial-year data showed the absorption rate sinking further through the first half of the year and the pace of rent growth decelerating further.  Lower output and rent increases have helped to slightly reduce vacancies in 2002.

Overall, new apartments completed in 2001 were absorbed less quickly than in 2000 in all the metro areas for which data are available.  In 15 of them, the share of apartments absorbed within three months of completion fell between 2000 and 2001.  Data for the year that ended in  the second quarter of 2002 show that absorption of new apartments remains weak in most areas of the country. [ return to top ]