MultiFamily Market Outlook - December 31, 1969

Rents Up, Vacancies Down as Rental Market Continues to Rebound

With the national vacancy rate at a four-year low and rents for new and existing units approaching an all-time high, the rental apartment market appears to be staging a rebound. In fact, almost all of the variables that measure multifamily rental demand indicate a steadily improving situation.

The vacancy rate for buildings with five or more units stood at 9.5% for the three months ending December 2005, down from 10.8% during the third quarter of 2005, and lower than at any time since early in 2001. The vacancy rate for all rental properties (of which nearly a third are single-family units) stood at 9.6% in the fourth quarter of 2005, down slightly from 9.9% in the previous quarter, and down from 10% during the last quarter of 2004 (Figure 1).

Asking Rents Are Way Up

Median asking rents were $972 for rental units completed during the fourth quarter of 2004. Although that is down from the record asking price of $1,025 during the second quarter of 2004, it still is the third-highest level ever recorded, and it suggests general improvement in this market. Regionally, the Northeast and West continue to have the highest median asking rents, at more than $1,050 in each case. They are followed by the South, with a median asking rent of $910, and the Midwest with $854. Although rents are clearly highest on both coasts, median asking rents in the Midwest are at their highest levels ever, and the median asking rent in the South is within $38 of its highest monthly reading.
  
Perhaps not surprisingly, asking rents for existing apartments also have been generally improving, and are also near all-time highs (Figure 4).  

For all existing units, the median asking rent was $593 during the fourth quarter of 2005, which is $21 lower than in the third quarter, $15 dollars lower than in the first quarter, and just $27 dollars less than a year ago. During the fourth quarter, the Northeast had the highest median asking rent at $727, followed closely by the West at $725. In the South it was $551, while in the Midwest it was $513.         

Because asking rent data on new apartments are volatile from quarter to quarter and can change directions quickly, we have constructed a four-quarter moving average, and calculated year-over-year changes based on those moving averages. The data show that year-over-year growth in rents has increased steadily since late 2003. From a fourth-quarter 2003 low of 1.6%, the rate of increase in rents has risen every quarter, and stood at 5% by the fourth quarter of last year. Some of the increase may be attributed to changes in the characteristics of the multifamily rental units being produced. If they’re bigger, they’ll cost more. New units completed in 2004 were slightly larger than their 2003 counterparts. Median square footage rose from 1,092 square feet in 2003 to 1,105 in 2004, breaking the previous record of 1,104 square feet set in 2001. However, the share of new units completed in 2004 with 2 or more bedrooms fell by two percentage points to 63%, and the share with two or more bathrooms also declined — albeit slightly — from 50% to 49%.    

Absorption rates for new, unfurnished rental apartments¹ are the exception to the boatload of good news on the demand front. Those rates declined by 10 percentage points to 58% for units completed in the fourth quarter of 2004. This is an substantial deterioration from the 63% absorption rate recorded one year earlier, and is the lowest rate recorded since the first quarter of 2003 (Figure 2).

Regionally, the highest absorption rate was in the Northeast, at 94%, followed by an absorption rate of 59% in the West, 53% in the South, and 47% in the Midwest. Importantly, these rates are all lower than they were in the previous quarter, with the lone exception being the Northeast, where absorption rates increased by 17 percentage points. 

Demand Up

While it is certain that some of the tightness in the rental market can be attributed to the number of units being converted to condos — and the lack of new apartments being built — there is also evidence that real demand is up. The formation of new households is a key part of the overall demand for multifamily housing, and household formation has risen significantly since the middle of 2004 (Figure 3).

There were approximately 105.3 million households in the U.S. in the fourth quarter of 2002, and just 105.9 million one year later, an increase of just 600,000 households, or slightly more than half of one percent.  However, by the fourth quarter of 2004, the number had risen to 107.5 million, up 1.6 million (or 1.5%) from a year earlier. And for the most recently completed quarter, the number of households stood at 108.9 million, an increase of 1.4 million, or 1.3%. Still more significant —and not in a positive way — is that year-over-year household growth for the four quarters of 2005 was 1.9 million, 1.8 million, 1.5 million, and 1.4 respectively. This trend suggests that the rate of household formation may be slowing as the backlog of people who delayed forming households — due to the weak economy earlier in the decade — has now been exhausted.

This generally robust growth in households helps explain the first sustained increase in renter households since the one ending in 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 33.7 million, down slightly from 33.9 in the second quarter of this year. That was its highest reading since the first quarter of 2003, up from a low of 33.2 million during the first quarter of 2004. Newly-formed households tend to be renters rather than owners.          

The Condo Market

In the fourth quarter of 2004, absorption rates for new condominiums and cooperatives² rebounded strongly and were once again higher than for rental units. This is a pattern of relationship that has been consistent since 1999, with the exception of the third quarter of 2004. Nationally, the condominium absorption rate was 77% in the fourth quarter of 2004, up from a surprisingly low 66% in the third quarter of 2004.  The highest absorption rate reported was 86% in the West, followed closely by the South at 77%. The Northeast was next at 75%, and the Midwest reported an absorption rate of just 63% during the fourth quarter of 2004.

Condominium production is up dramatically over the past several years.  There were 71,000 multifamily condos/coops started in 2001 and 2002, 87,000 in 2003, and 120,000 in 2004³. However, the 50,000 condos begun in the third quarter of 2005 is a whopping 35% more units than the 37,000 started in the third quarter of 2004.  Moreover, the 116,000 condominiums started through just the first three quarters of 2005 is only 4,000 fewer than were started in all of 2004, which by historical standards was an excellent year.       

Sales of existing condominiums and cooperatives, meanwhile, have been relatively strong, but have cooled somewhat during the latter part of 2005. During the full 2005 year, 896,000 existing condos/coops were sold — a 9% improvement over 2004, which was itself up about 12% from the previous year. Sales of existing condos rose by between 4% and 12% in 2005 across the four Census regions. The largest gain (12%) was recorded in the Northeast, which accounted for 37% of all existing condo sales last year.   

In December of 2005, existing condos sold at a seasonally adjusted annual rate of 877,000 — the sixth highest monthly rate of all time — but a 3% decline from September 2005 and a 9% decline from June 2005. Further evidence of strong demand for condos is their price appreciation. Median condo resale prices spurted by 16% and 17% in 2003 and 2004, respectively, to levels of $165,400 and $193,600. Prices have continued to climb during 2005, and in October 2005 condo prices reached an all-time high of $230,300, a gain of nearly 19% over 2004.

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 ¹ Defined as how what percentage of privately financed, nonsubsidized, unfurnished units in buildings with five or more units are rented within 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 of completion.
³ All condominium price and quantity information come from National Association of Realtors monthly surveys.  

Starts Stronger Than Anticipated

Starts in buildings with five or more apartments increased to a (seasonally adjusted annual) rate of 322,000 in December, the highest the starts rate has  been since April, and an 11% increase both over the previous month (November 2005) and the previous December (2004). The Census Bureau also revised its five-plus starts estimates for October and November upward substantially. As a result, the last three months of 2005 is shaping up as a stronger period for multifamily production than we would have thought only a month ago. As of now, the estimate stands at a total of just about 75,000 five-plus starts over the quarter. That's enough to bring the preliminary estimate for calendar year 2005 (the numbers are typically revised through March) to a total of 310,000. 

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

If that holds up, it will represent the second-strongest year since the 1980s — although annual production has been quite stable in recent years, with annual five-plus starts   staying within a band between 290,000 to 315,000 since 1998. That's remarkable, given some of the changes that hit the market over that period — including increasing home ownership, record vacancy rates that have only recently backed off, increases in the per capita dollar limits for both the LIHTC program and tax-exempt private activity bonds, and explosive growth in the condo share of new construction (see this month's lead feature).

Forecast: Another Interest Rate Hike Likely In March

Growth of real Gross Domestic Product (GDP) slowed even more than expected in the final quarter of 2005, slipping to an annual rate of only 1.1% (according to the “advance” estimate released on January 27). This was the lowest growth rate in three years, and raised questions about the sustainability of the economic expansion. The composition of the fourth-quarter slowdown, however, along with some advance indicators, point toward a nice rebound of GDP growth in the first quarter of this year. Although the quarterly patterns have changed quite a bit, NAHB still is forecasting above-trend GDP growth for 2006 (3.6% on a fourth-quarter to fourth-quarter basis), slowing to a trend-like performance (3.25%) in 2007. As expected, the Fed enacted another quarter-point increase in short-term interest rates at the January 31 meeting of the Federal Open Market Committee (FOMC), raising the federal funds rate target to 4.5%. The FOMC statement was less committal than in prior statements, and  dropped the word “measured” in describing possible future tightening. These changes give new Fed Chairman Ben Bernanke maximum flexibility to craft future monetary policy — a present from Alan Greenspan, who chaired his last FOMC meeting on January 31.

The FOMC statement not only insisted that the economic expansion remains “solid,” despite recent “uneven” economic data (including fourth-quarter GDP), but also fretted about the inflation potential of tightening resource markets and elevated energy prices. As the result of this rather hawkish tone, along with recent signals from both labor and energy markets, NAHB has added another quarter-point rate hike to its forecast of the funds rate at the next FOMC meeting on March 28. An additional increase is possible at the May 10 FOMC meeting, but NAHB is holding off on making that forecast adjustment pending incoming data. Indeed, the Fed has made it clear that its rate adjustments from here on out will be “data dependent” — rather than being semi-automatic, as policy was moved systematically from highly accommodative toward “neutral” after mid-2004.

Real Rents Climb Back Up

The real rent index (which adjusts residential rents for overall inflation) continued its gradual climb back from the low point it reached in September.

The index (after a consistent upward trend that persisted over several years) has basically been meandering without signaling a clear direction since mid-2003. The recent tendency has been for each decline to be followed within a few months by a rise of roughly equivalent magnitude. The last such cycle  began in June, when the index declined over a four-month period from 107.8 to 106.4, then recovered for three consecutive months back up to 107.4 by the end of 2005.

Based on seasonally adjusted Consumer Price Indices; U.S. Department of Labor, Bureau of Labor Statistics. The annual rates indicate what the percentage change would be if the current monthly rate were sustained over a 12-month period. The real rent index is the CPI for rent of primary residence divided by the CPI for all items and scaled so that January 1995 is 100.

Keep in mind that the index is based on rents paid for single-family as well as multifamily housing units. This rent data, collected for the Consumer Price Index by the Bureau of Labor Statistics, is used in the index because it represents the only source of timely information on rents provided on a monthly basis by a federal agency.

MFSI Hits Record High — Again

During the month of January, the MFSI jumped by an amazing 251 points — a rise of almost 10%. With this huge increase, the MFSI is at its highest reading of all time, shattering the old mark of 2,684 set last July, and is almost 32% higher than it was just 12 months ago. During the past month, the value of the S&P 500 increased by almost 3% and, as a result, it finds itself slightly more than 10% above where it was one year ago.

Because the MFSI rose by about four times as 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 130% in December to 145% in January, which is three percentage points higher than the previous all-time high of 142% set in July of 2005.

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.

Despite the very strong 67% rise in the S&P 500 since its low in late 2002, the MFSI has risen a staggering 100% during the same 40-month time period. In addition, the MFSI continues to dramatically outperform the S&P 500 over longer time periods including the past four, five and six years. Since December 1998, the MFSI has risen by a whopping 184% while the S&P 500 with dividends reinvested has gained a meager 16%. During the month of January, the price-to-earnings ratio (P/E) of the MFSI rose slightly and now stands at 18.29, 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 4.34%. The MFSI is an index of 26 publicly traded US headquartered firms, including 22 REITs, principally involved in multifamily ownership and management.