Supply Shortfall Persists for Apartments

Little new apartment construction and surging demand has created a shortfall of 2.5 million units, the largest the nation has seen in more than a half-century, according to research from Nareit, a trade group for real-estate investment trusts.

As we’ve reported, apartment landlords are seeing vacancy rates decline as more Americans rent by choice or necessity. In the fourth quarter, apartment vacancy fell to the lowest rate since late 2001, with the national rate dropping to 5.2% from 6.6% a year earlier, according to Reis Inc. The vacancy rate had risen as high as 8% in 2009.

Pent-up demand could pull that rate even lower. According to Nareit, the normal rate of household formation is about 1.2% annually. But, with the sour economy in the last four years, the rate plunged to about 0.5%, as people delayed moving out and opted to live with roommates and parents longer.

This has created an unmet demand of about 2 million households, “about three times what it has been in previous business cycles,” says Calvin Schnure, vice president of research and industry information at Nareit. He expects many of these people to eventually turn to the rental market.

This comes as construction of new apartments slowed dramatically after the financial crisis. Building of multifamily units fell to a 20-year low during the recession and the units under construction remain at nearly 60% below the long-term average. Apartment construction is slowly picking up, though it will be a year or two before many projects are finished.

As the economy heals and hiring picks up, many of these households will seek their own place and that’s expected to be rentals, Mr. Schnure says. Once those doubling up “have an income that they can make their own rent payment, they’re going to rent on their own,” he said.

Keep in mind that Nareit’s members include publicly held apartment owners. The seemingly red-hot sector could weaken if the housing market recovers and more people buy homes.

Another risk is overdevelopment, which could create competition that forces landlords to cut rents. There’s also the chance of the economy weakening further, keeping all that pent-up demand, well, pent up.

Mr. Schnure remains bullish. “The fun is just about to begin,” he says. “It’s going to take some time for these households to move up. It’s a question of when it’s going to be realized. Even if you take a fairly conservative assumption,” it could be several years.

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