It's no secret that the housing market has suffered huge setbacks over the past 24 months. Americans have already lost $13 trillion in net worth and the bloodbath doesn't appear to be over. Real estate markets that went on a building binge during the expansion phase are projected to lose as much as 25% in housing value in 2009. It's the talk of the town, and most of us are sick of hearing about it. But what does it mean for the apartment market? At one point it seemed a corpse could apply for a home loan and get approved in a matter of days. That put enormous pressure on apartment communities as they battled for anyone with a pulse to fill vacant units. A few years later and well into the housing boom, apartment rents increased dramatically as home prices escalated out of control. Now fast forward to the housing bust. At first, rental rates surged further and concessions were nearly nonexistent. Foreclosures soared in 2007 and 2008 and consumers were tossed back into the renter pool. Vacancy fell and cash flow increased. Today, however, the multifamily sector faces new challenges, like the "shadow" market, which consists of homes and condos that compete with apartments for renters. Apartment communities are again offering free rent and other bonuses to attract potential residents. Net operating income (NOI) is decreasing and fearful investors are panicking. During a Web seminar on Feb. 24, managing director Linwood C. Thompson of the National Multi Housing Group of Marcus & Millichap said vacancy rates are, "going to go up on average about 100 basis points (bps) across the entire portfolio. That's a significant move."
Thompson continued: "It's very difficult to get a 50 bps move across that average in a given 12 months, but with unemployment the way it is, we see the vacancy rate going up 1%, which is going to be a challenge." Indeed it will be, and investors know it. Bad news spreads like wildfire, and fearful investors bail in an already volatile market. Many of the largest apartment real estate investment trusts, including BRE Properties ( BRE), Equity Residential ( EQR - Get Report), Apartment Investment & Management Company ( AIV - Get Report), Essex Property Trust ( ESS - Get Report) and AvalonBay Communities ( AVB - Get Report), have been pounded in recent months. All of them are at five-year lows. Many investors and real estate enthusiasts believe commercial properties will face widespread vacancies as a result of rampant overdevelopment like those of the 1980s and 1990s, but the only sector to enter the downturn with too much construction is retail. According to the National Association of Home Builders, multifamily starts fell to the lowest number the association has on record, with just 119,000 units. That should bode well for the multifamily housing market. The recent increase in apartment vacancies is the result of rising unemployment and the competing shadow market, not new development. "We're in the early middle stages of this 20-year expansion of rental demand," Thompson said, referring to the echo boomers as they mature into their prime rental years. "We believe that once we hit bottom and once we start climbing out of this recession, we're going to see a fairly steep recovery." Commercial real estate sales have dropped significantly even though prudent investors know this is the time to buy. Apartment REITs like AvalonBay and BRE have canceled or postponed development projects throughout the country. REITs and private investors alike cite the cost and availability of capital coupled with job losses and slumping housing prices as top concerns.
All that said, the long-term outlook for apartment REITs still looks good. Although demand is hampered somewhat by the housing and job market, roughly 4 million people will turn 18 every year for the next 10 years. Combine demand with limited supply, and the apartment market will rebound relatively quickly, although job growth is the key ingredient. Steve Steadele, author of the book Multifamily Millionaire, is a successful real estate investor, broker, entrepreneur and self-made millionaire. He is a featured speaker at Real Estate Investment Associations across the country, where he shares his wealth of knowledge, experience and enthusiasm for the real estate industry. Today Steve specializes in the acquisition and disposition of investment real estate throughout the United States. To learn more about his products and services, visit his Web site at www.SteveSteadele.com.