Apartment Construction Growth: Danger or Opportunity?

Experts worry rents could slip if construction growth continues

Apartment Construction Growth: Danger or Opportunity?Many people have been viewing this year’s strong growth in multifamily housing as an excellent opportunity and a sign that this sector is ripe for even more investment. However, some experts worry that this attitude may lead to an eventual bursting of the apartment project bubble when the supply of multifamily housing outstrips demand.

Current State of Apartment Construction Activity

In June, groundbreaking on new homes and apartments hit an 8-year high. As of the end of September, we are still hovering close to this mark. As it has many times before, activity in the multifamily sector led this latest increase with an 18 percent bump in September.

In fact, apartments have led the recovery in housing starts since the Great Recession, according to experts like Oxford Economics’ US Macroeconomics head Gregory Daco. Back in 2005, the average share of multifamily projects in total construction starts as 17 percent. In the third quarter of this year, it was 36 percent, Daco noted.

Another key piece of data experts tend to mention is the fact that the number of units under construction in large buildings designed for 5 or more tenants has topped half a million for the fifth straight month. This the longest streak of mega-multifamily building construction activity we’ve seen since the middle of the 1970s.

What About Rents?

Due to a variety of factors, the rental market in most parts of the US has been very strong. Millennials are opting to rent instead of buy homes, and some baby boomers have been driven out of their single-family homes to apartments due to the mortgage crisis.

Private sector companies say rents are growing at about 4 percent year over year. Government experts peg the growth just a hair lower at 3.7 percent.

However, some experts worry that these rent growth rates cannot be sustained if the current pace of multifamily housing construction continues. Eventually there will be an oversupply of rental units, causing rent rates to stagnate or even decline. One expert, Richard Moody, predicts that this could occur as soon as the middle of 2016 in some markets. Moody is chief economist at Regions Financial Corp. in Birmingham Alabama.

If rents to decline, builders may face some difficult choices. They may have to lower the monthly rents or offer significant initial discounts in order to fill newly constructed units, and this change in expected income could affect their financing.

Get Help Weighing Risks With Our Software

If you are heavily invested in multifamily projects, you definitely need to consider the impact that an oversupply of units and a decrease in rental income might mean for the success of your project. One way to explore the possible consequences is using the portfolio stress testing feature of our Fund Control software. You can program in virtually unlimited stress scenarios and see how your various accounts would fare.

To learn more about stress testing and other features of our Fund Control software suite, we recommend contacting us for a free personalized online demo.