CREJ - Multifamily Properties Quarterly - January 2015
A prominent question facing the apartment industry is, “Can we absorb all of the new apartments being built?” Followed by, “If not,- then what will happen?” Looking back, we can see that absorption varies tremendously from year to year, so any forecast is likely to be slightly to highly inaccurate. The accompanying chart shows just how variable apartment absorption has been in the Denver metro area over the past 30 years, from negative 2,700 units in 2001 to positive 8,500 units only two years later, an 11,200-unit swing. There is often a correlation between increasing absorption and increasing new supply. This makes sense from a couple of perspectives. First, apartments typically are constructed when the local economy is doing well, jobs are being created and population growth is accelerating from in-migration. So, absorption should be higher when apartments are being built, if they are built at the right time. Absorption is also higher when a large supply of new apartments is added, because new apartment buildings, unlike office buildings, for instance, do not sit empty in the absence of adequate new demand. Rents get reduced, initially in the form of increasing concessions, until the desired absorption rate and final occupancy level are achieved. If there is inadequate demand, residents look for new properties and are pulled away from older properties, resulting in overall vacancy increases across the market. Older properties then react by offering concessions or reducing rents to achieve their desired occupancy. The resulting lower rent levels make apartments affordable to more people, expanding demand. This expansion occurs because roommates can now afford their own apartment, and more adult children living at home can afford to rent an apartment. In this respect, supply can create its own demand. But if new supply is excessive, vacancy also will increase and rent growth will decline, eventually turning negative if vacancy gets high enough. Note in the chart that there was very strong absorption during 2003 and 2004, a period of high vacancy, but very low levels of new construction. Similarly, 2010 achieved strong absorption with no obvious reason (the economy was weak at the time), other than possibly the fear from the financial meltdown in 2008 had subsided, the only other year with negative absorption. Renters seemed to emerge from their parents’ basements and ventured out to rent a place of their own, often with their parents’ financial support.
Looking back, absorption has averaged slightly more than 4,000 units per year over the last 30-plus years, and just over 5,000 units per year going back 50 years. But it has almost always been either higher or lower in any given year – rarely at the average level. Current conditions support higher rates of absorption, supported by above average job growth, strong population growth – particularly in the typical renter age group – a limited supply of new affordable housing (think condos and townhouses) for sale and limited financial means for large segments of the population (flat incomes, high student debt, lack of a down payment, a need to be mobile for the job market). Given these positive factors, my original absorption forecast for 2014 was 6,000 units, 50 percent above the 30-year average. This turned out to be low, as slightly more than 7,000 units were absorbed in conventional rental communities with 50-plus units (from an inventory of 177,000 rentals), and just over 8,000 units were absorbed, including both conventional and affordable properties (taken from the Apartment Insights survey of over 200,000 units each quarter). While 2014 was an extraordinarily strong year for absorption, it seems likely that a similar number could be achieved again in 2015, as little on the demand side has changed. It appears that even more apartments are likely to be built this year than last. Rents now are at even higher levels, and the volume of new for sale housing is steadily increasing, which could arguably slow absorption in the coming year. Either way, 2015 absorption is likely to be below the 9,200 new apartments added to the rental pool during 2014, and the 11,000 units expected to be completed during 2015. This assumes there is enough available labor to complete them. This gap between supply and demand should push vacancy rates higher, particularly in submarkets with heavy concentrations of new construction. The expected result is slowing rent growth. Since metrowide rents grew by an astounding 12 percent last year, there is plenty of room for rent growth to decline and yet still be positive.