Ryan Severino
Ryan Severino

Many prognosticators think the great run in the apartment market is coming to an end. After performing incredibly well for the past four years, the tide is starting to turn against the marketplace.

Sweeping changes over the next two years are going to cause fundamentals in the market to weaken for the first time since 2009. Significant increases in construction activity, for example, are going to send a torrent of properties into the market over the next seven quarters. Of course, these changes won’t be uniform across the United States. So it's critical to understand which markets are going to see the most challenges.

Demand Isn’t the Problem
Although the recovery and expansion phase of the apartment market cycle is now four years old, the issue facing markets going forward is not one of demand. Demand remains relatively robust at this juncture, due to the millions of people in their 20s and early 30s who are not in a financial position (nor do they desire) to be homeowners.

The homeownership rate for people age 35 and under fell to about 36 percent in the first quarter of 2014, the lowest figure since the U.S. Census Bureau began tracking homeownership by age, in 1982. Moreover, 22 is now the most common age in the United States, followed by 23, then 21. As the economy continues to create jobs for those in their 20s and early 30s, it will release pent-up demand as young adults move out of their parents’ house or out of shared multiple-bedroom apartments into studio and one-bedroom units.

In several markets around the country, however, this release of pent-up demand isn’t going to be sufficient to keep pace with the significant supply projected to come on line during the balance of 2014 and 2015. The number of newly completed units is generally increasing over time. Moreover, the number of properties in the pipeline that could likely be completed before the end of 2015 increases on a weekly basis.

Yet, the ramp-up in supply growth isn’t consistent across markets, nor is the imbalance between supply and demand consistent across markets. The majority of the primary markets are expected to experience vacancy increases by the end of 2015 as supply outpaces demand.

Rumblings of Oversupply in the South
Many of the markets that are projected to see the largest vacancy increases over that interval are among the fastest-growing markets in the country as measured by metrics such as employment growth, population growth, and household formation rate. Among the top 10 markets with the largest projected vacancy-rate increases are Charlotte, N.C.; Austin, Texas; Orlando, Fla.; Dallas, Houston, and San Antonio (see chart), all of which are in the South.

Top 10 Metros for Projected Vacancy-Rate Increases, 1Q14 to 4Q15
Charlotte, N.C. 1.3%
San Jose, Calif. 0.9%
Providence, R.I. 0.9%
Austin, Texas 0.8%
Orlando, Fla. 0.8%
Dallas 0.8%
Houston 0.8%
Knoxville, Tenn. 0.8%
Greensboro/Winston-Salem, N.C. 0.8%
San Antonio 0.7%

Of course, these markets have few, if any, supply constraints at the metro level, and investors and developers are well aware of their promising growth prospects. Consequently, new supply in these markets has increased to the point where it is racing ahead of the promising growth and projected net absorption.

Additionally, the majority of the units being developed are Class A, at a time when many markets around the country are experiencing historically high nominal rents. This will make many units unaffordable to prospective tenants.

It’s unlikely rent growth will turn negative in any market before the end of 2015, but growth could be muted, particularly in submarkets with a lot of new construction and fervid competition.

Slowing rent growth coupled with rising vacancy rates mean many properties could struggle to hit pro forma underwriting, and outright declines in submarket-level NOI growth could be possible as early as 2015.

Ryan Severino is senior economist and associate director of research at Reis, a commercial real estate research and analysis firm based in New York City.