The end of 2014 will test the exploding market for new high-rise multifamily projects across the United States.
Development and investment in these properties is being driven in large part by Millennials, who have shaped commercial development in many major U.S. cities in recent years. Indeed, the past few months have seen a significant wave of high-rises opening their doors to Gen Y move-ins, as well as their Baby Boomer parents.
Investors are concerned, however, that the growing number of high-rises could result in excess inventory. In response, many investors and lenders are waiting until the developments are fully marketed and residents start to occupy them before taking a deep breath, assessing the communities' potential, and deciding whether to invest further.
High-Rise Projects Take Time
Often reaching 20-plus stories, high-rises take time to plan, entitle, design, and build. Entitlements and architectural design take longer than with less-detailed buildings, and financing is more complex than that for a suburban garden-style project built out of wood. Construction of a high-rise can stretch to two years or longer.
Before the recent high-rise boom, smaller, two- and three-story wood-built apartments were the attraction for many investors. These garden-style developments are easier to design, execute, and capitalize than high-rises and take only about a year to construct. Yet, during the current cycle, high-rise projects have overshadowed their smaller counterparts.
Success Varies by Regional, Demographic Markets
The construction and development budgets for high-rise projects were given the green light just a few years ago. These bets are now gaining clarity, with some markets looking stronger than others.
Meanwhile, investors and developers continue to chase Millennials and Boomers, who increasingly prefer living in urban environments. These groups want easy access to efficient mass transit, prefer to rent than own, and want to live near entertainment venues, restaurants, and shopping. Upscale apartments in booming cities are fitting the bill.
Washington, D.C., was ahead of the trend for a time but now represents a cautionary tale. The expansion of the federal government at the onset of the recession led investors and developers to focus on the nation’s capital, and projects broke ground ahead of other major markets.
D.C. has seen thousands of upscale units come on line and, now, occupancy rates there are declining. Rental rates have gone flat, and, in some cases, fallen. If a developer missed the first wave in D.C. and opened a new project this summer, there are undoubtedly nervous partners watching and waiting.
Windy City Overstressed
To a lesser degree, a similar cycle is starting to play out in Chicago, where the number of projects opening their doors to renters has caused rent growth to stagnate. More projects will be completed there this fall, stressing an already fragile market.
Chicago is on the radar of market analysts watching apartment trends and wondering whether rents will decrease. If rents at new projects go down, the owners of existing apartment properties will start to feel the impact. And as new developments struggle to fill their units, they may resort to increasing concessions to entice renters to move out of an existing residence into a shiny new project.
This movement can have a devastating effect on nearby existing properties, which will often respond, in turn, by lowering their rents—thus precipitating the cycle's next downward trend.
Job Growth = Success in Texas
The question going forward is, will Millennials and Boomers continue to fill projects in other primary and secondary markets?
In Texas, where Austin, Dallas, and Houston enjoy growth, the answer appears to be a resounding yes, with lots of supply now opening up and more to come on line soon. Fortunately, job growth in the Lone Star State continues to be bright.
For example, State Farm is building a 2-million-square-foot campus in the Dallas area. The company has said it will hire more than 7,500 workers to staff the site. In Houston, the energy services industry is projected to add more than 75,000 jobs before the end of the year.
The markets with true job growth are performing very well and, to date, have been resilient in the face of staggering new supply. In markets where job growth is light, however, declining rents and occupancies prove that apartment developers are providing more than enough supply already. Demand from population growth in these areas is quickly being met, leaving developers to fight existing properties to fill their new buildings.
Jim Dobbie is a senior vice president for Hunt Development, which is involved in high-rise developments across the country, including recent projects in Dallas, Austin, and Houston.