A Slow Move Toward Potential Oversupply

Stop me if you’ve heard this one: “Apartment developers, optimistic about the long-term health of the sector, continue to build new units at a robust clip.”

Sounds like something you’ve heard ­recently, doesn’t it? Yet, those words come from an article published in National Real Estate Investor in 2003.

Much like what happened 11 years ago, today we’re seeing a lot of new units being delivered to market, even as effective-rent growth trends downward and occupancy remains relatively flat. Certainly, there are huge differences between the two time periods. For one thing, there wasn’t demand from Millennials a decade ago. And Baby Boomers were still opting for owning in suburbia rather than renting in the city.

And who can forget the home-buying frenzy of the early to mid-2000s. Thanks to the subprime mortgage collapse, people are more skeptical about homeownership today.

Despite these differences, there’s reason for concern in 2014. In February, annual permits for projects with five or more units shot up to 407,000 units, a 27.6 percent increase from January’s annual rate of 319,000 and the highest level since June 2008. February’s figure was also 26.8 percent higher than in February 2013, when five-plus permits stood at 321,000 units.

With five-plus construction starts, the increase is less dramatic but still noteworthy: Starts ­increased 9.9 percent from January 2013 to January 2014. Yet, rent growth is slowing. The national effective-rent growth was 2.8 percent as of February 2014, compared with 3.5 percent the year before. National occupancy, in the meantime, remained relatively flat, at 94.1 percent.

Too Much Supply, or Too Much Hype?
Does all this mean too many units are being delivered? The answer: It depends.

Oversupply isn’t an issue in markets such as Atlanta or Phoenix; people in those MSAs are renting the new units as quickly as they come on line. On the other side of the spectrum, Washington, D.C., saw an onslaught of new units in 2013 and continues to struggle to absorb them. The same thing is happening with urban core submarkets in many MSAs, such as downtown Denver.

In fact, the projected top 10 U.S. submarkets for identified unit deliveries (see chart) show that mainly urban areas are experiencing increased supply. (Identified deliveries describe projects already under construction; these numbers could increase as new developments break ground.) That trend, combined with increasingly budget-minded renters who are opting for Class B properties, is exerting downward pressure on effective rents.

This doesn’t mean we’re in the same straits we were a decade ago: The apartment market remains strong, and there are areas in which demand still outpaces supply. But the overall decline in annual effective rents nationally suggests that the period of rampant demand and limited supply is nearing its end. As such, developers and investors need to be careful when it comes to building properties with upper-end price points, especially in concentrated, land-constrained locations. Otherwise, we could see more articles about rising vacancies, lower rents, and empty units.

Jay Denton is the vice president of research at Axiometrics.