This article was posted on Wednesday, Jun 13, 2012

Why Many Apartment Markets Have
More Good Years Ahead
By Patrick Simons

Is a glut of new apartments inevitable?  Should you be worried about all the proposed projects you’re hearing about?  Are we seeing signs of irrational exuberance in the rental housing industry?
We do a lot of forecasting for clients based on detailed supply-demand analysis.  Sometimes, our forecast for a particular submarket raises a caution flag for a client.  Sometimes, our forecast comes in just about where a client expected.  But oftentimes, recently, our clients have been pleasantly surprised with forecasts projecting better stability and growth in a particular submarket than they had anticipated.
These better-than-expected forecasts are primarily due to two factors:

¢    Overly negative prevailing expectations for some markets.
¢    Our unique methodology.
First, let’s look at the overly negative prevailing expectations.  Everyone right now is concerned with the seemingly enormous pipeline of new apartment projects in many markets.  And, rightfully so.  Certainly, given where we’ve been the past ten years with the manic rush of new condo construction leading up to the glut and subsequent crash many markets are still working through, it is not only understandable but prudent that so many in the industry are concerned about the seemingly large pipeline of new apartment projects.
Did you catch that keyword in the last sentence?  ‘s seemingly.  Our detailed methodology addresses that keyword as we diligently evaluate the likelihood of each proposed apartment project actually becoming reality.
We categorize future projects into three tiers of likelihood of delivery (our three buckets of future supply).  These are likely, potential, and unlikely.
How do we do this?  By rolling up our sleeves and contacting planning departments, developers, and debt and equity sources involved in each proposed project in a market area.  We then, weigh the status of the government approvals, the financial strength and historical track record of the developer, and the status of the capital commitment for the project.  Depending on that evaluation, we then place a project in one of the three buckets.
Think about it, you’re probably familiar with at least one project that’s been anticipated in your market for ten, fifteen, or perhaps even twenty or more years.  But it has just never gotten built for any number of reasons including perhaps environmental challenges, an erratic owner or developer, tough financial challenges, or all of the above.
Would it make for a very accurate forecast to include that project in the future supply list?  Probably not.  While we would certainly place it in the unlikely bucket, our likely supply-demand forecast would not include it unless some favorable material changes were to occur.
So, here are a few examples of specific submarkets within larger metro markets from recently completed assignments.  Below are areas and  their percentages of total proposed projects that are likely.

¢    A San Jose Submarket:  60%
¢    A San Francisco Submarket:  47%
¢    A Los Angeles Submarket:  38%
¢    An Orange County Submarket:  27%

Right now, even though everything we read says that rental housing is the current darling of real estate, capital is still very (very) constricted and selective.  Yes, to overly simplify, the profligate capital markets that fueled the condo run-up, are still smarting and not at all interested in repeating the mistakes of the last boom.
This means that many of those new apartment projects being talked about will not end up in the “Likely” bucket. And that’s good for the apartment market, especially considering that much of the still anemic growth in employment will go to younger workers who will initially be renting apartments.
Now, don’t get me wrong.  There are still areas deserving real concern.  One of my oft-quoted sayings is not all submarkets are created equal.  So, while many submarkets will likely have less new supply delivered than is widely anticipated, some submarkets will be oversupplied in the near future.  Make sure you understand your submarket.

- Advertisers -

Patrick S. Simons of Strategic Property Economics has been personally involved in the development or redevelopment of more than 22,000 units and the oversight of nearly $700 million of residential assets.  For more information, please call (949) 933-9405 or e-mail [email protected].

Leave a Reply