The Rental Boom

REIT apartment projects respond to growing demand for rental housing


It may take several years before single-family home construction starts to climb again, thanks in large part to overbuilding during the boom years of the sub-prime mortgage craze. But that doesn’t mean all housing construction is flat.

In fact, Real Estate Investment Trusts (REITS)— or real estate companies that offer common shares to the public, with a primary function of managing groups of income-producing properties that then distribute a majority of their profits as dividends — are pouring billions of dollars into institutional apartment developments aimed primarily at so-called Generation Y renters. Members of this generation, also known as Echo Boomers, were born in the late 80s or early 90s,and according to some estimates, they number as many as 70 million and are the fastest-growing segment of today’s work force.

REITS Recognize the Gen Y Influence

Analysts, financiers, developers and REIT executives, all clearly recognize the influence of the younger generation in today’s marketplace. Many of these young people may be hesitant to buy a home after watching parents or older siblings affected by the housing decline of the past few years. They’re looking for the greater mobility and flexibility that apartment living offers compared to homeownership. In addition, studies show they’re interested in environmental sustainability and want shorter commutes; making them less inclined to buy a house in the distant suburbs, which has traditionally been a prime location for first-time homebuyers.

“For them, rent is not a four-letter word. They are thinking about their housing options very differently, compared to previous generations,” said Haendel St. Juste, an analyst with Keefe, Bruyette & Woods (KBW), an investment banking and security brokerage firm based in New York.

Yet surveys continue to show a high desire for homeownership, including among the younger generation. Most recent, the September 2010 NATIONAL ASSOCIATION OF REALTORS®’ Housing Pulse survey found that 77 percent of Americans believe buying a home is a good financial decision; a Gallup poll in April 2011 found that 69 percent of Americans say now is a good time to buy a home; and NAR’s newest Community Preference Survey (see page 10) found that 74 percent of those ages 18 to 29 want to live in a single-family detached home. However, St. Juste still predicts a strong rental demand from Gen Y buyers.

“They’re not really sure if they want to get locked into a home. They value the ‘liberty premium.’ They believe there’s a lot to be said for being able to pick up and move with their job or simply because they want to live in a different region of the country,” explained St. Juste. “So this Echo Boomer demand is strong and growing.”

“There’s been a wholesale shift and change in attitude about renting vs. owning,” St. Juste adds.

That means: an almost “perfect storm” for REITS planning apartment developments for the next few years. The combination of these prime factors position REITS to act now — they have access to reasonably priced capital, while private developers don’t; the demand for apartments is strong; supply is flat; and attitudes toward renting have shifted.

“In fact, for 2011 and 2012, we are forecasting we’ll see a net reduction in supply, meaning that the number of apartments being added is less than the amount that is becoming obsolete and getting torn down. That hasn’t happened since we have been keeping track of statistics since WWII,” said St. Juste.

He believes apartments will “garner more than their fair share of new household formation for the next couple of years.”

“I’ve seen some studies that predict that over the next five years, two-thirds of new households formed will be renters. That’s pretty interesting because if you look at the marketplace now, its two-thirds homeowners and one-third apartments. The balance is shifting somewhat. Homeownership peaked in the third quarter of 2007 at 69.2 percent, but it is trending down and will probably get below 65 percent.”

According to economists, each percentage point decline in homeownership means one million new renters.

In fact, St. Juste said the move back to apartment dwelling is already having an effect on how American cities look. “We’ve seen cities push toward designing 24-hour downtown centers that are based not only around jobs, but housing, retail and entertainment that add a certain desirability for people to move to and live in some of the downtown areas in some of the larger U.S. cities.”

“How significant it becomes over the long-term is anybody’s guess,” he said. “But this new generation, the people coming out of school now, have different views and tastes and desires. I think you will see that in new types of housing product that will be delivered and the location and the packaging of it to meet those changing views and attitudes.”

However, St. Juste is still cautious. “There doesn’t seem to be much risk for the REITS for the short term, which makes me a little nervous,” he added. “We can’t forecast global, macro, exogenous shocks or anything that is going to go on in the Middle East or Japan. But the U.S. economy, knock on wood, seems to be slowly recovering. And with supply at historical lows, emerging population growth — especially for those in the prime rental age — makes apartment development look almost too good to be true.”

Development through REITS

For REITS, it’s a major turn-around from 2009, when they were in a capital preservation mode and did very few apartment developments. In 2010, however, they broke ground on nearly $2 billion worth of new projects and are forecasting as much as $3 billion in developments this year.

The top developer is AvalonBay Communities of Alexandria, Va., which got a jump in 2010 with$650 million in project starts and is forecasting another$850 million this year. That’s a hefty total of $1.5 billion. Other top developers include Chicago’s Equity Residential, $400 to $500 million; Colorado’s UDR, $300 million, Houston’s Camden Property Trust, $50 million to $150 million; San Francisco’s BRE Properties, $90 million to $120 million; Atlanta’s Post Properties Trust, $100 million; and Alabama’s Colonial Properties Trust, $50 million.

That’s a lot of money invested into apartment dwelling across the nation. Some observers predict REITS may be funding up to 80 percent of the apartment projects this year and next — turning the old ratio on its head. In past years, it was private developers who did four-fifths of the apartment development. Most of them, however, have been shut out of the market by the financing squeeze.

Paula Poskon, a senior research analyst with Robert W. Baird, said “onerous” loan conditions offered by regional banks to private builders have kept and are continuing to keep them from developing many new projects.

“So the players best positioned to re-ignite development are the best capitalized players and those are the publicly traded REITS,” she said. “If the credit situation improves, private developers could come back into play.”

But that will only happen as regional banks clean up their balance sheets from the last round of lending.

“That is just starting to happen,” she said. “I would say as asset performance gets better with the steadily improving economy, these banks will finally address some of these outstanding bad loans and that will free up capital to re-lend.”

In the meantime, she said some private developers are teaming with REITS on projects because REITS have the money … “REITS have a window of opportunity, a sweet spot, while construction costs are still low. They have access to capital, so they are ahead of the regional merchant developers in this cycle. And the funda-mentals are improving for a multi-year period.”

Developers see the potential in what the analysts predict. According to Mark Tennison, an executive vice president at Equity Residential, the nearly $3 billion worth of apartment starts this year by REITS will only partially meet the growing demand.

“There has been a dearth of supply coming into the market,” said Tennison, whose company is building projects this year in the large metropolitan markets of Los Angeles, New York City and suburban Washington, D.C. The firm is also looking at other potential starts in Northern California and South Florida.

“If the normal supply run rate is 300,000 to 350,000 units a year, we dipped well below even a third of that number,” he said. “In fact, the net new supply was running negative for a period.

“It’s created an environment that is very supportive of development, one that should continue for three to five years. How soon we get back to that standard run rate is really a function of the capital markets.”

In addition to being reticent to own a home, he said the Gen Y cohort is migrating to metro markets for job opportunities and quality of life. “As they do so, they are shedding some of the components of suburban living,” he said. “If you live in Manhattan, you probably don’t need a car. Your neighborhood has the amenities you need for your life. And work is likely a subway commute away. That’s the demand we’re meeting, and we see it continuing for some time to come.”

Poskon also acknowledges the Generation Y influence, and cites, as well, that the younger demographics and changes in attitudes about rent are pushing apartment growth.

“In 2009, we saw a peak number of high school seniors graduating in the United States,” she said. “Some have already moved into the work force and others will be graduating from college in 2013 or later and starting their careers.”

Coupled with that is a decline in homeownership, fueled in part by a significant number of people moving into rental properties because of foreclosures, job loss or a new preference to rent. This latter reason is part of what Poskon called a “secular shift” in the Echo Boomer cohort.

“They are leery of owning a home, they want that all important freedom and they are marrying later, having children later…. All these things are shifting the demand curve. Also, with Echo Boomers’ focus on being environmentally friendly, mobility and thinking of themselves as citizens of the world, it is going to be a long time before we get back to those folks wanting to live 25 miles out in the suburbs.”

What might mitigate that a bit, she said, is a societal shift of having multi-generations back under one roof. Then it might make sense to buy a bigger house if you have parents with young children and grandparents all living in the same dwelling.

“When you think about the cost of long-term care, that could be a good option for some folks, especially if you add in tougher underwriting standards for mortgages and higher down-payment requirements,” noted Poskon, whose 80-year-old mother lives with her half the year.

In the meantime, who knows what will drive the next market surge, but for the moment, REITS are primed to meet the needs of the new generation.

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