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Will Multifamily Apartments Continue to Fuel Housing Demand?

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After reporting record prices in 2017, U.S. homebuilding has started 2018 on a high. U.S. homebuilding paced to a 15-month high in January, primarily due to a sharp rise in construction of apartments according to government data released last Friday. In fact, the rise was driven by a 19.7% surge in apartment construction.

On the other hand, single-family homes started increased a meager 3.7% from December. The surge in homebuilding is being credited to strong economic fundamentals supported by impressive job data and higher wages. This in turn is also likely to quicken the pace of rate hikes, which could boost the rate spread for REITs from the sector.

Shift Toward Multifamily Dwellings

Historically, Americans have shown an inclination toward single-family homes. However, the scenario has witnessed a sea change post recession, with people opting for multifamily apartments in the absence of sufficient funds.

The changing trend triggered a rise in construction of multifamily apartments, peaking on stepped up activity in the New York metropolitan area between 2010 and 2015, when the recovery was in its early stages. The increase continued in 2016, as other major metropolitan areas too witnessed a surge in activity.  

Recovery Prompts Growth in Single Family Homes

However, with the economy recovering, multifamily apartments started witnessing a decline. The downtrend was palpable in 2017, when multifamily apartment starts were lesser than 2016, per Dodge Data & Analytics.

According to Robert A. Murray, chief economist for Dodge Data & Analytics, the scenario changed in 2017, as markets such as Los Angeles, Dallas-Ft. Worth, TX and Washington DC retreated from the levels posted during 2016. Going by national volumes, multifamily and commercial starts were worth $194.7 billion, down 7% from 2016. However, it was still 8% above the amount reported for 2015.

Does this mean that demand for single-family homes has increased? Going just by prices, per National Association of Realtors (NAR), average cost of an existing single-family home in the fourth quarter was $247,800, up 5.3% from the prior-year quarter of $235,400. Moreover, November 2017 witnessed a 17.5% rise in sale of newly constructed single-family homes, the highest pace since July 2007.

That said, demand for multifamily apartments may not have really gone down. According to National Multifamily Housing Council’s latest research report, demand for apartments in the United States is rising and country will witness an additional demand for 4.6 million apartments by 2030. If that is the scenario, U.S. homebuilders are well on track. Multifamily apartment starts may have witnessed a decline in 2017 from 2016, but it necessarily may not be because of a shift toward single-family homes.

According to data released by the Commerce Department last Friday, total housing starts surged 9.7% in January to an annual rate of 1.3 million units. This is the highest level recorded since October 2016 and the largest increase in 13 months.

It has been observed that multifamily housing is attracting real estate investors primarily because of demographic changes. An increasing number of both young and older Americans are going for rented apartments than buying homes. Moreover, monthly rental prices are not increasing much. Per real estate research firm Yardi Matrix, national average rent was $1361 in January 2018, 2.8% higher year over year but flat month over month. However, this is nothing compared with the 5.1% increase in monthly rent prices witnessed in 2014. This is perhaps because of an overall increase in apartment construction.

Can Multifamiy REITs Recover in 2018?

Of course, the fate of REITs related to the sector has been quite different. Long-term quantitative easing had compressed the rate spread, which this sector depends on to generate income. As a result, stocks such as Camden Property Trust (CPT - Free Report) , Armada Hoffler Properties, Inc. (AHH - Free Report) , Apartment Investment and Management Company (AIV - Free Report) and Equity Residential (EQR - Free Report) are down 10.4%, 10%, -10.1% and 15% over the last three months. Each of these stocks carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank stocks here.

The situation is likely to change radically in 2018. Three rate hikes are already scheduled for the current year. Further, the recent jump in yearly wage increases is likely to provide the much-needed thrust to sluggish inflation levels. This in turn could lead to a quickening in the pace of rate hikes, which could boost the rate spread of REITs. Given this backdrop, it is likely that they have a much better year ahead.

Further, a booming economy is likely to boost rents and demand for apartments. This will also increase fund from operation levels that will offset higher interest costs and boost REIT prices.

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