The good news for multifamily investors is that there’s never been more demand for apartments, as both millennials and Baby Boomers seek an urban lifestyle without the expense or upkeep of home ownership.
The not-so-good news is that construction is not keeping up with the demand, say the leaders of the National Apartment Association (NAA).
“We’re not building at the levels we need,” said Robert Pinnegar, CEO of the NAA. “Consumer choices have shifted. While people talk about redevelopment the suburbs, at this point, people want an urban environment, whether it’s a city environment like New York or it’s out toward the suburbs with a walkable feel. And this challenge in cities is that land availability is a huge issue.”
The organization’s recently released study “U.S. Barriers to Apartment Construction Index” observed that the United States needs 4.6 million apartments at all price points by 2030 to keep up with current demand. Only in the last two years has development begun to meet those goals because of affordability, and high barriers to construction. For example, the study found that in New York City, the income required to afford an average rent is $102,840. But the median rental household income is $48,300.
Combatting opposition to new development requires a lot of legwork with community leaders, and requires substantial investment, he added. Large developments largely are building amenities including retail and entertainment first to create a destination before building the majority of the residential portion.
While many mall and office developers are talking about turning vacant buildings into residential towers, “we do not see this as a prevalent trend,” said Paula Munger, director of industry research and analysis. “There are pockets.”
Pinnegar notes not every mall is in the best location for residential. In addition, a project in transition may have to renegotiate leases with existing retail tenants to permit a new use, as well as deal with parking requirements and restrictions.
“We are seeing some cities and municipalities ease up on parking requirements,” Munger said. “They’re taking baby steps in the right direction, and would reduce the cost of construction.”
Meanwhile, many urban residential buildings are mandated to have retail on the ground floor, despite the sector now facing unprecedented challenges.
“I’m hearing that it is a challenge,” Pinnegar observed. “But change has to happen on a neighborhood basis.“
In addition, retail must also include services such as dry cleaners, to serve the community. These uses may need subsidies from the landlords.
Millennials are buying homes, Munger observed. But the sheer size of this generation (with 73 million people expected to overtake the Baby Boomers as the largest in history this year, according to Pew Research), still results in significant apartment demand. And there is a significant difference between the first millennials, now in their late 30s and starting families, and those in their 20s, who are still paying off student loans. Add in this generation’s distrust of using home ownership to build wealth as a result of the Great Recession, and apartments will be in demand for some time to come.
“Coming up behind millennials is Gen Z, a group nearly as big, who will be burdened with the same student loan debt as millennials, and the trend will be the same,” Pinnegar said.
Millennials/Gen Z and Boomers seek different amenities, however. Though tech-native millennials are perfectly happy controlling their environment through smartphone apps, seniors prefer physical keys for doors. WiFi, now considered standard, is more complicated than one might expect — landlords must have separate systems for the management, for the common areas, for the residents, and for all the services controlled by the smartphones.
“There’s a whole infrastructure issue surrounding all these systems,” Pinnegar said.
New communities can, of course, design all of the amenities into the plan. Retrofitting into existing product is much more challenging, he observed. While technology will catch up, buildings will be recategorized as A, B and C by amenities rather than age.
Foreign capital was originally gateway focused, but as it becomes more familiar with opportunities and the sector, it is becoming more comfortable with secondary cities. Meanwhile, as gateway cities become prohibitively expensive, residents are moving to satellite cities: Baltimore rather than Washington, D.C.; Milwaukee rather than Chicago.
Some of this could be helped by the establishment of Opportunity Zones, which defer taxes on monies deployed into qualified funds buying or building in a designated underdeveloped area.
“People were sitting and waiting it out as they waited for more information,” Munger said, with Pinnegar adding that there is still confusion about the program.
“Because there is demand, we’re getting returns that allow landlords to operate,” Pinnegar said.
But the lack of comfort with technology can be a challenge for a small margin industry. The result for some landlords will be a polarized industry as landlords struggle to accommodate an aging population less comfortable with tech, and the younger generation who expects a high-tech environment that allows them to control their environment remotely. And managers must choose their tech partners carefully.
“The company you integrate with now, will it be around in five years?” he observed. “Will it be acquired?”
In a recent NAA survey of landlords and residents revealed that landlords who are reluctant to invest are concerned about future proofing, which is nearly impossible, Munger said.
“It’s really challenging to keep up,” she said.
But there will be value in making portfolios more efficient through technology, Pinnegar noted. And eventually, there should be a turnover of portfolios as some members in the next generation of family-run firms decide to pursue other interests.