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With the U.S. housing market continuing to recover, residential real estate developers are welcoming increasing demand in the multifamily sector. However, for a number of reasons, some areas are offering more opportunities for profitable development than others.
Tightening supply, rising prices and changing renter needs are just part of the picture. Developers who understand the driving forces behind the rising demand in multifamily housing can craft better strategies for their next projects and achieve strong profitability as a result. After all, over the next five years, the top 30 U.S. metropolitan areas are expected to see 617,000 new apartment units, which is short of the 677,000 expected to be in demand, according to estimates by research firm Yardi Matrix for June 2018.1
While the growing demand offers plenty of ways to prosper, there are also challenges to take into account, such as the effect on home prices, which are rising. Developers should also consider changing expectations for amenities and preferred locations, as well as economic drivers.
Soaring prices in real estate are good news for real estate investors and homeowners, but for renters, housing is less affordable. The shortage of affordable housing provides opportunities for developers of multifamily housing. However, developing these projects can present challenges to profitability.
Development costs such as land, entitlements, materials and labor continue to increase and create pressure on new development budgets.2 Meanwhile, tax credit equity prices have declined due to tax reform, and increasing interest rates are cutting into loan proceeds. The combination of increased costs and reduced proceeds are having an impact on the type and location of new development, particularly development of affordable housing, where increased costs cannot be passed along to the tenants in the form of higher rents.
Within the affordable housing picture, many developers are turning to aging buildings to cut down on initial construction costs. About 66% of rental properties were more than 30 years old in 2016, up from 41% in 1980. Developers can expect that with the short supply of new buildings, demand for space in old buildings can still result in higher rents. In fact, the median rent for units in buildings built before 1960 increased 21.4% from 2000 to 2016.3
With stagnant wage growth, renters are spending more of their income on housing. To help keep rents affordable, some developers are trying to build lower cost units with fewer amenities. Others may push development into less desirable locations where they can build at lower costs.2
Developers can expect higher demand for a lifestyle that puts amenities closer to home. As one example, renters are calling for living spaces with “smart home” features. In the next two years, an estimated 26 billion devices are expected to be connected through the Internet of Things (IoT).4
For developers, that means prioritizing convenience for potential renters and perhaps integrating retail space, offices and gyms into their projects. Developers can also consider how technology can play a more prominent role in their apartment communities with features like high-speed internet.
Many demographic changes are influencing multifamily housing demands. Among them, aging Americans, including retiring Baby Boomers, are looking for living options that provide amenities like assisted living features and medical care services.
Meanwhile, younger generations like Gen Z (those born from 1995 to 2012), have different needs than in the past. They are seeking apartments within easy commuting distance of their work, but they also want to feel like part of a community. Developers can consider technology upgrades, shared entertainment spaces or transportation advantages like shuttles to attract the growing number of Gen Z renters.5
Finally, immigration trends can also affect the type and quantity of multifamily housing developers should plan for. Immigrants are far more likely to rent than native-born Americans, and their ranks are on the rise. The immigrant population is expected to grow by more than the native population by 2024 for the first time. Developers can expect these households to need living space for four or more people.4
Capital is anticipated to be plentiful throughout 2019 despite volatility in the stock market.6 Sources of capital, including a surge of non-bank lenders, are expected to compete heavily to win business. This may result in oversupply in some markets.7
More volatility in the market is expected throughout the year, with a downturn anticipated in the next three to five years.6
Both baby boomers and millennials are competing for the same type of rental property in many markets. Millennials, saddled with student loan debt, are having trouble qualifying for mortgages, which means they are pursuing rental properties. They are contributing to a rise in demand for more affordable housing options, but they also want attractive amenities. Meanwhile, retiring baby boomers who want to “age in place” are also looking for space in high-density areas with features that complement their active lifestyle.
Multifamily renters are also increasingly prioritizing location. In this housing sector, urban areas continue to attract a range of demographics with city-living advantages like convenient transportation.5
Developers should also consider that millennials are demanding that suburban areas be more like urban environments. With this generation marrying later in life, they are generally slower to move to the suburbs. And when they do, they expect many of the same advantages they enjoyed in the city.
That means developments that include “urban” features like walkability, proximity to mass transportation and communities that integrate office and retail will likely have an edge. For location, developments in suburban areas that are closer to cities may make it easier to provide those popular benefits.
Today’s housing market is indeed thriving, particularly in multifamily housing. However, developers should be aware of the challenges in this market, including the rising cost of construction and changing consumer demands.
By tapping into cost-cutting measures like renovating older buildings and targeting markets where demand is particularly high, real estate developers can find ample opportunity to profit amid today’s booming multifamily housing scene.
For more information, please contact your PNC Real Estate Relationship Manager or Loan Officer.
This article was prepared for general information purposes only and is not intended as legal, tax or accounting advice or as a recommendation to engage in any specific transaction, including with respect to any securities of PNC, and does not purport to be comprehensive. Under no circumstances should any information contained in this article be used or considered as an offer or commitment, or a solicitation of an offer or commitment, to participate in any particular transaction or strategy. Any reliance upon any such information is solely and exclusively at your own risk. Please consult your own counsel, accountant or other advisor regarding your specific situation. Neither PNC Bank nor any other subsidiary of The PNC Financial Services Group, Inc. will be responsible for any consequences of reliance upon any opinion or statement contained here, or any omission.
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