Massive Momentum

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The multifamily sector has for quite some time been viewed as the darling of commercial real estate. According to a recent report from MPF Research, US apartment rent growth came in at 4.6% in the year-ending first-quarter 2015, which matched the result from fourth-quarter 2014 but was up from 3.2% a year ago, and occupancy landed at 95.4% in first-quarter 2015, up 0.1 percentage point quarter-over-quarter and 0.4 points year-over-year. Certainly since the housing bust and Great Recession, the sector has benefitted from those either leaving the single-family market or unable to enter it due to dramatically increased mortgage restrictions and other economic factors. But what continues to fuel the sector is the proliferation of Millennials who are putting off buying homes either as a lifestyle choice or out of necessity, along with several macro factors affecting the US economy as a whole.

While the Millennial flock to apartments is occurring largely in cities, which are experiencing an unprecedented revival, it is by no means restricted to the CBDs. According to a recent MPF Research study, CBDs produce slightly lower apartment-lease renewal-conversion rates than the suburbs. From December 2011 to December 2014, CBDs generally tracked 200 bps below high-rent suburbs in terms of renewal conversion rates in the nation's top 20 markets. Of those metros, only four averaged higher conversion rates in CBDs than in suburbs. Diana Pittro, EVP of RMK Management Corp., tells Real Estate Forum, “While downtowns and city centers have been hot spots for development, fueled largely by Millennials, development in inner-ring suburbs with walkable locations and access to transportation will also be a bright spot thanks to more Boomer/downsizing renters.”

Still, MPF Research's report says, the CBDs are no slouch in the apartment sector, having received 27% of all apartment development since 2010, which is double the share seen in the 2000s and quadruple the share seen in the 1980s and 1990s. So, the demand for apartments is everywhere.

The large “echo boomer” or Millennial generation, which is 80 million strong, is beginning to enter the housing market, and they are predominantly entering the housing market as renters, Caitlin Walter, assistant director of research for the National Multifamily Housing Council, tells Forum. “There is also an overall demand for the flexibility that apartment living offers—apartment renters are able to relocate easily for jobs in other cities, and many apartment communities offer robust amenities, both inside the property itself and in the surrounding neighborhood.”

The phenomenon is so strong that many CRE firms that focused on other sectors are jumping on the multifamily bandwagon. Kilroy Realty Corp., first and foremost an office REIT, has a handful of mixed-use projects with multifamily and retail components. “We have become more active in the multifamily business in these mixed-use contexts in response to trends we are seeing up and down the West Coast,” Jamas Gwilliam, VP, Southern California development and investments for Kilroy, tells Forum. “There is an intensifying demand for quality urban and urbanesque environments that appeal not only to Millennials, but also to an increasing number of Baby-Boomer/empty-nesters. No matter who the generation is, the trends in office, multifamily and retail are toward healthy, vibrant community living.”

Simply put, the Millennial mindset is driving today's demand for multifamily, and the American Dream is truly changing. “Millennials see homeownership as an anchor, as opposed to an investment,” says Jeff Olshan, VP of asset management for Passco Cos. “Unlike generations past, Millennials value flexibility in their lives, especially when it comes to their careers. By purchasing a home, Millennials believe they are limiting themselves and potentially missing the opportunity to accept future job opportunities that may require them to relocate.”

Pittro agrees that a culture shift has taken place, which has greatly affected the rental market. “People are more mobile. They move more, change jobs more, marry later and settle down later. Buying a home doesn't fit the lifestyle of many Americans.”

Olsham adds that this generation also saw the risk of homeownership during the downturn. “They watched people lose their homes and savings by investing in real estate, and today, Millennials typically do not believe the risk is worth the investment.” Nick Ryan, CEO of the Marquette Cos., adds, “A large part of the population was impacted by the housing downturn beginning in 2008. There is not the same level of confidence that an investment in a house or condominium will grow, and there are worries you may get 'stuck.' ”

For today's young people who can afford to buy, “we are seeing a higher sense of caution when it comes to purchasing homes,” says Sagiv Rosano, president and founder of Rosano Partners. “These individuals saw what happened in 2008 and don't want to risk losing their equity.” He adds that young buyers will also be competing against older cash buyers/investors in high-demand markets, which adds another hurdle to this generation owning in these markets.

There's also a growing segment of the population that's remaining single longer or needs flexibility to move around for career purposes, and does not want to commit to putting down roots in a house, says Rosano. “In addition, many Millennials may find that their lower levels of income/capital will inhibit their ability to purchase in the metro locations in which they want to live.”

GENERATION RESHAPING STYLE

On the development side, the style of today's rentals is being completely reshaped by this generation, says Olshan. “Millennials want highly amenitized, technologically savvy resort-style living in communities that offer and encourage social interaction. Further, they want amenities that fit their young lifestyles, including state-of-the-art fitness facilities, Wi-Fi, resort-style pools and entertaining areas. Millennials have truly changed the face of multifamily, and this trend shows no signs of slowing.”

Macro factors like population growth, new-household formations and employment growth are also contributing to apartment demand, Luke Daniels, president of the Richman Group of California, tells Forum. “Additionally, low inventory of for-sale housing, rising home prices and constraints/inefficiencies to the mortgage market are driving would-be homeowners into the rental-apartment market.”

Rosano says that supply and demand are at the basis of rental-apartment demand. “For example, in the Los Angeles market, there had been very little construction of apartment buildings since almost 2004. From 2005 to 2008, developers focused on building new condos, or converting apartment buildings into condos. With little to no new product coming to market during the recession, this market now demonstrates a shortage of supply, coupled with strong demand as the local economy improves.”

The affordability gap plays a role as well, says Rosano. “Job growth and income are lagging behind the growing need for housing. As a result, people are continuing to be renters for longer periods of time.”

Experts predict that demand for multifamily could last well beyond the current real estate cycle. “The youngest Millennials are not even out of college yet, and the 25-to-34-year-old cohort has the highest rentership rate, so it's anticipated there will be demand for many years,” says Walter. “This, combined with the fact that there are many current 25-to-24-year-olds still living at home with their parents (more than 20 million people under the age of 35) reveals a fair amount of pent-up demand for rentals.”

Most experts predict that the rental market will continue to be strong for at least the next five years, says Ryan, and historically, real estate cycles have lasted between seven and 10 years, says Olshan. “If the recession ended in 2010, that puts us in the fifth year of this current cycle. That means we have at least two more years of the continuing positive trend for multifamily, though there may be a few additional years beyond 2015 and 2016 in which growth will stay strong.”

Pittro points out that homeownership rates have been falling steadily since 2004 and are actually currently at a 20-year low. “Even as the for-sale market shows signs of recovery, there just doesn't seem to be much momentum there. We have two of the largest population groups in history drawn to renting: Boomers and Millennials. I see that segment going strong for many years.”

The only factor that might change this course, notes Olshan, would be a significant national, political or global economic event. “That said, I do believe we have a solid two years or more ahead of us for multifamily strength,” he adds.

Gwilliam says the adage that “they're not making any more dirt” could not be truer when applied to the multifamily rental market on the West Coast, which is making multifamily development increasingly more difficult. “Vacancies are in the low single digits, rents continue to increase, entitlements are becoming increasingly difficult and developers who are getting projects approved are building and repositioning multifamily spaces to appeal more and more to the trends that we are also seeing in the office sector: collaborative community areas where people can interact and enjoy one another's company.”