As we move into a changing economic environment we must focus on diversification into other markets where cost of acquisition is lower but job growth and wage growth is still strong. Ideally, we are looking for markets where the cost of new construction is higher than existing housing stock and the macro market shows good economic growth.
National data as of Q2 2019 suggests that there are approximately 800,000 new renters that enter the market every year. The demand requires about 325,000 new units that are needed each year to keep up with demand. This volume was last delivered in 1989.
At the same time, approximately 125,000 apartments homes are lost each year due to obsolescence. Therefore American needs to build about 450,000 new housing units to account for growth and those lost annually. In 2018 the market only delivered 257,000 units – leaving s substantial shortage.
In general, we can broadly categorize rental housing into two categories. Workforce housing and luxury or lifestyle housing.
Workforce housing is targeted for renters by necessity. It is for people that lack the wealth to acquire a house on their own. Workforce housing tends to leverage existing, old product on the market because the sector is not facing competition from new built product. As real estate values have increased, so has the cost of land. Therefore, it is not cost effective for builders to build workforce housing to rent.
Looking to the future, workforce housing likely has the greatest amount of future growth – especially if you focus on smaller markets with good job growth. By necessity this housing has to pencil out to be effective so this product works best in markets in the middle of America. Think cities like Nashville, Memphis, Cincinnati, and suburban Atlanta.
Despite being more prevalent in smaller markets, the sector has still experienced impressive growth in the past year. The national vacancy for Class C properties has dropped from 7% to 4%. Rent growth year over year increased more than five percent – more than each Class A or class B.
The national vacancy for Class C properties has dropped from 7% to 4%. Rent growth year over year increased more than five percent – more than each Class A or class B.
The second segment of renters are the luxury or lifestyle households. These residents are renters by choice. They can be retired baby boomers or single professionals that may have high incomes but not the credit to purchase a home. A number of the larger REITs cater to this market. Avalon Bay, for example, targets millennials in urban, high density locations. They build the newest buildings in close in suburbs. Similarly, MidAmerica (MAA) is a sunbelt REIT that focuses on areas with high job growth and put strong management in place.
What does this mean in a changing economic cycle?
First, remember that real estate is local. One market could be a very tight sellers market while another is relatively flat. It is important to keep fundamentals and focus on markets that have the best economic indicators or job growth rates. Larger operators can diversify markets while being cognizant of job creation and income growth.
Our portfolio is regional. This means while we do have some geographic or market diversification, should the entire region be hit simultaneously, our footprint may not offer much of an advantage. We have an interesting dilemma of needing to achieve a certain degree of scale in each market while maintaining diversification. To make entering a market financially feasible, 50 units is required. Our primary objective going forward should be to obtain at least 50 operating units in each market.