Published: December 31, 2007
By Linwood Thompson, Marcus & Millichap

Job growth, tighter mortgage underwriting and rising residential foreclosure activity are expected to generate adequate demand to offset competition from shadow rentals at the macro level in 2008. Apartment development has remained in check, and only a moderate increase in completions is anticipated this year. Some previously hot housing markets, however, are facing a glut of for‐rent condos and single‐family homes. Local vacancy rates in these markets are headed upward, though a major correction is not expected.

In South Florida, for example, the majority of new condos are in high‐rises. It is estimated that less than one‐quarter of new stock could realistically compete with traditional apartments for renters, though the Class A market may encounter more competition as some luxury condo owners lease units at discounted rates to partially offset mortgage payments.

Meanwhile, in high‐growth Southwest markets, there are many converted condos available at competitive rents, but single‐family properties present a minor threat to apartments. In most cases, single‐family homes offered at affordable rents are in perimeter locations; given high gas prices, lengthy commutes will dissuade most in‐town renters from moving.

Upcoming demographic shifts will work in favor of apartments, as roughly 70 million echo boomers will make their way through college over the next decade. There are, however, some near‐term trends worth watching, including an anticipated shift in performance by property class. In 2008, the Class B/C market is well‐positioned to outperform Class A for the first time in several years. From 2005 through early 2006, the Class A market posted above‐average rent growth and the tightest vacancy registered since 2001, as the sector lost almost 200,000 units to conversions.

Class A vacancy is now set to tick up to the national level due to re‐conversions and competition from shadow‐rental stock, while Class B/C vacancy is expected to fall slightly. Residential foreclosure sales in some markets could also bring home prices down to levels in reach of Class A renters. Fortunately, higher down payment and underwriting requirements will help to offset this trend.

The following are highlights of the report:

• There are just over 100,000 apartments slated for delivery in 2008, up from 84,000 units in 2007 but still low compared to the period between the late 1990s to 2001. The more cautious lending environment will help to prevent overbuilding.

• Apartment vacancy is forecast to hold steady at 5.8 percent this year as a minor uptick in Class A vacancy is offset by a slight decline in the lower tiers of the market.

• Rent Growth Moderating. Healthy occupancy will support asking rent growth of 4 percent this year, compared with 4.5 percent in 2007.

• Effective rents are forecast to rise by 3.6 percent as owners increase concessions to compete with shadow‐rental stock.

• After rising 400 basis points from 2001 to 2005, the homeownership rate among the 25 and younger age cohort is declining. The timing of this trend could not be better for apartment owners, as echo boomers are entering their prime renting years.

• Roughly 315,000 apartments were converted from 2003 to 2006, 10 percent of which recently returned to apartment inventory. Even after considering individual condos for lease, supply reductions remain a net positive for the market.

Markets to Watch in 2008

In Marcus & Millichap’s long‐awaited 2008 edition of the National Apartment Index (NAI), we provide a snapshot analysis that ranks 43 apartment markets based on a series of 12‐month forward‐looking supply and demand indicators. Markets are ranked based on their cumulative weighted‐average scores for various indicators, including forecast employment growth, vacancy, construction, housing affordability and rent growth. Taking into account both the predicted level and degree of change over the forecast period, the index is designed to indicate relative supply and demand conditions at the market level.

It is also important to note that because the NAI is an ordinal index, differences in specific rankings should not be misinterpreted. For example, the top‐ranked market is not necessarily twice as good as the second‐ranked market, nor is it 20 times better than the 20th‐ranked market.

The impacts of the housing slowdown on the apartment market are expected to vary throughout different regions of the country in 2008. The glut of for‐sale inventory in Florida and some high‐growth markets in the Southwest will lead to competition from the shadow rental market. In other more expensive housing markets, such as the Bay Area and New York City, the shadow‐rental market is less of a threat, and the slowdown in home sales, tightening of credit standards and rising foreclosures should provide some additional renter demand for apartments. Some of the hardest‐hit housing markets rank in the top 10 of our index, apartment fundamentals are still generally strong in these markets, and forsale housing remains out of reach for many residents.

In the 2008 NAI, San Francisco moved up seven places to take over the #1 position. San Francisco, already one of the tightest markets nationwide, is forecast to post the highest effective rent growth in the country and will also rank in the top three for vacancy improvement. Seattle moved up five places to the #2 spot, as above‐average employment gains, particularly by high‐tech firms, and significant increases in the renter population will fuel demand for apartments.

Last year’s leader, New York City, slipped to #3, despite ranking near the top for several metrics measured in the index; slowing employment growth and a mild uptick in vacancy caused the decline.

Technology hiring is also supporting Silicon Valley apartments, and above‐average effective rent growth and tightening vacancy moved San Jose up eight places in the index to the #4 spot.

Oakland holds the #5 position in the 2008 NAI, down two places from last year. Oakland has one of the least affordable housing markets and a comparatively low vacancy rate. The reason for this year’s fall is due to a minor uptick in vacancy. Los Angeles moved up three positions in the index to the #6 spot.

Despite housing‐related layoffs, Los Angeles is expected to increase payrolls in 2008, and the vacancy rate will remain one of the tightest in the country. Improving economic conditions placed Las Vegas in the #7 spot, a three‐position fall from last year.

Orange County dropped six positions in this year’s ranking to #8, as fallout from the subprime collapse is slowing job growth, but the metro remains one of the strongest apartment markets nationwide. High scores in vacancy improvement and employment growth bumped Tucson up eight places in this year’s ranking to the #9 spot. San Diego fell five places to round out the top 10. Despite slowing job growth, San Diego ranks among the top markets for effective rent growth and metrowide vacancy levels.

The most significant downward movers outside of the top 10 are the major Florida markets. These markets were on the forefront of the condo conversion craze and have lost a significant amount of ground due to high exposure to housing‐related industries. Fort Lauderdale (#15), West Palm Beach (#24), Orlando (#27) and Tampa (#28) all dropped nine places in this year’s ranking. Miami (#20) also had considerable downward movement, falling seven positions.

Similar to previous years, the lower tier of the index includes mostly slower‐growing Midwestern markets, although many of these areas will improve in 2008. Kansas City (#34) will record the nation’s strongest vacancy improvement, while Indianapolis (#32), Cleveland (#38), Columbus (#39) and Detroit (#43) are forecast to build on last year’s occupancy improvements with additional gains in 2008 as well.

Linwood Thompson is the senior vice president and managing director of Marcus & Millichap’s National Multi Housing Group