Multifamily investment returns have exceeded all other property returns according to the National Council of Real Estate Investment Fiduciaries(NCREIF), the market standard for measuring real estate performance, by 63 basis points over the past decade (1995-2004). In addition, multifamily returns are less risky, showing just over half of the volatility of a composite of all property types over that same period.

These stellar results have produced strong interest in the sector from institutional investors, yet few probably fully appreciate the intricate dynamics ofthe multifamily market. Like commercial real estate markets, apartment markets are subject to the forces of supply and demand; however, multifamilymarkets are also strongly influenced by a unique set of other micro- and macro-level forces. Demographics are the underlying driver of multifamilydemand, but demand is also shaped by economic and public policy, lifestyle considerations, local land use laws, and other nonquantifiable factors. The importance of these factors means that multifamily investment results are exposed to a set of risks that are unique among real estate property types.

Starting with demographic factors, forecasts of rental unit demand can be readily derived from a series of demographic calculations starting withforecasts of population growth by age cohort. The U.S. Census Bureau, along with private demographic data services, prepare long-term population forecasts by age cohort, which can be used for this purpose. As indicated in the diagram on the following page, household formation rates and tenure rates (indicating renter or owner) are applied to individual age cohorts to derive forecasts of rental demand. Like the marketing firms that use this data to estimate demand for consumer products, real estate researchers prognosticate on future prospects for the multifamily sector based on counting heads in this fashion.

The most recent demographic forecasts for the U.S. suggest that rental demand will surge in the coming decade as “echo boomers” enter the workforce. Echo boomers, who are currently 20-24 years-old, will be the fastest growing cohort over the next 10 years, and households in this age range are predominantly renters. The echo boom will generate the bulk of new unit demand, but demand will also be generated by baby boomers. While the baby boomer population is static and boomers are predominantly homeowners, these cohorts will be a source of rental demand growth by virtue of their sheer numbers and the fact that small changes in their overall lifestyle preferences and living arrangements have major repercussions in U.S. housing markets. For boomers, career considerations and lifestyle changes cause sizeable numbers to rent because of the mobility, flexibility and convenience renting offers.

While demographics will be the primary demand driver, macro-level demand will also be shaped by economic and public policy, lifestyle factors, and other exogenous forces. For example, the homeownership rate in the U.S. has grown steadily over the past decade partly as a result of proactive government and quasi-government policy. This has included U.S. Department of Housing and Urban Development and Fannie Mae programs designed to increase homeownership among low-, moderate, and middle-income families. Similarly, recent cyclical lows in mortgage interest rates combined with low- and no-downpayment programs enabled significant numbers of renters to become homeowners. In fact, the homeownership rate is at an all-time high of 69 percent, up from 64 percent in 1990. Offsetting this reduction in the size of the rental pool was the growth in the number of lifestyle renters. These households choose to rent for a variety of reasons including flexibility with respect to their jobs and careers, a maintenance-free lifestyle, multiple residences, the loss of a spouse, or the attraction of the empty-nester lifestyle.

Unfortunately for the institutional investor, forecasts of rental demand do not provide an estimate of apartment demand, or even more importantly, demand for institutional quality apartments. For forecasts of apartment demand, rental demand must be further disaggregated by unit type. Data from the 2000 Census show that significant numbers of renters occupy single family homes, duplexes, and other noninstitutional quality rental units. As indicated by the diagram below, only one-third of all renter households occupied iarden, mid- and hi-rise apartments.1 Other Census data suggest that only 13 percent of these units were of institutional investment quality.2

This modest demand for institutional quality apartments is further explained by Census income and spending data which show that less than one-quarter of all renter households had 1999 household incomes over $50,000. In addition, only 25 percent were paying rents typical of institutional quality units.3 Since the Census was completed, roughly 1.0 million new apartment units have been constructed in the U.S., and that construction has mostly targeted the most affluent renter households. Given the recent volume of construction and the relatively modest demand base, it is evident that the margin for error in multifamily investing can be quite small.

Forecasts of metro level demand are also derived from cohort-based models with the quantity and quality of unit demand modeled from metro-specific population forecasts, household formation rates, tenure rates, and unit preferences.

Additional metro-specific factors also contribute to demand such as the nature of the local employment base, migration rates, household income
levels, housing affordability, local land use controls, land availability and the like. These additional factors explain why roughly two-thirds of all households in the New York metro area are renters compared with only one-third in the Atlanta metro area. The challenge here is that local influences can change rapidly, and in turn, cause relatively quick changes in market fundamentals.

Even after forecasts of metro-level apartment demand are derived using this methodology, the timing and manifestation of that demand are uncertain. For example, there is often pent-up demand for rental units in affluent suburban locations that goes unfulfilled because of lack of appropriately zoned or developable land, opposition from local neighborhoods, land values that dictate higher and better uses, and the like. Similarly, there is a dire need for new affordable housing in many urban areas that goes unfulfilled because the rents necessary to support new nonsubsidized “market rate” rentals are not attainable. Consequently, demand and rent growth prospects will differ markedly for a downtown hi-rise, a mid-rise in a built-out suburb, and a garden apartment complex in a suburban growth corridor. Some of these uncertainties are addressed by analyzing development pipelines as indicated by multifamily building permit activity at the metro level. But, parceling out that supply, and
demand as well, to smaller areas is much more difficult.

TIAA-CREF’s investment strategy for investing in apartments involves a synthesis of macro- and micro-level analysis. Macro-level analysis begins with
a comparative review of projected population and household growth rates across major U.S. metros. Cohort-based demand forecasts are compared with permit activity to identify markets that are potentially under- and oversupplied.

Housing affordability is calculated based on median home prices, household incomes, prevailing mortgage interest rates and appropriate income/mortgage payment ratios as reported by The National Association of Realtors.

In general, U.S. apartment markets can be categorized as either “growth markets” or “lifestyle markets.” Growth markets include many of the fastest
growing metropolitan areas in terms of population and employment, and collectively generate the bulk of the nation’s rental demand. Lifestyle markets are those where the high cost of homeownership, lengthy commutes, the local employment mix, and other factors generate large numbers of renters-bychoice.

Growth markets often have weak barriers to entry; lifestyle markets generally have high barriers to entry. Housing affordability in growth markets is often considerably lower compared with lifestyle markets. Investors tend to gravitate to growth or lifestyle markets depending upon their investment
objectives and risk tolerance.

TIAA-CREF’s investment strategy focuses on lifestyle markets because we believe the breadth of rental demand, the relative affluence of renter households, the size and diversity of the economic base, and high barriers to entry create a less volatile environment for investing compared with growth markets. From our comparative macro-level analysis of near-term supply and demand conditions and housing affordability, we compile a preliminary list of target lifestyle markets. In these markets, we prefer submarkets with the best accessibility to major employment centers, direct linkages to the local transportation network and mass transit system, proximity to major shopping nodes, and other such amenities that appeal to affluent, mobile renter households.

We do make some selective investments in growth markets, targeting "lifestyle locations” within the larger growth markets. Lifestyle locations like
Buckhead in Atlanta typically have advantages typical of more homogeneous lifestyle markets including high barriers to entry, accessibility to major
employment centers, transportation systems, shopping and other amenities that we look for in lifestyle markets.

As investment opportunities present themselves, we supplement our macrolevel analysis with detailed micro-level analysis. The first phase involves a
comparative analysis of the potential acquisition vis-a-vis its competitive set of properties including a comparison of age, rents, concessions, unit sizes, street appeal and amenities. We also evaluate local factors such as planned and proposed construction, construction costs and replacement costs, neighborhood home prices and the cost of homeownership, proximity and accessibility to shopping nodes, major employment centers, and the like. We prefer  areas with stringent land use controls and limited land for development/redevelopment.

We believe that submarkets where the cost of homeownership are two or even three times the project’s average rent are likely to create and sustain
a sizeable and affluent pool of renters.

The second phase of our micro-level analysis involves a detailed physical evaluation of the potential acquisition. TIAA-CREF’s investment strategy is to look for opportunities where a proactive capital improvement program will enable us to raise rents aggressively as leases roll over. We prefer newer
projects (e.g., between two and 10 years old) with above-average unit sizes that have lacked aggressive ownership and management. Projects of this
vintage and with these characteristics often offer good relative value to renters in terms of price per square foot. To owner/investors, projects of this
type often possess inherent upside that can be unleashed with judicious capital improvements.

TIAA-CREF® has intimate knowledge of apartment investing and operations as a result of its $1.5 billion debt and equity portfolio. We are active in all major U.S. markets and possess a wide range of industry data and contacts from which to evaluate investment opportunities.

TIAA-CREF personnel, through its investment management area, provide investment advice and portfolio manager services through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®).

The information provided herein is for informational purposes only. It does not constitute an offer or recommendation to buy or sell any security. Martha S. Peyton and Thomas Park are managing directors and Fabiana Badillo is a director in the Investment Analytics group of Teachers Advisors, Inc. (TAI), a registered investment advisor and part of the TIAA-CREF organization. TIAA-CREF Asset ManagementSM is a division of TAI and provides investment advisory services to institutional and other qualified investors. Securities distributed by TIAA-CREF IIndividual & Institutional Services, LLC, member NASD/SIPC.

TIAA-CREF Asset Management is a division of Teachers Advisors, Inc., which is a registered investment advisor and a subsidiary of Teachers
Insurance and Annuity Association. We provide institutional investors with access to the TIAA-CREF organization’s sophisticated investment management, research and analytical capabilities. Our investment strategies cover a wide spectrum of asset classes, from traditional equity and fixed income to real estate, convertible bonds, inflation-linked bonds, social choice equities and other specialized portfolios.

An investment with TIAA-CREF Asset Management puts you in exceptionally good company. The TIAA-CREF organization has long been recognized by more than 15,000 colleges and universities for its leadership role in corporate governance, broad investment capabilities and financial strength. For more information about TIAA-CREF Asset Management, please contact us at (212) 490-9000 x7183 or This e-mail address is being protected from spam bots, you need JavaScript enabled to view it