U.S. multifamily starts (5+ units) per 1000 households
Annualized monthly data
In the second part of our Living Sector Series, we focus our attention on apartments, which we believe to be among the most dynamic of all commercial real estate sectors today (See Part 1: Growth and diversity in the living sector). Although apartments and multifamily rentals were once the primary form of investing in the institutional housing sector, the residential market has become larger and more diverse over the past decade. That said, apartments still represent a key subsector of the broader rental market and offer investors several interesting tactical and strategic opportunities.
In this paper, we will focus on the apartment sector in the U.S. and Europe, with an emphasis on the moderately priced, or affordable segment of the market, which we believe offers the most broad-based exposure to renter demand due to shifting demographics and income distribution.
A need for more housing...
Over the past 12 months, demand for apartments has remained near record levels across key strategic markets and vacancy rates are well within their equilibrium ranges. Strong rent growth since the start of the pandemic has continued to fuel impressive NOI growth as leases have continued to roll up to market asking rents. Since 2020, U.S. apartment rent growth has averaged 5.6% on an annualized basis, and in Europe that figure is 3.7%. The impact of mark-to-market rents with more frequent rollovers than other property sectors and low vacancy rates have translated into annual NOI growth in the low double digits.
If there has been a question mark regarding the apartment sector in both regions, it has been the high levels of development. In the U.S., the pace of new deliveries has pushed vacancy rates up toward their long-term historical averages for institutionally managed properties (Exhibit 1).
EXHIBIT 1: High levels of development have pushed vacancy rates higher in the U.S.
U.S. multifamily construction and vacancy
Source: CBRE EA, Principal Real Estate, Q2 2023.
Recent supply and demand trends may be somewhat misleading, however. Despite an increasing number of projects that are under construction, apartment units have been under-delivered over the past decade. Consequently, there has been a shortage of housing which has resulted in an affordability crisis in many major cities for both the rental and for-sale markets. In the U.S. for example, Exhibit 2 (left chart) shows that since 1990 only 2.5 new multifamily units have been built for every thousand households—well below the average of 6.4 between 1960 and 1990. In Europe as well (right chart), construction permits issued for residential dwellings have yet to recover to their pre- Global Financial Crisis (GFC) levels.
EXHIBIT 2: We have not been building enough apartment units
U.S. multifamily starts (5+ units) per 1000 households
Construction permits issued for residential buildings in the Euro Area
Index 2015=110, Seasonally adjusted
Most major markets in the U.S. and Europe are now facing a housing deficit with many needing more units to accommodate population growth than are currently being supplied. In fact, a research report from Freddie Mac—a U.S. government sponsored entity founded to provide liquidity to the residential sector— recently stated the U.S. needs an additional 3.8 million housing units to meet current demand growth.1 In Europe, the construction of new residential buildings is also unable to keep up with demand. The German Property Federation for example has reported that the deficit of housing in the country has reached its highest level in 20 years and that by 2025 the shortage may increase to 700,000 flats.2 As a result, across both sides of the Atlantic, the outlook for current landlords and developers remains positive and suggests that secular demand through demographics will provide a steady flow of new renters looking for space.
To get our full perspective on demographics driving apartment demand, affordability trends and middle-income investment strategies, download The Apartment Sector: Increasing demand for affordable living (PDF).
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