CREJ - Multifamily Properties Quarterly - July 2015
Perhaps the biggest question multifamily investors are asking themselves as they consider investment in the Denver metro market is: Can the multifamily market continue to improve? After studying the fundamental supply-and-demand characteristics of today’s market, we think the answer is yes. How can this be after we have seen unprecedented rent growth, as well as incredible levels of construction of new multifamily properties over the last half-decade? Our conclusion is that the market will continue to improve because there simply is not enough housing to meet the metro area’s pent-up, as well as continually growing, demand. The chart provides a great visual representation of the mysterious “pent-up demand” we have been hearing about over the last few years. Focus first on the period from 1995 to 2006. During that time, the Denver metro population grew from 2.1 million residents to about 2.65 million – a gain of 550,000 residents in 12 years. That equates to a population increase of roughly 46,000 residents per year. During that same time period, single-family developers and contractors delivered approximately 175,000 new homes to the market, and multifamily developers and contractors delivered approximately 55,000 new apartment units to the market. Total housing deliveries combined (excluding condominium and townhome deliveries as we were not able to find reliable data on those markets) equaled 230,000 units, or two-fifths of a unit for every new person added to the market. The average number of units delivered each year during that time period was about 19,000. Next, focus on the period from 2007 to 2014. During that time, population grew from 2.65 million to roughly 3 million – a gain of 350,000 residents in eight years. That growth breaks down to a population increase of roughly 44,000 per year – just 2,000 fewer residents per year than Denver had from 1995 to 2006. Throughout that same period, single family contractors only delivered 41,000 new homes and multifamily contractors delivered just 33,500 new apartment units. At a total of 74,500 units (again excluding condos and townhomes), only one-fifth of a unit was delivered for every new member of the population added to our area. The average number of units delivered each year declined to just over 9,300 compared to 19,000 in the previous period reviewed. This represents an annual shortage of 9,700 units; multiply that out by eight years and we could be looking at a current shortage of 77,600 units and growing. Add to that the fact that the construction defect litigation environment has largely constrained for-sale condominium and townhome development from 2007 to 2014, and the housing shortage is likely much greater than demonstrated. When you consider that the fundamental driver of rental rates and home prices is supply and demand, it is no wonder rental rates and home prices have reached historic highs and are continuing to climb. As population increases, so does demand, but supply has failed to keep up with the growing demand over the last eight years. Even as construction deliveries are reaching historic norms (2014 was close with over 17,000 combined units delivered), it will take several years above the historic norm of 19,000 units, and a significant uptick in the condominium and townhome construction market, to make a dent in the current shortage of likely some 80,000 units. So, what will stop the growth? When do we see the downside of this cycle? We see several factors that could slow down the market. First, builders will have to deliver more units to flood the market with supply. If they are able to deliver enough units to match continuing demand and make up for the shortfall of 80,000 units, then prices should flatten. But the big question is: Can that be done? And if it can, when? The biggest year of single family deliveries over the period we studied was 2004 when 18,000 units were delivered, which is 10,000 units more than we saw delivered in 2014. Therefore, we have a long way to go to make up for the shortfall, and rising construction costs are making building moderately priced housing more and more difficult to meet this demand. Second, a lack of sufficient high paying jobs to provide salaries for people to afford the newly constructed apartments and single family homes would slow the market. But with Denver’s diversified economy and continued desirability of our area, that seems unlikely. Even the current oil bust won’t significantly impact jobs, as oil jobs are only a relatively small part of our overall economy. In fact, according to recent data, job growth is exceeding population growth, which will only drive salaries higher. Third, even if there are sufficient jobs to support new construction, where will the lower and lower-middle class live? Currently, these classes are moving to the suburbs to occupy 1970s product. But with annual rent growth of 13 percent for this product, vacancy in the low 4 percent range, and investors rehabbing older product for value-added upside, lower- and middle-class workers will struggle to pay rent even in these areas. There certainly are a host of unknown factors not mentioned above that could undermine the population and economic growth that Denver is experiencing – think dot-com bust or derivatives in mortgage-backed securities. However, after every recession, Denver’s economy has come back bigger, stronger and more diverse. Additionally, people not only move to Denver for jobs, but also it is one of the most popular places to live in our country due to the quality of life, great outdoors, recreation, entertainment and dining. Our long-term view is that Denver will continue to attract new residents and employers for these reasons. While we certainly miss the old Denver without traffic and parking problems, we really enjoy all that the new Denver has to offer!