By Al Lord, Founder and CEO, Lexerd Capital Management
There are five current trends that indicate apartments are the second best real estate investment for serious investors. These are low supply, high demand, rising prices, inflation and labor shortages. Let’s explore.
1. Low Supply: A Housing Shortage Creates an Opportunity for Investors
According to a study by Freddie Mac, there was a shortage of 2.5 million residential units at the start of 2020. Zillow economist Matthew Speakman said in January this year that there was no only three months supply on the market. This is the lowest for twenty years.
Today, long-term housing construction fell 5.5 million units from historic levels. It took us 30 years to get here. While a wave of construction took off in the second half of 2021, the pace is not keeping up with the shortage. From 2010 to 2020, fewer homes were built than during the 1970s. Yet population growth has exceeded 123 million since 1970. Meanwhile, there is a national shortage of low-income housing for the poor.
Fannie Mae in May 2022 reported severe shortages in housing supply in America. Total new construction in May 2022 reached 1.5 million units, down 14.4% from the previous year. The decline in new construction is more marked for multi-family dwellings at 23.7% than for single-family dwellings at 9.2%. Additionally, permits for future construction of single-family units fell 5.5%, while permits for multi-family units fell 9.4% from a year earlier.
The National Low Income Housing Coalition conducted an analysis of low-income housing in March and concluded that there was a shortage of seven million affordable and available units for very low-income tenants. All this represents a unique opportunity for real estate investors, single-family and multi-family.
2. High demand: post-pandemic migration and surge in home purchases
Even before the pandemic, there was growing interest in home ownership, especially among millennials. In fact, 89% of millennials would like to buy a home. Unfortunately, their financial situation is an obstacle. Nevertheless, as a result of the COVID-19 pandemic, 30% have gone into house hunting mode. But whether those potential buyers can afford the purchase remains to be seen. In May 2022, Zillow reported that housing affordability hit a 15-year low due to rising house prices and mortgage rates.
Another dynamic created by the pandemic is that of intra-urban moves. A great migration has occurred from the city center and town centers to the suburbs. Telecommuters who no longer need to live close to their place of work choose to live in suburban communities. The hybrid workplace means they can work from home in the suburbs three days a week and drive to the office if necessary. Higher crime rates in inner cities also favor suburbs.
This dynamic creates new opportunities for real estate investors. The challenge is to provide affordable housing for buyers and suitable amenities for those who cannot afford to buy.
3. Rising prices: another opportunity for real estate investors
Low supply and strong demand are driving up house prices and rents. The average house price increase from April 2020 to April 2021 was 16%. Some parts of the United States have seen a 20% increase in real estate prices. More recently, the May 2022 median existing home sale price of $407,600 represents a 14.8% increase from a year ago. Rental prices are also increasing. In August 2021, the year-over-year increase was 11.5%. That’s three times the growth in rents before the pandemic. For multi-family units, Yardi reports that the average US asking rent for apartments rose $19 in May to a record high of $1,680 with year-over-year growth of 13.9 %. A similar report from Redfin reveals that in May 2022, the median asking price for all rental properties increased by 15% year-over-year.
Several factors explain this price growth. A supply chain shutdown last year meant builders struggled to find the materials they needed to build. Over the past six months, when home purchases have surged, supply chains have opened up. But the huge jump in demand for materials has pushed up material prices.
In addition, builders are struggling to hire workers. Many companies had to raise wages to attract construction workers. Rising material and labor costs drive up prices for buyers and renters. The low supply of housing, combined with an increase in multi-family construction and strong demand for rental units, means that rents will likely continue to rise.
The National Apartment Association estimates that 4.6 million new apartments need to be built by 2030 to meet demand. With just 490,000 new apartments entering the market this year, the highest since the Great Recession, that’s still not enough. Rising prices are a golden opportunity for investors in apartment buildings. With rising house prices and rents, now is the best time to buy. The recent hikes in the fed funds rate, which are expected to reach 3.4% by the end of the year, will certainly act as a drag, but will most likely moderate the increases, not reverse the trend.
4. Inflation: Rising prices are the immediate buy signal
The Federal Reserve forecasts an inflation rate of 5.2% by the end of 2022. If you compare the annual inflation rate from April 2021 to April 2022, the increase is 6.3%. When inflation rates are too high, the Fed raises interest rates as it did recently by 0.75% in June 2022. Otherwise, people keep buying, increasing demand for products and services, which continues to drive up prices. The danger is galloping inflation and shortage of goods. Interest rate increases slow the economy, but the effect is not immediate. This means that the increases in inflation that we have seen over the past three months are likely to continue until the Fed acts with further rate increases that will impact mortgage rates. Indeed, mortgage rates rose as the Federal Reserve adjusted fund rates to moderate increases in inflation. In June 2022, mortgage rates stood at 5.81% compared to 3.02% a year ago. Cautious real estate investors will buy now to avoid exposure to even higher mortgage rates in the near future.
This is even more vital for apartment owners. The apartments offer a hedge against inflation as the leases are renewed every 12 months. As leases renew each month, landlords can increase the rent.
There is hidden inflation lurking beneath the economic surface, making inflation look weaker than it actually is. And it’s not transient. When you have to pay a worker a higher wage to keep them, you can’t come back when inflation is lower and say, “We’re going to pay you less now.” Overall, rents have risen faster over the past year than they have in 15 years. In some parts of the country, year-over-year rents rose 12.2% in April alone.
Historically low interest rates and higher inflation mean now is the perfect time for property investors, especially apartment owners, to borrow money and invest in the right properties.
5. Labor Shortage: Higher Wages Lead to Higher House Prices
Last year’s pandemic wreaked havoc on the job market. Mandatory business closures in many states meant workers were out of work for months and received higher than normal unemployment benefits as an incentive not to work. When the economy picked up, many workers were not ready to return to work. As new construction surged towards the end of last year, builders struggled to find workers. This led to higher wages and hiring bonuses, reducing builders’ profits. The only way to account for these losses is to increase the prices of the product. Again, a labor shortage benefits investors, especially small individual and multi-family investors.
Apartments are the best real estate investment right now
Take one of these real estate trends and all you have is a trend. Put all five together and there is a golden opportunity for investment.
Albert L. Lord III is the founder and CEO of Lexerd Capital Management LLC. Lexerd is a real estate company that primarily sponsors investment in opportunistic multi-family assets across the United States.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.