Developers are rushing to start construction on new apartments—and so far, the demand for new apartments is likely to remain high enough to fill them.
Occupancy rates remain strong and rents for rental apartments are rising rapidly. The biggest question for developers is not whether enough tenants would like to live in their proposed buildings. Instead many are concerned about whether delays in construction will affect their schedules or whether rising costs will blow their budgets.
“Barring another ‘black swan’ event, demand for newly-built apartments is still very high,” says Jay Parsons, deputy chief economist at Realpages. “Investors continue to fund new developments, and we are likely to see another major increase beginning in 2022.”
Many apartment developments that begin construction today are likely to lease out units within a year or two. Those apartments should continue to benefit from strong demand from tenants.
“Strong economic growth, continued strength in the labor market, higher single-family home prices and international migration will help drive demand,” says Thomas LaSalvia, senior economist at Moody’s Analytics.
Renters signed enough new leases to absorb 200,000 vacant apartments in 2021. According to LaSalvia, this is a “solid year” relative to the years before the pandemic.
Developers opened over 386,000 apartment units in 2021, according to estimates by Dodge Data & Analytics Supply Track. This was slightly lower than the 405,000 units that were delivered in 2020.
“Supply chain issues and some uncertainty from the start of the pandemic had the effect of delaying and slowing new product arrivals in the market [last] years,” says LaSalvia.
This year, the Dodge Data & Analytics Supply Track, estimates that more than 600,000 units will be delivered, although it is possible that further disruptions could delay some units.
With supply exceeding demand, rents are rising rapidly. “This combination helped drive rent growth in the area to a record high,” says LaSalvia.
For example, according to CoStar, apartment rentals in luxury, four-star and five-star properties rose 11 percent across the US in 2021. (Most new apartment developments are designed to earn higher rents, paying the higher cost of land and construction, unless they receive government subsidies.)
According to CoStar, rents for these asset classes are expected to continue to rise by another 7.0 percent in 2022, as the number of potential renters looking for housing is likely to continue to rise.
“In the last year or so, international migration was minimal – we anticipate that will change in the short term, until the virus subsides,” says LaSalvia.
Developers will also open more number of new apartments in 2022. Many will eventually open projects that were delayed in 2021. “2022 is on course to be the biggest year for new supply since the mid-1980s,” Parsons says.
Luxury Renters Can Afford Rent Hike
As property managers push rents higher, they are unlikely to lose out to potential residents.
“Developers have found that tenant income is growing as fast or even faster,” Parsons says. “Therefore, they are able to pass on the increased cost to the base rent, and that has not impacted the demand for lease-up.”
In a typical Category-A+ luxury property – such as in a new urban high-rise development – costs are in the low 20-cent-range of a typical renter’s income. “There isn’t a major affordability barrier. There’s a bigger risk for renters finding better deals on slightly older and cheaper Class-A properties, but right now, there’s so little vacancy that it’s not a factor,” Parsons says.
Construction cost and delays affect development plans
The biggest challenge for developers is the rising cost of construction and delays which add even more additional cost.
“The big question is around cost and timelines,” Parsons says. “Everything is more expensive and it is taking longer to get everything – from materials to labor to equipment. This is making it difficult to formulate budgets and timelines for development. ,
Apartment developers are also highly excited to build in prime suburban areas—but those sites are difficult to find and increasingly expensive.
“As suburban land prices skyrocket, suburban site options narrow,” Parson says. “The most desirable suburbs severely limit where you can build apartments due to restricted zoning and NIMBYism.
This is bringing many developers back to urban areas, where rents for apartments are rising once again, even as the coronavirus pandemic continues and relatively few workers have returned to the office.
“As the price premium for cities is low, some developers are finding better opportunities in more urban locations,” says Parson. “High-demand suburbs have far more significant barriers to entry than most cities. This has been true for a long time, but it has become even more important since COVID as suburban land prices have soared.”