Apartment Construction is Back – But is it Enough?

Supply chain disruptions have impacted many industries – including apartment construction, which delayed the delivery of much needed apartments in 2020 and 2021. As markets return to pre-pandemic conditions and owners and contractors adapt to increases in material and labor costs, an increase in new apartment deliveries is expected in 2022. According to a recent study by RealPage, 426,000 apartments will be completed this year, more than any year since the 1980’s.

Phoenix, the largest metro in Arizona at nearly 5,000,000 residents, is anticipated to deliver over 21,000 apartments in 2022, one of only two U.S. markets set to build more than 20,000 units this year. The increase in housing supply is much needed – Arizona posted the fourth largest population growth of any state in 2021. While institutional investment capital has historically skewed to coastal markets due to strong demand and consistent rent growth, the outward migration of renters from coastal cities to inland metro areas has caught the attention of multifamily developers and spurred growth in new construction in these areas. The influx of new residents has also put upward pressure on rents. Between 2016 and 2020, rents in metro Phoenix grew 80%, creating robust demand for new supply.

In Denver, construction delays have slowed the delivery of new apartments with 8,000 and 11,000 units being delivered in 2021 and 2022, respectively. Supply is increasing in 2022, according to Colliers International, with over 23,000 apartments currently under construction. Denver’s year-over-year rent growth in the first quarter of 2022 was over 11%, suggesting that demand is outpacing supply.

While an increase in new apartments is a step in the right direction in resolving the housing crisis, the country continues to experience a massive shortage in housing (estimates range from 3,800,000 to 5,500,000 units) with demand growing steadily through new household formations. Despite the upcoming increase in new supply, renters across the U.S. should expect rents to continue to rise for the next two years with many experts forecasting 5% to 7% annual increases.

Apartments as an Inflation Hedge

Inflation continues to climb, with the Consumer Price Index hitting 8.5% at the end of March. The Fed has increased interest rates twice already this year – with additional increases coming. As the Fed moves to slow the economy, investors are eager to preserve the value of their assets and hedge inflation.

Historically, multifamily real estate has been an exceptional hedge during inflationary periods. Because housing is a necessity – “you can’t sleep on the internet!” – many people prioritize paying rent over other more discretionary expenses, creating a stable income stream that generally tracks inflation closely. The industry’s short-term lease durations, generally 12 months or less, offer multifamily owners the ability to mark rents to market, keeping pace with and sometimes even outpacing inflation. Additionally, apartment owners with fixed-rate mortgages receive higher levels of rental income as their leases renew while their mortgage expenses remain constant.

Meanwhile, the fundamentals for multifamily real estate remain exceptionally strong. National occupancy rates are 94.2%, up a full percentage point since the onset of the pandemic coupled with rent growth of approximately 13% during 2020-2021. Fewer Americans are able to qualify for a mortgage today due to the skyrocketing cost of for-sale housing and higher interest rates, further increasing demand for apartments.

According to RealPage, occupancy at class-B apartment properties, which house most Americans who rent, is at 96.4%, essentially full occupancy when accounting for the time it takes to clean and re-rent vacant units. Rent growth was stifled during the early stages of the pandemic but the swift rebound has led to unprecedented rent growth in 2021 and early 2022. While the inflationary and interest rate headwinds are present, the fundamentals for the multifamily sector are very strong and appear well positioned to remain so.