Construction Rises In Apartment Boom

Construction cranes are coming back on the scene after a stay in storage.

But their handlers are choosy, returning them for now to the lone sector of the commercial real estate market that is fertile ground: rental apartments.

Amid an arid new-development landscape in commercial real estate, the apartment market is blooming. Vacancy rates are falling, demand is surging and new supply is scant, letting landlords raise rents for seven straight quarters, says Ryan Severino, senior economist with Reis, a commercial real estate research firm.

"More people in the (rental apartment) industry are getting excited about new projects," he said.

Besides tight supply, new construction is being driven by falling homeownership rates and growing numbers of people in their 20s and early 30s who are finally landing jobs and moving to their own place.

Rental apartment operator AvalonBay Communities (NYSE:AVB - News) has $1 billion in development projects under way, and notes that rental household formation has grown by over 1 million units the past 12 months.

AvalonBay broke ground in the third quarter on four projects on both coasts, at a cost near $210 million. Plus, $600 million in projects is starting this quarter, including in Manhattan where rental vacancy has dropped to the low single digit percentages, pushing rents up.

An additional $3 billion in the development pipeline should keep AvalonBay busy the next two or three years, President Timothy Naughton told analysts recently.

UDR (NYSE:UDR - News), another big apartment operator, has more than 2,500 units in development for an estimated $751 million. Management says it's looking for more sites to buy.

Construction of rental housing is even starting in hard-hit Florida housing markets. Colonial Properties (NYSE:CLP - News), which focuses on multifamily apartments in the Sun Belt, began construction recently on a 232-unit apartment community in Orlando — Colonial Grand at Lake Mary — with completion set for late 2012.

Still, the return of the flock of metal cranes and bulldozers is hardly a stampede. Rental-apartment developers need to get their ducks in a row before they can break ground. The lag time from idea to fruition can run a year to 18 months.

"At this point, there is some noticeable pickup in new construction, but a lot more pre-construction activity is going on," said Mark Obrinsky, chief economist with the National Multi Housing Council.

Most observers don't expect a big building pickup till late next year.

New starts follow two years of an unusually low 100,000 units a year, says the NMHC. That's vs. 300,000 units a year from 1998 to 2007.

"Last year was the lowest new-construction start level we recorded from (Census) data going back 50 years," Obrinsky said.

Some markets are seen as more desirable for starts than others. Reis pinpoints the largest surge of new market-rate apartments next year for Dallas; Houston; Orange County, Calif.; Los Angeles and suburban Virginia outside Washington, D.C.

The new inventory will range in size and price, Severino says.

"They're all trying to find their angle. They're trying to build higher-end apartments, lower-end apartments, big apartments, small apartments," he said.

Yet AvalonBay executives have expressed concerns over new inventory in the D.C. market in the face of slowing employment growth there as spending from the fiscal stimulus has waned.

Markets with lots of high-tech jobs that attract young renters — such as in Northern California, Seattle and Boston — are seen as better new-construction candidates.

San Francisco and San Jose rents rose more than 13% in the third quarter vs. a year ago. That's more than three times this year's U.S. average of 4.2%, says MPF Research. It sees rents up 4% to 5% next year. Other hot markets with rent spikes were Oakland; Seattle; Austin, Texas; New York and Minneapolis.

Los Angeles surged in the third quarter "out of nowhere," MPF reported, with sudden demand for 15,000 apartments pushing the areas's occupancy rate up 1.5 points to 96.4% and rents up 2.1% to an annual rate of 4.8%.

"Los Angeles and Orange County ranked as notable laggards in 2010, but they are really gaining momentum now," said MPF Vice President Greg Willett in a statement.

Financing isn't always a breeze. Lenders are still picky about projects they back. But it's easier to get construction loans for multifamily development than other commercial sectors, watchers say.

For publicly traded real estate investment trusts, which include UDR, AvalonBay and Equity Residential (NYSE:EQR - News), "there's a lot of buy-in for construction loans," said Warren Troupe, UDR's senior executive vice president, in a conference call. He sees construction lending "still difficult" for private developers.

Ill winds could knock plans off path. "There are of course things that get in the way," Obrinsky said. "The economic outlook is a little uncertain now. If things should worsen considerably, some of this pre-construction activity probably gets put on hold.

For now, a robust rental construction environment could continue into the middle of the decade.

"The current apartment recovery is still quite young," Bryce Blair, CEO of REIT AvalonBay, told analysts in early November.