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Investing in Demand Always Wins

Everyone understands the fundamentals of supply and demand.

As a seller, demand guides what kind of price you can command for your product. The more significant the gap between demand and supply, the better off you are as a seller.

Remember Tickle Me Elmo in the ’90s? Everybody wanted one – adults and children alike. Some buyers lucky enough to get their hands on one turned around and sold it in the classifieds (remember those?) for hundreds, sometimes thousands of dollars. Since the toy was released right before the holidays, demand was off the charts.

Real estate is driven by the same laws of supply and demand.

There is, however, one class of commercial real estate right now experiencing unprecedented demand that is expected to last well into the foreseeable future – multifamily. The high demand, along with an undersupply, puts investors in multifamily in the driver’s seat. The demand is projected to only grow in the foreseeable future with supply not looking to catch up anytime soon.

The widening gap between supply and demand in multifamily will guarantee investors with not only consistent cash flow but also the ability to augment that cash flow in the future by being able to increase rents without losing tenants.

Here’s why investing in demand – specifically in the demand of multifamily – will make winners out of investors willing to take the plunge in this asset class:

1. Widening Gap Between Supply and Demand – 
A report in 2017 conducted the National Multifamily Housing Council (NMHC), and the National Apartment Association (NAA) found that, on average, 325,000 new multifamily units will be needed each year through 2030 to meet demand. However, between 2012 and 2016, only an average of 244,000 new units came online (whether from new construction or terminating leases).

What are some of the explanations for this widening gap?

Shrinking Supply
Surprisingly, shrinking supply is one of the factors. It is estimated as many as 125,000 units per year are taken offline – whether due to disrepair, destruction, or demolition. Most of these units are in the affordable segment, which is already undersupplied.

While current supply shrinkage is due to disrepair, destruction, or demolition, new supply is hindered by interest rates and other construction costs.

Interest Rates
After a decade of record-low interest rates, we are in a rising interest rate environment. Rising interest rates, along with increases in other expenses like land, labor, and overall construction costs, impact builders negatively with a corresponding fall in supply.

Government Regulation
Another factor for increased costs and accordingly decreased supply is government regulation. Safety and quality standards in the construction industry are necessary to protect workers and consumers. Still, the number and burden of regulations from state, federal, and local sources are out of control.

A recent research report conducted jointly between the National Association of Home Builders (NAHB) and the National Multifamily Housing Council (NMHC) found that, on average, regulations imposed by all levels of government accounted for an outrageous 32.1% of multifamily development costs.

In a quarter of cases, that number reaches as high as 42.6%. Politicians lament the lack of affordable housing, but they can’t seem to get out of the way of the developers and builders trying to fill that void.

2. Demographic Trends Point to Booming Demand – 
Echo Boomers, Baby Boomers, immigrants, and single households will drive unprecedented demand for at least the next ten years.

Echo Boomers. The average renter age is falling, and Echo Boomers (those born between 1980 and 1995) are fueling this trend. Echo Boomers number 80 million, and it is estimated that about 15 million of them will enter the prime renter ages of 18 to 34 this year.

Baby Boomers. Baby Boomers, numbering around 77 million, are aging – with 40% of them (~ 30 million) set to retire in the next five years. As an age group, those over 55 as a group rent more than they own as many seek to downsize or sell their homes to extract equity to fund their retirement lifestyles.

Additionally, there are signs that Baby Boomers will rent at higher rates than past generations in the same age group because, as a group, Baby Boomers are less financially prepared for retirement with less than 30% on track for retirement and 50% expected to live off social security exclusively.

While many retirees as a whole may be less well off in the future, there will be plenty of affluent Baby Boomers to take up mid-level to high-end housing, thereby satisfying demand across the entire spectrum of multifamily price levels.

Immigrants and Single Households. The renter population of the future will be more ethnically diverse, with immigrants joining the U.S. population at the rate of about 1 million a year. Because of the immigration of mostly unskilled labor, the average renter in the future will be, in effect, poorer.

In addition to immigrant renters needing affordable housing, the most significant segment of renters requiring affordable housing in the future will be in the 24-40-year-old age group, mostly female-headed households, with lower-income profiles than seen before.

These two facts make investing in multifamily more appealing and favorable than any other time in history:

  1. Demographic trends indicate that multifamily demand is going to continue to boom at a minimum for the next ten years, with no corresponding increase in supply.
  2. Economic trends point to supply shrinking relative to demand.

Investing in demand always wins, and there will be no other segment that will make more winners out of investors than multifamily.

Mike Foley

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