Millennial-age renters are driving much of today’s demand for apartments, and millennials have made their preferences clear. They want to live in trendy neighborhoods close to where they work. They want the latest amenities, but their rents also need to be affordable.
This bodes well for the value-add apartment market in which investors buy older multifamily housing properties and renovate them with an eye toward raising their value and income. Get to know this market well. Chances are, more multifamily deals will involve value-add properties over the next few years.
Commercial mortgage brokers continue to stay busy in a strong multifamily market driven by millennial renters. Although older millennials have started buying single-family homes, the data suggests that, overall, millennials still favor renting over buying.
At the end of 2018, for example, the homeownership rate for people under the age of 35 was 36.5 percent, nearly 7 percentage points lower than the peak of 43.3 percent in 2004, according to the U.S. Census Bureau. The homeownership rate for this younger generation has ticked up since bottoming out in 2015 and 2016, suggesting that older millennials are buying more homes, but renting clearly remains the preference of younger people.
The multifamily market’s key fundamentals — such as rents, occupancy levels and asset prices — remained stable during the first quarter of 2019 despite concerns over a pending economic downturn, according to market-tracking company Reis Inc. Although this is great news for mortgage brokers who work with multifamily housing, it’s important to keep an eye on profitable niches within the market. One such area is the market for value-add properties — which are typically older properties that can be improved so that the rents can be increased.
When choosing a place to live, millennials are heavily influenced by their preference for mobility, flexibility and social offerings. Younger people, for example, consistently have shown an appetite for live/work environments (dwellings that combine a living area with workspace that can double as a home office). Investors and developers, therefore, should focus heavily on the types of value-add apartments that will appeal to these preferences.
Renters in today’s market tend to want to live in a well-situated area close to where they work and play, or they are looking for affordable luxury. Many major metro areas, however, have a shortage of available apartments.
The supply of new apartment units has been further challenged in numerous cities by construction industry labor shortages. Value-add opportunities, therefore, are fertile ground for investors who see the potential in older, less expensive buildings situated in growing rental markets such as Baltimore, or those located in the suburbs with easy access to major downtown areas like Atlanta.
Value-add properties are often located in desirable areas and can be updated to appeal to renters’ tastes. Older housing units can check all the boxes for millennials who want to live close to their work, as well as after-hours dining and recreation. Young professionals also are naturally drawn to quality rentals that have been upgraded with modern amenities and technology.
Importantly, it often costs less to buy and upgrade an older property than to build a new apartment complex from the ground up, given the hurdles of land development, the escalating costs of construction materials, city zoning and permitting, and environmental regulations. Investors in value-add properties normally complete these projects for less than replacement costs, and renters get to live in bustling metros without sacrificing comfort or security. Rebranding these properties to appeal to a certain group, and placing them under suitable management, also tends to increase their value.
An abundance of available value-add apartments is driving property investors to secondary markets such as St. Louis; Philadelphia; Charlotte, N.C.; and Oakland, Calif. These cities offer lower purchase prices than primary markets such as New York and Miami.
Investors in value-add properties also are drawn to Dallas-Fort Worth, Phoenix and Atlanta. These cities have two key attributes going for them. First, there are substantial economic incentives for companies to relocate and establish headquarters in these markets. Second, these lower-cost cities have seen rapid job growth in the technology and healthcare sectors. Digitally savvy millennials now have alternatives to the prohibitively high cost of living in tech hubs such as San Francisco. Updated rental housing will appeal to the younger people relocating to jobs in these cities. Millennials require affordability and comfort, and they also demand live/work/play communities, which combine residential and retail assets near their workplaces and nightlife.
The greater Washington, D.C., area is another potential hot spot for value-add multifamily deals. Investors see the potential of adjacent regions in Maryland and northern Virginia. Baltimore and Alexandria, Va., not to mention other nearby cities, offer easy access to D.C. metro-area employers, including the millennial-age workers interested in affordable, quality rental housing. The greater D.C. market will always need workforce housing and older, renovated assets will be in demand.
Amazon’s second headquarters in Crystal City, Va., will further increase the appeal of value-add apartments in the D.C. metro area. This should draw more value-add deal activity to neighborhoods that are popular with young people, such as Pentagon City near Alexandria, where Amazon also is leasing space. The demand for lower-cost housing and amenities will outstrip the number of rental units in desirable areas of D.C.
WHAT THE FUTURE HOLDS
There should be ample opportunity over the next two to four years for investors to do deals involving value-add properties that cater to younger people. Many millennials prefer the lifestyle and flexibility of renting rather than paying the burdensome costs of down payments, mortgages and taxes.
Millennials are often saddled with heavy student loan debt and earn a lower median wage than older generations, the Pew Research Center reported. This has created demand for affordable workforce housing. According to real estate services company CBRE, workforce housing and rental communities that are affordable for low- to median-income workers have consistently outperformed the overall multifamily market, thanks to relatively low vacancy rates and above-average rent growth.
It’s true that as millennials age, they may buy single-family homes. For the short term, though, they will continue renting before transitioning into full-fledged homeowners. Younger millennials definitely start out as apartment renters. The other important demographic group to watch are baby boomers, who are increasingly selling their homes as they retire and choosing to rent. Empty nesters are now renting more than ever.
Daniel Palmier is founder, president and CEO of UC Funds.