Housing is number 1 on my macro list. Mostly because it’s a huge part of the American economy, but also because I think it makes for a great investment. I’m slowly trying to convince myself to buy my own home – or maybe a 4-plex on FHA 😀 – for speculative purposes.
Vacancies Down; Rents Up
Residential real estate is the best thing since sliced bread. We all know about the overwhelming weakness in the office and retail corner of the real estate market. The real money to be made is in homes, not cubicles.
In July, Reis reported that apartment rents were rising at their fastest pace since 2007. In the same report, we discover that vacancies are at an 11 year low – you have to go all the way back to 2001 to find the same low vacancy rate.
Here’s a chart from CalculatedRiskBlog.org that details the forever falling vacancy rate:
A declining vacancy rate isn’t all that surprising. Here’s my rationale:
- Pent up demand – There are a ton of 20-somethings living at home, waiting for a job that pays enough to warrant a move out of mom and dad’s place. That makes for a good, steady supply of people coming into the rental market over time. Any improvement in job growth injects more demand into the market. I wrote about this at InvestorJunkie in a post about single family homes.
- Foreclosures – People who lose their homes don’t go homeless. They find a new place to live, often renting a comparatively less expensive apartment without the 15- or 30-year 800 pound gorilla that is a home mortgage.
Rental Real Estate Cost Structure
The cool thing about rental real estate is that it is not economically feasible to make more of it. Homes are selling for less than their cost of replacement, which means people buy existing homes rather than new homes. Existing homes are part of the current supply. If home prices appreciate beyond the cost of replacement, only then will the supply of homes increase.
Since the financial crisis, the cost of building a new home or apartment has only gone up. Rents should necessarily follow. Only in a select few, very populated cities does it make sense to build new apartments and living spaces for renters. Zelman & Associates forecasts construction of 235,000 apartment units in 2012, 285,000 in 2013, and 320,000 in 2014. As of 2009, there were 17,452,000 units in the United States, according to the National Multi Housing Council. The projected pace of new apartment construction would be faster than the average annualy apartment construction from 1990-2009.
New construction isn’t the real estate investor’s only concern. I remain committed to the idea that online retail will destroy traditional retail, and that the days of the corporate office are limited. Naturally, I think the long term prospects for retail and office real estate is weak. More bankruptcies will be filed, and more real estate will be purchased at a lower, and lower cost.
I eventually expect millions of square feet of office/retail centers to be converted to residential real estate. If I can buy 50,000 square feet of retail or office space for $1, I can easily justify the investment to turn it into 50-1,000 square foot apartments. Or 100-500 square foot studios. It’s an outrageous viewpoint to many, but I’m not betting against the creative destruction that is online retail and telecommuting.
Don’t laugh – proposals are popping up everywhere. In Baltimore, office buildings could be turned into apartments at a price tag of $100-125 per square foot. Apartments in Baltimore, from my quick check, are anywhere from $1.50 to $3 per square foot. The only thing stopping the project is the cost of the building. Don’t worry – office space gets cheaper every year!
The Long Slog in Real Estate
I think you have two converging trends here:
1. A growing population, and also a growing renter population. This is good.
2. A glut of commercial and office property waiting for bankruptcy. This isn’t good.
For investors interested in compounding wealth over time, the trend is excellent. Lower prices are especially advantageous for individual investors, as the rigidity in the capital requirements necessary to add one more home (20% down on $100-$500k is no small amount) slows down the compounding process.
My bottom line expectation is this: rental prices go higher, but housing prices wiggle with conversion costs. Midwestern cities will probably fare best, since there isn’t any tangible “location premium” in old office space relative to that of a beastly city like New York.