By: Gary H. London
As published in the San Diego Business Journal, March 19, 2012
With signs of economic recovery finally promising to be sustainably good news, it’s time to reflect on what this means to the residential real estate sector.
In short order, it doesn’t mean much. Most of the for-sale residential real estate sector will lag in recovery. In the long run, the housing sector should fully recover, although new housing will be dominated by apartments and condominiums.
The first to recover has been rental housing occupancy. At its weakest in 2009, apartment vacancy was estimated to have been 7 percent to 8 percent.
That hasn’t lasted long. Rental vacancy now stands at 4 percent to 5 percent and is declining. Average rental rates have increased approximately 14 percent in the last seven years.
This is the undisputed stronghold of the real estate investment and development sector right now. Investment grade apartments have recently been trading at 5 percent to 6 percent capitalization rates, a metric indicating rising revenues and aggressive pricing. New apartment construction totaled fewer than 1,000 units last year, and we are on pace to add more than 2,000 units this year.
An important demographic is at work here. Gen Y — 18- to 32-year-olds — are entering the housing market as renters. With only 15,000 units currently vacant out of an inventory of 300,000-plus units, this movement alone could lower the vacancy factor to 2 percent to 3 percent.
Next in Line for Recovery
The next residential sector to recover should be residential resales. Currently the average number of transactions has ranged from 2,000 to 2,500 per month. It really needs to regularly reach the 4,000-plus per month levels to be operating at a pace that would suggest that the market has finally expanded to include nondistressed transactions.
What I am tracking in particular here is voluntary listings: I want to see that people who are not forced to sell electing to sell. When this happens, the sector is finally recovering. Following this, we will likely see a fairly steep rise in average values of transactions.
New starts will trail, perhaps two to three years. Even if an unusually high number of new housing developments were to be proposed and begin their entitlement journey today, this would not translate into “sticks and bricks” for some years.
However, the number of housing permits sought and received over the past few years has been historically low. During the next six years, approximately two-thirds of all units permitted will be multifamily, most of which will be rental apartments.
In 2012, we foresee minimal change in the available inventory of new sale housing.
Our projections anticipate that the single-family production will remain at current levels with minimal increases.
Downtown San Diego will account for several thousand, most of them rentals, although we anticipate that condominiums will be delivered again by 2015-2018.
This level of anemia will not instantly correct. The housing delivery system has been shaken. For the development sector to recover, new housing companies will be created to build attached housing versus single-family housing; new skills and trades are required; a lethal entitlement process awaits these urban and suburban infill projects; and projects have to be feasible, which requires a rise in values.
All of this translates to a delayed and gradual recovery.
The last to recover will be value.
While the downward trend in local real estate values has now bottomed to 40 percent to 50 percent below the peak of 2006 (in some ZIP codes), the best we can say is that we may see some modest value recovery this year.
However, I expect values to fully recover at or near their 2006 peaks. The overarching reason is that supply cannot possibly keep pace with demand, assuming there is job growth. The bid up of pricing should eventually become particularly steep in the single-family housing sector. If we continue to add 25,000 jobs annually, and average 1.6 jobs per household, then demand level will exceed 15,000 annually. Homes cannot be delivered at these levels with diminishing land supply.
Tight lending standards will not change the situation.
If we don’t see new housing peak pricing during the next six to 10 years, it will be unprecedented. Pricing “peaks” have always been higher than the previous top-of-the-cycle peaks. We historically pronounced that housing can’t get more expensive, but it always has.