Friday, December 09, 2011

Marginal Multifamily

It's funny. I read these reports on multi-family all the time. Some of them are by sophisticated people.
But they seem to make some pretty big goofs about how/why rents go up or down.

The big error, I think, is that the analysis is done on the total population when pricing rents (or anything) is all at the margin. I mean, the people who set the prices aren't the 250,000 renters in Portland.
It's the 2000 or so who, at any given time, are looking for an apartment. There are around 110,000 units in Portland
At the moment there are 3000-4000 vacancies. In desirable neighborhoods, there are almost none.

There has been some speculation on why vacancies are so low. Some people cite population growth. But there's not much to support that. Some people say it's from employment improving - but it's still historically low.

But a thousand or two more people looking basically means there are zero apartments available. That appears to be what's happening now. There have been many thousands of foreclosures. Many thousands more people who would normally have purchased a home cannot (unemployment, or can't get a loan because of tougher down payment & credit standards - like my tenants at Savier) or are afraid to buy a house.

A few thousand more renters make a disproportionate change in rents. 10% (for example) more renters who soak up all the available vacancies will cause rents in any new vacancies to skyrocket much more than 10%. People NEED to live somewhere and will give up a lot for housing. On top of that, the people who do get the remaining desirable vacancies are going to be the ones with more money. The people who get the few vacancies there are will be the ones with money. The people at the bottom will be pushed out to the burbs.

The other big mistake is looking at rental inventory instead of total inventory of housing -including houses and condos - now vacant vs total renters currently looking at any given moment. Because the fact is, rents will rise high enough to push some of those who can buy to buy. And it will push some of those condos and houses onto the rental market (companies have sprung up in other states to manage large portfolios of foreclosed houses as rentals, for example).

That's where the real volatility in rents and multi-family valuations is. Adding a thousand foreclosed houses (a small fraction of total Portland foreclosures) to the rental market really throws the game out of whack. It can suck up a pretty large chunk of the renters looking at any given moment. But I think the bigger factor will simply be people buying houses again. Eventually those who can will start buying again. I think I'm already seeing that with some of my tenants. Also I get a lot of people coming from out of town who say they want to rent for 6 months while they figure out Portland and buy a house.

A market with just a FEW too many rentals drops the prices dramatically. How much will a landlord lower prices to fill a unit? A LOT. If the market is satiated, rents could (in theory) drop 50% from these levels. I don't think that's likely. At least, not close to the City. The burbs could find themselves with half empty buildings again though. House buying and rental vs buy preferences don't even have to get back to normal levels for that to happen. A fairly small shift will make for a pretty rapid vacancy surge.

I guess the biggest mistake is to always interpret what's happening at the moment as a long term trend. Rents are up and new construction units coming on-line are few (for the next year. Different story after that). So there is a tendency to project the higher rents forward as a trend. It ignores the fact that pricing is at the margin and that there are huge factors that can increase inventory and decrease demand other than population and construction.


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