An Ideal Apartment Marketplace.

When you deal with the day-to-day challenges of property management, development or investment, things don't always run smoothly. Today's multifamily housing market represents a textbook case of the ideal marketplace: occupancy is tight, rents are on a sharp upswing, product demand is strong, and construction levels are under control.

Here's a brief look at where things stand today and what led to this healthy market.

Occupancy Holds Strong

Plenty of factors suggested that apartment demand would falter during the past several years. For example, with Baby Boomers now in their late-30s to mid-50s, the nation added relatively few of the younger households that form the main demographics for multifamily housing. Plus, low interest rates made home purchases attractive. These factors combined to drive home ownership in the U.S. to record levels.

Apartment demand remained solid, however, as a robust economy led to impressive new household formations. Lifestyle changes also created an older and more affluent generation of renters. This demographic group would have opted for home purchases in previous decades, but they remained in the apartment marker during the 1990s.

Demand for apartment homes surpassed the volume of new supply delivered recently, pushing occupancy rates upward. Multifamily housing occupancy is currently 95.4 percent, according to the M/PF Research survey of more than 1.4 million apartment homes in the first quarter of this year. This occupancy rate is up 0.9 points since early 1999 and ranks among the strongest performances seen in recent decades.

Nearly full occupancy is particularly impressive since this present period is considered an apartment development cycle. Overbuilding has been avoided through seven years of notable construction activity. In comparison, the building boom of the 1980s led to a five-point dip in the nation's multifamily housing occupancy rate.

Few vacancies now exist in any region of the country. Occupancy rates range from 94.9 percent in the Midwest to 96.6 percent in the Northeast. Even the South, which experienced considerably more construction than other sectors of the nation in the past few years, posts healthy occupancy of 95.1 percent.

Among the 57 major metros tracked in M/PF Research's U.S. Apartment Market Report, Newark has reported the nation's tightest occupancy for all but one quarter since mid-1996. Newark again ranks first in the first quarter this year, with occupancy topping 99 percent. Neighboring Middlesex also is nearly full. Boston is another market from the Northeast region with only a handful of available apartment homes.

Occupancy likewise is very strong in the Bay Area/Silicon Valley in California. San Jose, San Francisco and Oakland all are 97.6 to 99 percent occupied. San Diego is at 97.3 percent capacity, making it Southern California's occupancy leader.

Washington, D.C. and Minneapolis, which are traditionally tight markets, continue to post nearly full occupancy. New in recent months to the list of occupancy leaders are Austin, Texas, and South Florida. With nationwide performances so strong, another half dozen cities are posting occupancy rates between 96 and 97 percent.

Significant vacancies register in only a handful of metropolitan areas. Most notably, Houston is struggling to absorb a sizable wave of new completions. Occupancy there has dipped 0.9 points during the past year to 91.9 percent, and the metro still faces the addition of another substantial block of new supply in the next few months. Indianapolis is also a comparatively weak market right now, with occupancy reported at 91 percent for the first quarter this year.

Phoenix lost its momentum during the past year, as increased new supply levels in late 1999 temporarily overtook demand. Its first quarter occupancy this year of 93.9 percent is down 0.6 points from a year earlier.

Other metros that experienced occupancy declines during the past year include: Chicago and West Palm Beach, Fla. However, since the performances in those two areas were so strong a year ago, today's increased vacancies still leave the apartment occupancy rate at more than 95 percent.

Rents Are Growing Rapidly

Tight occupancy is allowing rents to climb at a rapid pace. M/PF Research's survey for the first quarter this year shows that rents at existing communities grew 5.2 percent during the past year. This performance is the largest rent increase seen since this nationwide survey was initiated in 1992. Rent growth statistics from the survey measure same-store change, tracking rents in the same properties from one point in time to another. Therefore, the figures avoid the misrepresentation of actual performance that can occur due to sampling variations, particularly the addition of newer, high-priced properties. Today's rent growth pace surpasses the general increase in consumer prices, reported by the Bureau of Labor Statistics at an annual rate of 3.7 percent as of this past spring.

Rental rate escalation reached especially high levels in the West and Northeast. Same-store rents climbed 6.5 percent in the West during the past year, while the Northeast's rates jumped 6.3 percent. Rent inflation from four to five percent occurred in the South and Midwest.

The Bay Area/Silicon Valley of California is the nation's hot spot for rent growth. Average rents at existing properties in metropolitan San Jose rose 17.7 percent this past year. This growth rate triples the record performance posted for the nation as a whole. San Francisco's rents are up 12.3 percent annually, and Oakland's rents have jumped 10.6 percent. Other markets reporting double-digit rent growth rates for the past year include: Miami and Middlesex.

Annual rent growth from six to eight percent occurred in Washington D.C., Denver and parts of Southern California, all areas that have histories of substantial rent growth for the past couple of years. Also currently posting particularly strong rent growth were Austin and St. Louis, metro areas where momentum surged during the past few months.

Most of the nation's rent growth leaders added modest volumes of new supply during the past year. Thus, competition among new apartment properties in lease-up, which generally slows rent growth, is not especially pronounced.

Looking at markets where recent deliveries were more substantial, ongoing rent growth near three percent appears typical. Rental rates are increasing at this moderate pace in Dallas/Fort Worth, Tampa, Chicago and Seattle. A somewhat stronger growth of 4.3 percent occurred in Atlanta, but rent inflation lagged at 1.4 to 1.7 percent in Phoenix, Houston, Orlando and Las Vegas.

Is Today's Strong Performance Sustainable?

Apartment demand appears likely to remain solid through the foreseeable future. The national economy continues to defy expectations of a meaningful slowdown and keeps producing jobs at a rapid pace. These jobs are leading to the creation of new households and demand for single-family homes and apartment homes.

Rising interest rates could dampen the pace of single-family home purchases over the next year, pushing a larger share of total housing demand into multifamily housing.

Looking at the other half of the supply/demand equation, new construction in the apartment market remains at significant levels in most metropolitan areas. Nationally, some 328,000 apartment homes were authorized for construction by building permit during the past year, an eight percent decrease in new construction from a year earlier.

What is particularly encouraging is that starts have decreased significantly in some of the cities with weak or declining occupancy and limited rent growth. The number of apartment homes permitted in Houston during the past year dipped by more than half, and a decline in starts also occurred in Dallas/Fort Worth. Other metros reporting substantial slowdowns in new building included: Las Vegas, Portland, Ore., and Nashville, Tenn.

Notable upswings in new development did register in a few cities. Among the nation's largest cities, Chicago reports a building pace up 19 percent, while construction has climbed 15 percent in Atlanta and 11 percent in Seattle. Perhaps in more danger of overbuilding are some of the nation's small to mid-sized markets. The supply/demand relationship can get out of balance quickly in smaller metros, and some of these cities are seeing double-digit growth in the pace of new construction. The increase in the number of new apartment homes authorized by building permit is especially large in Austin, Charlotte N.C., San Antonio, Texas, Kansas City, Mo., and Columbus, Ohio.

The nation's apartment marker is expected to continue to maintain healthy occupancy. This favorable occupancy outlook in turn suggests that property owners should expect substantial rent increases. Rent escalation, at least slightly above the general consumer price inflation rate, appears achievable. Though rent growth at the impressive level seen earlier probably will not be sustainable.

G. Ronald Witten is president of M/PF Research, Inc., a multihousing industry consulting firm based in Dallas, Texas.