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Economic trends.

After years of disastrous declines, are things finally starting to look up a bit for multifamily housing? Perhaps so. The multifamily housing sector is by no means poised for a boom, but a gradual recovery from current levels now seems possible.

Chart 1 shows multifamily housing starts. The chart begins with 1985, when multifamily starts reached their 1980's peak, and ends with the MBA economics department forecast for the remainder of 1991 and 1992.

The magnitude of the decline in the late 1980s and early 1990s is clearly illustrated in the chart. Multifamily units were started at an annual rate of more than 600,000 units during late 1985 and early 1986. After that, production fell virtually non-stop until early 1991 to only about 190,000 units--nearly a 70 percent decline.

The decline reflected a multitude of problems. First, the Economic Recovery Tax Act of 1981 put in place many economic incentives that encouraged investment in multifamily properties, such as attractive depreciation schedules. However, tax reform in 1986 removed many incentives and added onerous passive loss limitations that made many projects unprofitable. Partly as a consequence, production of new units slowed to a snail's pace after the reform.

Second, vacancy rates were clearly on the rise. Chart 2 shows rental vacancy rates for the U.S. as a whole and by region. Nationally, the vacancy rate rose to a plateau of 7.7 percent in 1987 and 1988. Since then, the vacancy rate has come down some but still remains well above the rates of the late 1970s or early 1980s.

All regions contributed to the rise in the vacancy rate from 1985 to 1987, particularly the South and West. During the early 1980s, multifamily starts soared in both regions at a much more rapid pace than those units could be absorbed. Partly as a result, rental vacancy rates in these two regions were higher than the other two regions by the mid-1980s. Things continued to deteriorate as the impacts of the collapse of energy prices severely depressed the econoies of the oil patch states, such as Texas, Oklahoma, Louisiana, Colorado and Wyoming in 1986 and 1987. After construction slowed considerably, vacancy rates finally started coming down in these two regions in the late 1980s.

The Northeast was not so fortunate. The vacancy rate continued to rise in the region, particularly in 1990, and partially offset the improvement in the South and West. As a consequence, the national average vacancy rate remained fairly high in the late 1980s and into 1990.

Recently, two other developments hit the multifamily sector: regulatory changes and the credit crunch. As to regulatory changes, the implementation of handicapped-accessibility requirements in accordance with the Fair Housing Amendments of 1988 increased the costs of building units, making some marginal units unprofitable to construct.

With respect to the credit crunch, the slowing of the economy, poor performance of many real estate loans and increased regulatory scrutiny starting in 1989 made many lenders reluctant to fund construction loans for multifamily properties. According to a National Association of Home Builders' survey, a majority of builders indicated that securing construction loans had become more difficult over the course of 1990.

With all these impediments, it is little wonder that multifamily construction slowed so much. So why should it turn around now? The MBA economics department forecast (shown in Chart 1) calls for a gradual improvement over the course of 1991 and into 1992.

Part of the story is that some of the fundamentals underlying the decline of multifamily housing may have played themselves out or are in the process of reversing. For example, improving economic conditions encourage business activity of all kinds, including construction. With the economic recovery likely to begin soon after the first quarter of 1991, multifamily construction will operate in an environment of improving economic conditions in contrast to deteriorating conditions in recent quarters.

Further, rental vacancy rates have been coming down now in most regions for several years. Sooner or later, that means that rents will rise enough to warrant further construction even in the context of tax laws put in place by the Tax Reform Act of 1986. Once investors expect rents to justify construction, that construction will begin. That threshold has probably now been crossed in some markets.

The weakening of construction activity attendant to the handicapped accessibility changes also may have now played out. That would hake further declines from this source unlikely.

With respect to the credit crunch, there are still significant problems, but there may also be reason to expect improvement. The Federal Reserve has been ecouraging lenders to make loans to creditworthy borrowers for creditworthy projects. To the extent that some of the weakness in multifamily construction reflected overly tight standards applied to multifamily projects, more reasonable standards may promote a modest pick up in activity.

Finally, surprising demographic factors may help the multifamily market in the next couple of years. The slowdown of household formations during the 1990s as a result of the aging of the baby boomers (i.e., most baby boomers will already be in households and will not be forming new ones) is an almost inescapable fact. That will reduce the overall demand for additions to the housing stock. However, the extraordinarily low rate of household formations in 1989-1990 suggests that there is a significant degree of pent up demand right now that may be unleashed as the economic recovery unfolds in the next couple of years.

In short, the multifamily market may finally have bottomed. Progress will be gradual, but it sure beats the seemingly endless series of declines that charaterized most of the last five years.
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Title Annotation:effects of economic trends on multifamily housing
Author:Holloway, Thomas M.
Publication:Mortgage Banking
Article Type:column
Date:May 1, 1991
Previous Article:Secondary market.
Next Article:Boardroom view.

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