The home price appreciation since the COVID-19 pandemic began has been staggering. Over the past year, the Federal Housing Finance Agency (FHFA) House Price Index has risen 17.5%, and that is an average number. In some of the hottest markets like Phoenix, prices have been rising up to 38%.
Recently, developer Marvy Finger, who has over 5 decades of developing luxury real estate properties sold half of his Sunbelt apartments, as he considers the recent price appreciation to be unsustainable. He warns of an upcoming glut of apartments. Does this mean trouble for apartment real estate investment trusts (REITs) like Equity Residential ( EQR -1.49% )?
The housing shortage is acute
One of the cardinal rules of real estate investing is that market sentiment can change quickly, and when you want to sell, you might not be able to find a buyer, or at least one that will pay what you think the property is worth. This means that it is often wise to sell into a hot market, with the understanding that missing the last part of the move is better than being stuck with depreciating property. That said, does Finger’s sale indicate that we are on the cusp of a bear market in real estate? Probably not. There is a shortage of housing in the United States, not a glut. The supply and demand situation is not conducive to a bear market in real estate.
The National Association of Realtors estimates that the housing shortage in the U.S. is somewhere between 5.5 million and 6.8 million units. Given that housing starts last month came in at an annualized pace of 1.8 million, it will take several years at double that pace to eliminate that gap. In fact, if you look at the pace of housing starts since 1959, we are barely above where we were in the early 1960s when the population was about 58% of what it is now. According to CBRE, the vacancy rate fell to an all-time low of 2.5%, and rents rose 13.7% last year. While there is new supply coming onto the market, we still have a long way to go before supply equals demand.
Not only are house prices rising — rents are rising as well. According to Freddie Mac, rents rose 14.9% from October 2020 to October 2021. That said, rents are expected to moderate as interest rates rise. This forecast was done before the inflation of the past few months, so that forecast may well increase given that materials and labor costs are up across the board. Given the shortage of housing, developers should maintain pricing power as new construction will be expensive and limited.
What does this mean for holders of Equity Residential? Probably not much will change. Equity Residential specializes in luxury apartments in the fastest-growing urban areas. Approximately 27% of Equity Residential’s square footage is in Southern California, which is experiencing robust job growth. According to NAR, Los Angeles is seeing one new unit built per eight jobs created in its area.
This plays into Equity Residential’s strategy, which is to focus on areas of limited supply and strong job growth. It focuses on affluent professional young adults who are drawn to walkable, urban areas. At the end of 2021, its occupancy rate was 96.4%. While many of these young adults may be interested in moving out to the suburbs, that might not be a possibility given the inventory issue. These renters may end up staying put for a while.
The real estate market looks well-supported going forward
Finger’s sale may well be a case of “sell when you can, not necessarily when you want to” and doesn’t really signal anything like an imminent crash. Given rising wages and costs to build, any new housing will be expensive, which works in Equity Residential’s favor. There is no indication of any sort of softness in the apartment market. This should support rents going forward.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.