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Does Omaha need any more apartments?

A couple of years ago I published my views about the supply and demand of multifamily rental housing in the Omaha metropolitan area. My conclusion was that softness would appear by late 2017 due to an acceleration of supply. I have been pleasantly surprised by the continued strength of the market. Occupancy levels are at 95% or better in most parts of the city.

Unfortunately, the day of reckoning has only been postponed, not cancelled. I believe 2018 will be the first year since 2010 that landlords will be caught short-handed. While I don’t see vacancies rising to the 10%-plus levels we experienced during the dark days of 2004-06 when just about anyone with a pulse was purchasing a house, any pullback in occupancy will feel painful simply because we haven’t been exposed to much adversity in recent years.

Omaha has become large enough now, at nearly 950,000 people, that submarkets can have widely disparate experiences. Northwest Maple Street is an entirely different beast from the Blackstone neighborhood. However, on a macro level, a decline in occupancy of 2-3% seems possible.

There are two reasons why my prediction of market softness has been delayed until 2018. Omaha has grown faster than I thought and developers have been mindful of delivering units at a slower pace.

On the supply side, it’s hard not to ignore the revival of midtown Omaha. Over 1,200 apartments are under construction or just opening south of Dodge and east of 72nd St. Prudent builders released units to the market more slowly than anticipated, however, and the real impact will be felt in 2018 and 2019 when major projects in Blackstone, Aksarben Village and other midtown neighborhoods hit the streets.

On the demand side, population and employment growth have been stronger than I thought possible. We have exceeded 1% population growth for the past few years with a high degree of contributions from international and domestic migration.

My theory has been for many years now that Omaha can absorb 1,200 apartments per year without disrupting decent rent growth in line with inflation. During the recession multifamily permits dropped precipitously to just over 300 units in 2009. Pent up demand and pinched supply signaled a robust market from 2010 – 2016. Now supply is exceeding the 1,200 unit “magic number”. By 2019, Omaha could experience a glut of 2,000 apartments. In the grand scheme of all rental housing, this amounts to about a 2-3% weakening in occupancy levels. This is not disastrous when taken in the context of the metro area.

The pain will be be felt at the top end of the market. The 2,000 unit overhang will attempt to command units nearing $2 per square foot due to the massive building cost and land inflation since 2013. Geography matters. East Omaha will suffer the brunt of the weakness. Developers are correct to recognize the trend towards urban living. It’s unfortunate that they all decided to recognize the trend at the same time.

Like most booms, the story is more about cheap money than it is about demographics. There was a moment this past summer when the 10 year Treasury bond yield began to head towards 3%. Cassandras who had been warning for years that hyperinflation was lurking just around the corner and gold was a safe haven, suddenly began to sound like they were on to something. But as the summer waned, the Treasury dropped to nearly 2% again. It is only about 2.3% now. This rate reprieve has given green lights to many new projects.

Forecasting interest rates is a fool’s errand, but what can not be disputed as we enter our 10th year of extraordinary central bank intervention in the money supply, is that asset price inflation has been rampant. Stock market multiples are as high as they were during the dotcom bubble. If you call a broker looking to purchase an investment property today, you will go straight to voicemail.

The problem is not one of America’s sole making. The Federal Reserve is planning to decrease its purchases of agency bonds and Treasuries. Under normal circumstances, this would signal a dramatic rise in rates. But America does not operate in isolation. Japan, Europe and China have been increasing their supply of money at an ever faster pace. If the US Treasury rises to 2.75%, a fund manager in Zurich will surely be buying when the alternative is less than 1% domestically. The yield on American bonds can not escape the gravity of sub – 2% yields elsewhere. The international market for capital won’t let this US diver come up for air.

The truly international scope of cheap money infects housing as well as securities. Try bidding on properties in San Francisco, Sydney, Vancouver or Toronto and you’ll see what I mean. Even in Omaha, the numbers are distorted. When developers can continue to borrow money at cheap rates, the estimate of risk gets diminished.

I identify five major risks threatening the Omaha apartment business today: The first is the persistently low interest rate cycle. As mentioned above, the cheap cost of capital is giving green lights to developers who might have otherwise tapped on the breaks by now. The second is student loan debt. Young people are the lifeblood of new apartments. They are under tremendous financial pressure today due to the enormous amount of college debt that’s been incurred. While we have a robust economy with local unemplyment rates hovering near 3% today, a slowdown in the economy would stall wage growth and diminish the affordability of high rents. Student loan debt has surpassed the eye-watering level of $1.4 trillion dollars. Yes, that’s trillion with a “T”. Number three is the challenge facing university enrollment. UNO has been growing but is nowhere near it’s target of 20,000 students by 2020. Small colleges are shrinking or disappearing (Grace University is the most recent casualty). National college enrollment peaked in 2011. Fourth, the possible limitations on international workers from the current administration could dampen population growth. Omaha grew by 9,800 people in 2016 and over 1,000 represented international migration.

The fifth challenge facing apartments deserves its own paragraph. The apartment market must also compete with its big brother: the single family home market. The very slow recovery in single family home starts has worked in the apartment market’s favor. Peaking near 6,000 units during 2005, the supply of houses has only now climbed back above 3,000 on an annual basis. The lack of inexpensive new homes has prolonged the renter experience. But this trend will reverse if the economy stays strong and wages continue to grow. Single family permits are on an upward trajectory. When coupled with multifamily permits, the  entire supply of housing is exceeding levels not seen since 2008. The same low interest rates that help apartment developers are the double-edged sword that drives house affordibility.

What’s more, I do not subscribe to the belief that there has been a permanent paradigm shift away from homeownership. Young people still want to start families. When they have children, and if they have the means, they will move to Elkhorn and Sarpy County where pristine schools beckon. Homeownership will probably never return to the insanity of the mid-2000’s but the dream of owning a home did not vanish from society. Millenials may have delayed their family expansion, but the overwhelming human instincts of procreation and self preservation have not ceased. And there’s no place better than a good suburban home for this most American of pursuits.

 

 

 

 

 

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Omaha Apartment Market, Pockets of Oversupply but No Worries

We continue to have positive views on apartment demand going forward. Occupancy has exceeded 95% for over two years. However, we view 2016 with some trepidation as a surplus of 500 units reaches the market in 2016. 

Market Breakdown

We believe the Omaha Metropolitan Area apartment market is heading towards an over-supply level of 500 apartments. However, this amount is fairly insignificant in light of the pace of job creation, population growth, and the overall amount of units in the market.

Three reasons support this idea.

  1. Supply is roughly in line with demand, but has slightly outpaced typical homeownership percentages.
  2. Multifamily supply has been in line with job growth, but has recently exhibited a ratio that signals some caution.
  3. The perceived amount of oversupply is not only a function of job growth. It is also a function of income growth. Construction costs have pushed rents to levels that many new entrants to the housing market will lack the means of stretching for rental payments in new projects.

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Supply and Demand Equilibrium Levels

The Omaha metropolitan area has grown beyond a population of 905,000 and has a consistent level of household formation around 4,000 per year. With about 70% of new housing demand typically attracted to homeownership, rental housing stays at rough equilibrium between supply and demand at 1,200 units per year. That number is roughly line with current supply numbers, but there are signs that new apartments have begun to outpace growth.

As a percentage of total housing supply, multifamily units have, in aggregate over the past three years, exceeded the typical homeownership ratio by 2%. There were 3,041 single family permits issued in 2013, 2,639 permits in 2014, and 2,830 for the trailing 12 months ending September 2015. Multifamily housing hit 1,370 units in 2013, 1,533 in 2014 and 1,114 through September 2015. The sum of the three years shows that multifamily has been approximately 32% of new housing. Meanwhile, historical averages for homeownership in the Omaha MSA have hovered at 70%. In this instance, the oversupply of 2% translates in 250 excess apartments.

As an aside, the peak single family construction occurred in 2005, when 5,877 units were permitted.

Total Units

Units         Single Family    Multifamily    Total      % Multifamily

2013             3,041              1,370            4,411              31%

2014             2,639              1,533            4,172              37%

2015 ttm       2,830              1,114            3,944              28%

Total             8,510              4,017            12,527            32%

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Job creation and Housing Demand

Apartment demand follows job creation levels in a fairly lock-step pattern. The Omaha employment market has been robust since 2012. Between the 2008 nadir of 437,000 jobs and the recent 2014 figure of 462,500 jobs, Omaha has created over 25,000 jobs. This level far outstrips the supply of housing by more than double. By comparison, the stock of housing increased increased by an astonishing 56,700 between 1999 and 2008, but jobs only grew by 26,200!

Typically market research firms such as Axiometrics use a ratio of 5 jobs per unit as a demand equilibrium ratio. In an ideal equilibrium, the 25,000 jobs created in Omaha since 2008 implies a maximum apartment supply of 5,000 units. In fact, over 6,000 multifamily units have been permitted between 2008 and the end of 2014. This implies a ratio of 4 jobs per unit. If one assumes a job growth rate for 2015 of just over 1%, it can be figured that 5,000 jobs have been added during the past year. The ratio for 2015 is, therefore, slightly better at 4.50.

The ratio of jobs to units at a sub-5 level implies an oversupply of about 750-1000 apartments in the metro area.

Year Employment Population Jobs/Population
1999 411,240 761,603 54%
2008 437,478 845,119 52%
2014 462,515 904,421 51%

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Income Concerns

So far, we’ve established that an oversupply of between 250 and 1000 apartments exists in the metro Omaha area. While this number is statistically insignificant out of Omaha’s 100,000 rental units, the direct peer group for new construction is much smaller. The peer group for these units really amounts to about 10,700 units built over the past ten years. These apartments have been built at the top end of rental rates. In this case, a 5-10% oversupply is a number that deserves watching.

Why do we say this? The new apartment math requires an annual income of $38,800 per year. This is towards the high range for single person households who have recently entered the workforce. With young people graduating with significant amounts of student debt, the ability to afford rents approaching $2 per square foot per month may be under pressure.

In Conclusion

Apartment supply as a percentage of homebuilding implies a 2% level of oversupply – about 250 units. When a job ratio is applied as a benchmark, the oversupply level rises to between 750-1,000 apartments. Our best estimate is that the Omaha MSA is heading towards a 500 apartment surplus in 2016 that will cool the occupancy levels from the peaks enjoyed the past several quarters. Additionally, units being delivered to market must be cautious about the pressure of income levels. While employment growth has been robust, student debt is high and many new jobs are below $35,000 per year.

Are we concerned? Not yet. We believe that many of the areas receiving supply have been absorbed at a rate that has exceeded our own expectations. Meanwhile, some experts believe that the Midtown Omaha area is going to be pushing the limits of absorption by late 2016. Also, while supply may have been running ahead of demand recently, the level of occupancy has been in excess of 96% for a few years now. Anything above 95% implies a very tight market. In this regard, there is proof of continued high demand.

One final caveat: We are not in the camp that there has been a paradigm shift in home-buying attitudes. Millenials will eventually get married and have kids. This process may have been retarded by the recession, but it will continue.