If you have trouble reading this email, please go to the online version.
December 15, 2016

Demand for High-End Apartments

One of the hallmarks of the current expansion has been the widespread development of high-end apartments. Both proponents and critics have focused on the pricey Class A+, or luxury, properties that have gone up in metro areas around the country, including many that had seen little, if any, such supply in years past.

Along with this shifting landscape of new construction, there’s been greater media focus on apartments, in general, as the homeownership rate continues to edge downward. This combination makes this trend toward higher-cost, higher-rent infill construction seem like a new phenomenon. But it’s not. Conventional wisdom has long been that the only new developments that pencil in most areas are either high-end or tax-credit properties.

But old trend or new, a common worry is whether the industry is in danger of overbuilding the high end of the market. We heard that same refrain a year ago, two years ago, even three years ago in some markets, and yet, in most cases, demand has held up better than many expected, resulting in good absorption of the new supply of higher-end units.

Still, it’s fair to ask whether this can continue. In this Research Notes, we look at large, public microdata sets to see if we can get some valuable insight into who’s renting these high-end residences. While a definitive conclusion is impossible, our analysis suggests that there are still many households—even many apartment renters—with sufficient income to rent new Class A apartments. Potential pullback in demand for these higher-end units in the future is more likely to reflect changes in resident preferences than affordability, with some residents perhaps choosing to spend less on their housing or opting for different types of housing altogether.

Many Upscale Renters Downsize from Single-Family Homes

Publicly available microdata sources contain much valuable information, but they also have a key drawback: Housing units lack class ratings (A, B, C, etc.). This is mainly because there is no uniform agreement on how to define these class ratings. Hence, analyzing upscale apartments requires an alternative approach.

Theoretically, we could use the apartment characteristics that these data sources provide to try to create our own ranking system. However, one critical piece of information—namely, exact location—is unfortunately missing, rendering any such attempt futile. Instead, our approach focuses on apartments where the rent is at or above the 90th percentile of all apartment rents in the same metro area, which we’ll call upscale apartments. While an imperfect measure—what qualifies as luxurious or upscale differs across diverse metro areas—it is, nonetheless, a useful proxy in gaining perspective on the high end of the market.

One of the first things the analysis showed is that there are some noticeable differences in who moves into upscale apartments. Data on recent movers (those that moved within the past two years) from the American Housing Survey (AHS) show that a slim majority (51 percent) come from other apartments. However, another 30 percent of upscale renters come from single-family owner-occupied homes and 15 percent from single-family rentals.
 


In other words, 45 percent of those who moved into upscale apartments in the last year came from single-family houses. This is only a little higher than the 41 percent share in 1999-2001, suggesting this trend is not just a temporary bump caused by the bursting of the housing bubble. Clearly, existing apartment renters are not the sole source of demand for upscale apartments. The fact just under a third of upscale apartment renters had previously been single-family owners/occupiers is noteworthy, particularly considering that single-family owners tend to move far less often than renters (see Research Notes March 2015).

Recent movers to upscale apartments also are considerably less likely to live by themselves; just 31 percent of movers to upscale apartments are single-person households versus 43 percent of movers to other apartments. And they are much more likely to have roommates (15 percent) than other recent movers (9 percent), and a little more likely to be married.


These differences make sense. Roommates and married couples tend to have more income than single-person households, making such households more likely to be able to afford upscale apartment rents. In contrast, single parents are likely to have higher expenses relative to income than other households, so they may be less able to afford upscale apartments.

Many Renters Can Afford Expensive Apartments

Among apartment renters, the pool of potential upscale renters is substantially larger than the number currently living in upscale apartments, at least using the standard affordability metric that says housing costs should be no more than 30 percent of income. In fact, in the top 45 metros, there are 1.5 million apartment households that could afford to pay the 90th percentile rent but whose currently pay rent rates between the median and the 90th percentile. This is especially true in New York and Los Angeles, where there are the most apartment households that could afford the 90th percentile rent but currently pay less.


Most of the metro areas on the top ten list also have seen considerable apartment development in recent years. This suggests that resident incomes might not be as large a governor on potential new development as some have suggested.

That said, the high cost of new development in many of these metros means that rents on new apartments may exceed, perhaps by a lot, the 90th percentile rents on the existing stock. In addition, many residents may be happy paying a good deal less than 30 percent of their incomes for rent, even if it means fewer amenities or inferior location. 

The More Educated, the More Likely to Live in Upscale Apartments

We also analyzed the key economic, social and demographic variables available from the American Community Survey (ACS) to try to identify any additional distinguishing characteristics of upscale renters. Only one stood out: education.


Among those who can afford 90th percentile rents, there is a strong relationship between the number of years of education and the rent they pay; the more schooling, the more likely they are to pay upscale apartment rents.

For example, among those who can afford 90th percentile rents and are living in upscale apartments, 42 percent have four years of college under their belts; another 35 percent have five or more years of college. By contrast, among those living in apartments with rents in the 50th – 74th percentile range, 33 percent have four years of college education while 21 percent have five or more.

It is unclear why greater education leads to a greater likelihood of living in an upscale apartment, even after taking into account income; there are likely other characteristics of an individual or household that play a factor. But it does suggest one additional element to look for when trying to estimate the size of potential upscale apartment demand.

Conclusion

To return to the question of whether the industry is in danger of overbuilding the high end of the market, our analysis suggests that, from a macro-market perspective, there is still a substantial reservoir of households who could afford upscale apartments.

The data show that many high-end renters are essentially lifestyle renters or renters by choice. Many are highly educated and are married or living with roommates, making them more willing and able to pay higher rents for upscale apartments. Moreover, a good portion of them have had a single-family living experience, either as an owner or renter, prior to living in an upscale apartment. For whatever reason, an upscale apartment now makes more sense for their current needs.

But arguably more important is the fact that there appears to be more depth to this market, as there are many apartment residents that could afford to pay upscale apartment rents but spend less. So the question is less about whether they can afford it and more about whether they see enough value in upscale apartment living to pay the higher rents.  

About Research Notes
Published quarterly, Research Notes offers exclusive, in-depth analysis from NMHC's research team on topics of special interest to apartment industry professionals, from the demographics behind apartment demand to effect of changing economic conditions on the multifamily industry.
Questions
Questions or comments on Research Notes should be directed to Mark Obrinsky, NMHC's Senior Vice President of Research and Chief Economist, at mobrinsky@nmhc.org or 202/974-2329.
Tools
Print-Friendly Version RSS Search Back Issues
Contact Us
1775 Eye Street, N.W., Suite 1100,
Washington, D.C. 20006
202 974 2300 Office
news@nmhc.org
Connect
Facebook
Twitter
LinkedIn
Manage My Email / Unsubscribe
Please add ‘news@nmhc.org’ to your email address book or Safe Sender List. If you are still having problems receiving our communications, see our White List page for more details.