Apartment Construction: Things Are Looking Up

Bentall Kennedy, a Canadian real estate company, plans to break ground by June on a 654-unit luxury apartment complex in downtown Seattle. It's a $200 million wager on rising demand for U.S. rental properties—spurred in part by the housing slump that's driving people from their homes.

The complex will be the first apartments Bentall Kennedy has built in the city in 10 years, says John M. Parker, president of the U.S. arm of the Toronto-based company, which oversees $23 billion of real estate. "There will be a spike in rents over the next one to three years," says Parker. "It's in anticipation of the spike in rents that we can be comfortable on our return on costs. A few years ago, we couldn't do that."

Companies such as Parker's and AvalonBay Communities (AVB), the second-biggest publicly traded U.S. apartment owner, are stepping up new rental construction as vacancy rates fall and building costs hold steady. Starts of multifamily homes, including townhouses and apartments, jumped 78 percent in January from the previous month, to an annual pace of 183,000, the highest since February 2009, the Commerce Dept. said on Feb. 16. Starts of single-family houses decreased 1 percent.

Stable costs are one factor behind the construction boomlet. The producer price index for materials rose 4.9 percent in January from a year earlier, while the PPI for new office buildings—the best proxy for luxury apartment construction costs—gained 0.4 percent, according to Associated General Contractors of America. "Materials costs are rising, but contractors aren't pushing them through because they're bidding so fiercely to get work," says Ken Simonson, chief economist of the contractors' trade group.

With the foreclosure rate at a record 4.63 percent in the fourth quarter, thousands of homeowners have been forced to rent. In addition, many would-be buyers soured on the idea of a house as an investment after the median price of existing homes tumbled 27 percent in 41/2 years. Homeownership in the U.S. dropped from a peak of 69.2 percent in 2004, to 66.5 percent at the end of 2010, according to the Census Bureau. "There's going to be something like 1 to 1.5 million additional renters per year over the next few years in the U.S.," says Doug Poutasse, head of research for Bentall Kennedy. "That's going to be concentrated in places like Seattle, San Francisco, Washington, and New York."

New rental apartment construction plummeted to a 50-year low in 2009, according to Census Bureau figures. Two years ago, builders started 97,300 apartment units in multifamily buildings of five units or more, the lowest figure since the Census Bureau began tracking the data in 1959. The record high was 906,200 units in 1972. "Nationwide, supply is needed right now and it's going to increase," says Dean Frankel, a senior portfolio manager for Urdang Securities Management in Plymouth Meeting, Pa.

AvalonBay, the Arlington (Va.) real estate investment trust, started 11 developments in 2010 with a combined 2,446 apartment units, 70 percent more than it had forecast at the beginning of the year. It also added more than $600 million of deals to its development pipeline, Chief Executive Officer Bryce Blair said in a Feb. 3 conference call.

Apartment landlords began to raise rents last year as vacancies fell to a national rate of 6.6 percent in the fourth quarter, the lowest since 2008, from 8 percent a year earlier, according to Reis (REIS), a New York-based research firm. There are risks to the outlook for apartments. As home prices come down and interest rates stay low, buying becomes more appealing. Parker isn't concerned: "We think it's going to be an attractive ... sector over the next 10 years," he says.

The bottom line: With home foreclosures helping to drive people into rentals and construction costs flat, builders plan to put up apartment buildings again.

    Before it's here, it's on the Bloomberg Terminal.