Multiunit Rental Construction Hits a 35-Year High
Plus: a sharp drop in lumber over the past month
In the month of April, approximately 612,000 new multiunit housing projects (defined as 5+ units in the same property) were started on a seasonally adjusted basis. This was up from 499,000 at the start of the year, 430,000 one year ago, and just 235,000 in April 2020, which was the low point for this type of construction in recent years as it was right at the outset of the COVID-19 pandemic and construction activity had briefly fallen off a cliff.
What to make of this current boom in multiunit housing construction? The last time there were this many new multiunit properties under construction, the year was 1986 and Haley’s Comet was passing overhead. I think the story is pretty simple: even in the face of high costs of materials, significant energy expenses, massive supply chain challenges, and tight labor markets, the private sector is responding to robust demand for new housing because that demand is just so strong.
The chart below shows the number of new multiunit housing starts over the past 20 years, with the recent surge evident on the far right side of the graph:
Two weeks ago I wrote about President Biden’s housing plan, and while there are certainly ideas and proposals in it that make sense and will help alleviate the nationwide housing crunch, what the data says to me and what I see anecdotally in my work as a commercial lender is that builders, developers, and construction contractors are rushing in to fill the need for multiunit housing. This is largely because rents are so strong (and continue to rise). The profit opportunity is significant and there is such little inventory of existing properties on the market that it is often more viable to build new units instead.
What it All Means
There are a number of key implications of this data. First, I know this makes me sound like a foolish contrarian given just how significant the current housing crunch is nationwide, but I believe the housing gap will somewhat close over the next 3-5 years. By “somewhat” I mean that we really need 7-10 years of robust building to fully close the housing gap, but the gap will narrow over the next few years simply because there is actually new inventory coming online, which the chart above illustrates. Markets react and when there are as many people who need housing as there currently are and the profit opportunity is so significant, builders, developers, and others who are entrepreneurially-minded will rush in to respond, which is what is happening.
The increase in construction is good for both prospective tenants and builders. Rents have been rising at a strong clip over the past two years. This new surge in building might help us to return to more of an equilibrium. For each 5-unit property that is new to a local market, that is 5+ people or families who have a place to live, which disperses the pool of prospective renters just slightly, loosening up the market for other tenants. A single example like this is only anecdotal, but multiply it out over an entire community, region, or state let alone nationwide, and you can see how the rental market might start to adjust.
Existing rental property owners, which I know many of my readers happen to be, should be mindful. The supply crunch has been, ironically, favorable to owners of existing properties as they have had the upper hand for several years now with a greater number of prospective tenants than available units, which has pushed rents upward. But as the number of units increases through new construction, the ratio will move back towards equilibrium. I think we are a long way off from the ratio actually flipping, but rental property owners should pay attention: if the trajectory continues in the chart above, there will be a lot of new units coming online in the next few years, which will ease pressures on the rental market for tenants.
Will the Trajectory Continue?
The number one reason why the recent surge in multiunit rental construction might not continue at such a brisk rate is rising interest rates. As the cost of borrowing increase, so too does the cost of construction (for most developers anyway; those that can self-finance and are therefore not subject to interest costs are in a different category). Extremely high rates would deflate the construction boom.
But consider this, as interest rates have risen sharply in recent weeks, there are signs that other construction costs are actually dropping. Consider the chart below of the price of lumber on the commodities market, which has dropped from just over $1,000/per thousand board feet to $620 in just the last month. That is a significant short-term drop that will reverberate through the market as decreasing prices cycle through to the stores.
If the cost of building materials drops, the negative impact from the rising cost of borrowing might be at least partially offset. That being said, other challenges remain including frustrating supply chain issues. I still hear stories almost every day of things like bathtubs, wire, garage doors, etc., taking months to be delivered. And the labor market is still extremely tight. For every home a contractor can build, he or she could probably build another two if they had the labor right now. That might not loosen up for awhile as just this week there was another strong jobs report showing 390,000 new jobs were created, which beat economists’ prediction of 328,000 jobs. In the “good news is bad news” school of investing, the stock market dropped as the strong jobs report gave fuel to the fire that the Fed is likely to continue to ratchet up interest rates to cool inflation given how strong the job market remains. I wrote about the relationship between the jobs report and interest rates back in February if you want to read more on that.
The word on the street these days is recession and whether we will enter one. On a positive note, however, both the jobs report this week and the data showing such strong multiunit construction are both signs that plenty of things about this current economy are actually humming right along. The real test for the Fed and other policymakers is whether they can engineer a soft landing or if they will overshoot on jacking up interest rates, reversing the positive things we do have going right now. Time will tell.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram. Opinions and analysis do not represent First National Bank.