CNBC released a report last week that said that the multifamily real estate sector is in the midst of an "acute crisis". The article suggests that the upper end of the luxury market is over-built and prone to flattening or a market correction. Apartment developers in the largest 150 US towns built 395 775 housing units in the last financial year. This represents an increase of 46% over the previous year. About 75-80% of these new homes are in luxurious communities. ,Read more.

While living in Boston over the past few years, I've witnessed numerous major developments being constructed in a rapid manner. Not surprisingly, the overwhelming majority of these are high-end luxury apartments which the average citizen are unable to afford. In actuality there is a reason why the Spotlight Team at the Boston Globe recently released a set of articles that focused on creation of the "Seaport" neighborhood. It highlighted the city's lack of affordable housing, as well as the excess of luxury housing which doesn't accommodate its diverse population.

With the emergence of all these new luxury multifamily properties, does this put the entire multifamily industry at risk of a collapse or flattening? The threat to Class A new construction is apparent if the market flattens but the the existing Class B & C multifamily communities are uniquely placed to withstand market imbalances as well as corrections. Let's go through why there has been such an unprecedented growth in the luxury market and what could happen if demand subsides.

Luxury Demand is Strong

There are two main reasons for the rising demand for luxurious apartments. Generation Y and baby boomers who are empty-nesters are moving into cities such as Boston, Austin & Denver with a discerning taste for high-end finishes and amenity-packed structures. One reason to this increase is that lots of double-income households of millennials and empty nesters with the money to purchase are choosing to rent. Perks such as high-end gyms, concierge services, and pet spas that are full-service are now the norm. With every new development, it seems as though there's an arms race. Developers are rushing to incorporate modern amenities in their developments, however they're not inexpensively.

New Construction is Cost Prohibitive

The reason the overwhelming majority of new homes being put up for sale is expensive is because of the rising cost of construction labor and materials. Construction labor is in high demand and materials are priced at their most expensive ever. Toby Bozzuto is the CEO of the Bozzuto Group. He says, "The two-by four doesn't care if it's in luxury structures or in affordable ones." It costs the same." Because of the high cost of labor and materials, and the rising value of the natural resources, developers are required to construct luxury homes since the numbers don't allow for building any other kind of building. Cities are forced to pass regulations to force developers to create a certain number of affordable homes within their construction projects. The typical range is between 10 and 20%, based on the number of units and the location. The regulations won't result in an increase in housing for the poor.

If Affordable Housing Can't Be Constructed, What's the Alternative? Click here.

There have been numerous boom and bust cycles within the building industry over the years. In many markets around the country, you will notice large numbers of homes built between the 1970's and the 1990's. While these homes may appear out-of-date compared to the current construction but the "bones” are still good. The buildings built during this time were built using the most modern materials and techniques. They typically just require minor repairs, and wear-related items are able to be repaired. These communities, as well as the secondary markets they serve are well-positioned to offset the flood of luxurious homes. They also provide affordable housing. The best part about Class B properties is that they tend to are able to perform well across all economic climates. When the economy is strong, Class C tenants move up into Class B properties When the economy is struggling the Class A tenants will not afford the high rents and typically move down to more affordable class B properties. They are typically accessible for less than cost of building. This allows investors to offer a great place to call home and still maintain attractive rents that tenants of different incomes can afford.
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