CNBC published a report this week that stated that the multifamily realty sector is experiencing an "acute crisis". The article concludes that the upper end of the luxury market is overbuilt and vulnerable to a flattening or a market correction. In fact, apartment developers in the top 150 US cities delivered 395,775 new housing units in the last year, which marks an increase of 46% Y-o-Y. In these new homes, around 75-80% are classified as luxury communities. ,View source.

I've witnessed many large developments being built at a rapid pace when I lived in Boston in recent years. Not surprisingly, the overwhelming majority of these are high-end luxury apartments that the average person cannot afford. The Boston Globe's Spotlight Team recently published a series of articles on the progress of the "Seaport" neighborhood. It highlighted the city's lack of affordable housing, as well as the overabundance luxury housing that don't meet the needs of its diverse population.

Do these multifamily developments pose a threat to the multifamily industry? The danger of Class A new construction is apparent if the market flattens, however; the existing Class B & C multifamily communities are uniquely positioned to withstand market imbalances and corrections. Let's take a look at the motives of this luxury boom and what happens if it comes to an end.

Luxury demand is strong

There are two main reasons for the rising demand for luxury homes. Millennials and empty nester baby boomers are making their way to cities like Boston and Austin as well as Denver with a discerning palate for high-end finishes and luxurious structures. This boom can be attributed to the fact that empty nesters and double-income millennial households are choosing to rent rather to purchase. High-end gyms, concierge services and spas with full-services for pets are becoming more regular. It seems like there is an appalling amount of amenities being offered in every new building. These types of modern amenities are being incorporated into development projects rapidly and aren't cheap.

New construction is expensive.

The reason the vast majority of the new housing complexes you see being put up for sale is expensive is because of the increasing cost of construction labor and building materials. Construction labor is in high demand and materials are at their highest price ever. As Toby Bozzuto, CEO of Bozzuto Group puts it, "The two-by-4 doesn't matter if it's in a luxury structure or in a budget-friendly construction. It's the same price. Because of the high cost of labor and materials, and the appreciation of the raw land developers are required to construct luxury homes since the numbers don't work to build any other kind of building. To make sure that affordable housing is available, cities are enforcing regulations which require developers to build affordable units in their construction plans. The average unit count and the location will determine how much they will charge. But, on their own, these rules will not provide a meaningful increase in the number of affordable housing.

If Affordable Housing Isn't Built, What is the Alternative? Homepage.

Over the past few decades, there has been building boom and bust cycles. In numerous markets across the country, you'll notice large numbers of homes built between the 1970's-1990's. Although these homes may appear outdated when compared to the buildings that are being built nowadays but they're "bones" are quite good. These buildings were built using the most modern techniques and materials. They typically need only surface repairs and wear and tear items can be repaired. These communities, as well as the secondary markets that they're in, are positioned well to counterbalance the influx of new luxury apartments and provide housing that's relatively affordable. The best part about Class B properties is that they tend to are able to perform well regardless of the economic conditions. If the economy is flourishing Class C tenants are able to are able to move into Class B properties When the economy is in decline, Class A tenants can not afford the high rents and are typically forced to move to more affordable class B properties. These properties are often offered for less than the cost of building. This allows investors to offer an ideal place to call home and still maintain appealing rents that tenants of different income levels can afford.
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