CNBC issued a report this week that said that the multifamily realty market is in the midst of an "acute crisis". The article surmises that the upper end of the luxury market is over-built and prone to a flattening or market correction. In fact, apartment developers in the 150 largest US cities constructed 395,775 brand new housing units in the last year, which represents an increase of 46% year-over-year. Of these new homes, around 75-80% of them are considered to be luxury communities. ,Web site.

When I lived in Boston in the last few years, I've witnessed several major developments being constructed at an incredibly rapid pace. The majority of these properties are expensive luxury apartments that the majority of people are unable to afford. In fact there is a reason why the Spotlight Team at the Boston Globe recently published a series of articles that focused on growth of the "Seaport" neighborhood. The article pointed out the absence of affordable housing, as well as the overabundance of luxury homes which does not serve the diverse population of the city.

Do these multifamily developments pose a threat to the multifamily sector? The threat of Class A new construction is apparent if the market flattens, however; the existing Class B & C multifamily communities are uniquely positioned to stand up to market imbalances and corrections. Let's look at the reasons for this boom in luxury, and what happens if the boom ends.

Luxury demand is strong

There are a couple of major factors driving the increasing demand for luxury homes. Baby boomers and empty nesters are moving into cities like Boston, Austin & Denver with a keen interest in high-end finishes and amenity-packed buildings. One specific reason for this growth is that a lot of double-income households of millennials and empty nesters with the money to purchase are choosing to rent. High-end gyms, concierge services and spas with full-services for pets are becoming more regular. There is an appalling amount of amenities being offered with every new construction. Developers are rushing to incorporate these types of modern perks in their developments, however it's not cheap.

Construction costs are high for new construction.

The main reason why the vast majority of the new residential developments coming on the market are luxurious is because of the ever-rising cost of construction materials and labor. Construction labor demand is at an all-time high, and the price of building materials is at the highest they've ever been. 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 an affordable construction. It's the same price." Because of the high cost of labor and materials, and the rising value of the raw land developers are forced to build luxury products because the numbers simply don't work to build any other type of construction. Cities are forced to pass rules that require developers to create an amount of affordable homes within their construction projects. The number of units and the location determines how much they will charge. But these rules alone will not provide a meaningful increase in the number of affordable housing.

What alternatives are there for affordable housing? Read more here.

There have been numerous cycles of boom and bust within the building industry throughout the decades. There are many apartments constructed between 1970 and 1990 in various markets across the country. Although they may seem very out of date in comparison to the modern buildings being constructed today but they're "bones" are good. The buildings built in the frame have been constructed with modern materials and techniques and typically require only surface renovations with the replacement of wear and tear items. These communities, as well as the secondary markets they're in, are positioned well to counterbalance the influx of new luxury apartments and provide housing that's reasonably affordable. The benefit of these Class B homes is that they typically are able to perform well regardless of the economic conditions. When the economy is strong, Class C tenants move up into Class B properties . When the economy is suffering the Class A tenants will no longer justify the luxury rents and typically move down to Class B properties. Investors can usually buy these homes for only a small portion of the cost of building they can provide a great home, but keep the rents at a level attractive for tenants with different income levels.
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