CNBC published a report this week that said that the multifamily real estate sector is in the midst of an "acute crisis". The article concludes that the upper end of the luxury market is overbuilt and vulnerable to flattening or a market correction. In reality, apartment builders in the top 150 US cities built 395,775 new housing units last year, which represents a 46% increase Y-o-Y. Nearly 75-80% of these new housing units are luxury communities. ,Home page.

While living in Boston during the last couple of years, I have witnessed many major developments being built at an incredibly rapid pace. A majority of these developments are expensive luxury apartments which the majority of people can't afford. The Boston Globe's Spotlight Team recently published a series of articles on the growth of the "Seaport" neighborhood. The article highlighted the lack of affordable housing and an overabundance of luxury housing that do not meet the needs of the diverse population of the city.

With the advent of all these new luxurious multifamily homes, does this put the entire multifamily industry at risk of a flattening or collapse? The threat to Class A new construction is obvious if the market flattens but the existing Class B & C multifamily communities are uniquely placed to withstand market imbalances and corrections. Let's go through the reasons for such a luxury boom and what happens in the event that demand declines.

Luxury Demand is Strong

There are two main drivers for the rising demand for luxury apartment. Baby boomers and empty nesters are moving into cities like Boston, Austin & Denver with a desire for luxury finishes and luxurious structures. One reason to this increase is that lots of double-income households, as well as empty nesters with the money to buy are opting to rent. Facilities like top-of-the-line gyms, concierge services, and fully-service pet spas are now the norm. Every time a new construction is completed there is a sense that there is an amenities arms race. Developers are rushing to incorporate these types of modern perks into their projects; however, it doesn't come at a cost.

Construction costs are high for new construction.

Luxury housing is the main reason why the majority of new developments you see on the market are expensive. This is due to the growing cost of construction work. Construction is a high-demand industry and materials are priced at their highest ever price. Toby Bozzuto is the CEO of Bozzuto Group. He says, "The two-by four doesn't matter if it's in luxurious buildings or affordable buildings." It's the same price. Because of the high cost of labor and materials, and the rise in the value of natural resources developers are being required to construct luxury homes due to the fact that the numbers do not allow for building anything else. To make sure that affordable housing is available cities are now enforcing laws that require developers to incorporate affordable units within their construction plans. Typically between 10%-20% depending on the number of units and the location. But these rules alone do not guarantee a significant growth in affordable housing.

If Affordable Housing Can't Be Constructed, What's the alternative? Read this.

There have been many cycles of boom and bust within the construction industry over the years. In numerous markets across the country, you'll notice large numbers of homes built between the 1970's-1990's. While they may seem outdated compared to current construction but the "bones” are still good. The buildings built in the frame have been constructed with contemporary materials and techniques, and generally only require surface rehabilitation and wear-related items replaced. These apartment communities, and the secondary markets they're located in are strategically placed to counterbalance the flood of luxury homes being built and to maintain housing that's reasonably affordable. These Class B properties are able to perform in any economic climate. When the economy is strong Class C tenants are able to shift to Class B properties. If the economy is in decline, tenants of Class A have to shift to Class B homes. These properties are often available for less than the cost of building. This lets investors offer the perfect property to live in and yet still pay attractive rents that tenants with different income levels are able to afford.
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