The Allure of Apartments via NREI Institutional Outlook

Apartment fundamentals have improved significantly and are outpacing the recovery of other property types. After peaking at 8.0 percent in the first quarter of 2010, the national apartment vacancy rate declined 240 basis points to 5.6 percent as of the third quarter of 2011, according to Reis.

In addition to positive net absorption, an improving job market and favorable demographics have supported a sharp rise in apartment rents. Reis reported that effective rents increased by 2.3 percent in 2010, and we expect rent growth to accelerate through 2013 as demand remains strong and construction remains below its historical long-term average.

As a result of the quick recovery of apartment fundamentals, interest in purchasing core assets has driven up the pricing of class-A apartments in primary markets to near pre-crisis levels in both cap rates and price per unit. As of the second quarter of 2011, the average transaction cap rate, including all asset classes, declined by about 20 basis points to 6.6 percent, while average cap rates for class-A apartments in primary markets declined to 4.7 percent, according to Witten Advisors.

The apartment sector’s robust recovery is supported by favorable demographic trends (echo boomers), declining homeownership, a limited supply pipeline, and attractive government-sponsored entity (GSE) financing. Based on these demand drivers, we believe the apartment market will likely experience a continuation of improvement in vacancy and rent growth over the next three to four years.

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