Omaha Apartment Market, Pockets of Oversupply but No Worries

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We continue to have positive views on apartment demand going forward. Occupancy has exceeded 95% for over two years. However, we view 2016 with some trepidation as a surplus of 500 units reaches the market in 2016. 

Market Breakdown

We believe the Omaha Metropolitan Area apartment market is heading towards an over-supply level of 500 apartments. However, this amount is fairly insignificant in light of the pace of job creation, population growth, and the overall amount of units in the market.

Three reasons support this idea.

  1. Supply is roughly in line with demand, but has slightly outpaced typical homeownership percentages.
  2. Multifamily supply has been in line with job growth, but has recently exhibited a ratio that signals some caution.
  3. The perceived amount of oversupply is not only a function of job growth. It is also a function of income growth. Construction costs have pushed rents to levels that many new entrants to the housing market will lack the means of stretching for rental payments in new projects.

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Supply and Demand Equilibrium Levels

The Omaha metropolitan area has grown beyond a population of 905,000 and has a consistent level of household formation around 4,000 per year. With about 70% of new housing demand typically attracted to homeownership, rental housing stays at rough equilibrium between supply and demand at 1,200 units per year. That number is roughly line with current supply numbers, but there are signs that new apartments have begun to outpace growth.

As a percentage of total housing supply, multifamily units have, in aggregate over the past three years, exceeded the typical homeownership ratio by 2%. There were 3,041 single family permits issued in 2013, 2,639 permits in 2014, and 2,830 for the trailing 12 months ending September 2015. Multifamily housing hit 1,370 units in 2013, 1,533 in 2014 and 1,114 through September 2015. The sum of the three years shows that multifamily has been approximately 32% of new housing. Meanwhile, historical averages for homeownership in the Omaha MSA have hovered at 70%. In this instance, the oversupply of 2% translates in 250 excess apartments.

As an aside, the peak single family construction occurred in 2005, when 5,877 units were permitted.

Total Units

Units         Single Family    Multifamily    Total      % Multifamily

2013             3,041              1,370            4,411              31%

2014             2,639              1,533            4,172              37%

2015 ttm       2,830              1,114            3,944              28%

Total             8,510              4,017            12,527            32%

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Job creation and Housing Demand

Apartment demand follows job creation levels in a fairly lock-step pattern. The Omaha employment market has been robust since 2012. Between the 2008 nadir of 437,000 jobs and the recent 2014 figure of 462,500 jobs, Omaha has created over 25,000 jobs. This level far outstrips the supply of housing by more than double. By comparison, the stock of housing increased increased by an astonishing 56,700 between 1999 and 2008, but jobs only grew by 26,200!

Typically market research firms such as Axiometrics use a ratio of 5 jobs per unit as a demand equilibrium ratio. In an ideal equilibrium, the 25,000 jobs created in Omaha since 2008 implies a maximum apartment supply of 5,000 units. In fact, over 6,000 multifamily units have been permitted between 2008 and the end of 2014. This implies a ratio of 4 jobs per unit. If one assumes a job growth rate for 2015 of just over 1%, it can be figured that 5,000 jobs have been added during the past year. The ratio for 2015 is, therefore, slightly better at 4.50.

The ratio of jobs to units at a sub-5 level implies an oversupply of about 750-1000 apartments in the metro area.

Year Employment Population Jobs/Population
1999 411,240 761,603 54%
2008 437,478 845,119 52%
2014 462,515 904,421 51%

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Income Concerns

So far, we’ve established that an oversupply of between 250 and 1000 apartments exists in the metro Omaha area. While this number is statistically insignificant out of Omaha’s 100,000 rental units, the direct peer group for new construction is much smaller. The peer group for these units really amounts to about 10,700 units built over the past ten years. These apartments have been built at the top end of rental rates. In this case, a 5-10% oversupply is a number that deserves watching.

Why do we say this? The new apartment math requires an annual income of $38,800 per year. This is towards the high range for single person households who have recently entered the workforce. With young people graduating with significant amounts of student debt, the ability to afford rents approaching $2 per square foot per month may be under pressure.

In Conclusion

Apartment supply as a percentage of homebuilding implies a 2% level of oversupply – about 250 units. When a job ratio is applied as a benchmark, the oversupply level rises to between 750-1,000 apartments. Our best estimate is that the Omaha MSA is heading towards a 500 apartment surplus in 2016 that will cool the occupancy levels from the peaks enjoyed the past several quarters. Additionally, units being delivered to market must be cautious about the pressure of income levels. While employment growth has been robust, student debt is high and many new jobs are below $35,000 per year.

Are we concerned? Not yet. We believe that many of the areas receiving supply have been absorbed at a rate that has exceeded our own expectations. Meanwhile, some experts believe that the Midtown Omaha area is going to be pushing the limits of absorption by late 2016. Also, while supply may have been running ahead of demand recently, the level of occupancy has been in excess of 96% for a few years now. Anything above 95% implies a very tight market. In this regard, there is proof of continued high demand.

One final caveat: We are not in the camp that there has been a paradigm shift in home-buying attitudes. Millenials will eventually get married and have kids. This process may have been retarded by the recession, but it will continue.

The Discipline to Say NO

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You want to follow the herd. It’s natural. Do you remember the 1999 internet bubble? I got so frustrated hearing about my neighbors investing in Level 3 Communications, I thought I was the dumbest person on the block. I bought some Level 3. I made a little money, but I was too chicken to ride it out. I’m glad I didn’t.

Yes, some people escaped that bubble with fortunes intact, but most were swept away. The same can be said of house flippers and land developers in Las Vegas during the middle of the 2000’s. I remember feeling so envious of all these people making quick bucks left and right. What did I do? I went to Baltimore. I flipped a house and lost my ass. Thankfully I got out before the meltdown and I didn’t lose my entire net worth.

So, now, I look at my industry: apartments. Everybody loves apartments as an investment right now. The yield, the safety, the myth that people can’t afford houses anymore. I remember fretting about Omaha surpassing $1.00 per square foot rents in the late 2000’s. We’ve blown through that number.

Downtown is hot. Midtown is hot. But someone is going to be the last one in and they’re going to be late to the party. They will overpay for land, underestimate costs, and underestimate the depth of the market at an affluent level of rent.

It’s frustrating. You know people are making a lot of money right now. But you also have a sick feeling in your gut that everything is being propped up with artificially low interest rates. I went to a conference and heard they are paying 4.82% cap rates in Dallas.

Are we there? Is this Japan with a perpetual zero interest rate policy?

Everybody repeats the same cliche that real estate is about location, location, location. Here’s what they don’t say: real estate is also about price. You can have the best corner in the world, but if you pay too much for it you will dig yourself a hole that will take a generation to extricate yourself from.

We have to take risks as developers. You can’t make money without taking a risk. But you can’t follow the herd. Sheep get slaughtered as the saying goes. Lemmings head blindly over the cliff.

Farnam Street blog has an outstanding transcript of a television interview in India featuring Warren Buffett and Ajit Jain. Everyone needs to read it and watch the interview. It is pure gold.

Ajit: The discipline to say no, if you have that and you’re not willing to let people steamroll you into saying yes. If you have that discipline, that’s more than 50 percent of the battle.

Warren: Don’t do anything in life where, if somebody asks you the reason why you are doing it, the answer is “Everybody else is doing it.” I mean, if you cancel that as a rationale for doing an activity in life, you’ll live a better life whether it’s in the stock market or any place else.

I’ve seen more dumb things, and sometimes even illegal things, justified (rationalized) on the basis of “Everybody else is doing it.” You don’t need to do what everybody else is doing. It’s maddening, during the Internet craze when the bubble was going on.

You have to forget about all those things. You have to do what works, what you understand, and if you don’t understand it and somebody else is doing it, don’t get envious or anything of the sort. Just go on and wait until you find something you understand.”