High Rises for the Apartment and Condominium Construction Industry

By IBISWorld Analyst Deonta Smith

As Seen In The ABA Journal

The Apartment and Condominium Construction industry is rapidly gaining steam, which can be attributed to Americans increasingly moving to metropolitan areas. Young adults typically want to live closer to the center of metropolitan areas, and senior citizens are relocating to areas with more amenities. These factors are the main determinants for industry growth. Also propelling industry growth are decreasing rental and vacancy rates; with inflation and the high cost of borrowing, the industry is emerging to compete with the diminishing Single-Family Home Construction industry.

Although housing market conditions are improving, tight lending practices continue to hinder home sales; only a limited pool of applicants qualify for top interest rates, and many cannot qualify for a mortgage. Unable to purchase a home, many Americans with improved income are choosing to upgrade their rental residences. Meanwhile, the high number of home foreclosures over the past five years has increased competition for rental housing. Shifting attitudes toward homeownership as a result of the housing market collapse have dissuaded people from buying. As a result of improved income and lower unemployment, younger adults who moved back home or lived with friends during the economic downturn will now be looking to rent a place of their own. All these factors have caused the rental market to shift away from the rental discounts and other freebies that landlords offered to keep units filled during the recession.

This industry, which comprises firms that construct multifamily homes, is currently experiencing a boom in demand; multifamily homes are emerging as one of the strongest sectors in the real estate market. Generous rental rates continue to push revenue growth, encouraging multifamily housing for those who want to live on their own, yet seek to keep their costs low. The prevailing low rates benefit the industry in the form of lower vacancies and increased demand; furthermore, people approaching retirement age seeking lifestyle-housing communities (or active-adult communities) has supported the demand for multifamily housing construction. Younger generations are demanding more from their residential complexes and communities, particularly in cities. As a result, the construction of newer complexes that offer more amenities than before – including swimming pools, lounges, gyms and theaters – has greatly contributed to industry growth. As such, industry revenue is expected to grow at an average annual rate of 5.7% to $27.6 billion in the five years to 2012, including an 18.4% jump in 2012. 

Rental and mortgage rates serve as a barometer of industry performance; if mortgage rates are too high, occupants are more likely to rent and vice versa. However, significant rent increases could lead to inflation, and the Federal Reserve, in turn, may be forced to raise interest rates, possibly in late 2013. Higher interest rates could significantly hinder condominium sales. The 30-year fixed-rate mortgage, the most common type of loan for home purchases in the United States, is expected to decline for the sixth consecutive year in 2012, falling 12.1%. However, as in 2013, IBISWorld expects the mortgage rate will go up 4.9%, and rates will continue rising through 2015. With that said, an increase in the aforementioned rate would in turn benefit the apartment and condominium market, making apartments a more affordable alternative to buying a house.

Industry risk assessment

IBISWorld uses a nine-point scale to assess industry risk, with a score of one indicating very low risk and a score of nine indicating very high risk. Overall, the Apartment and Condominium Construction industry is considered to have a low level of risk, with a score of 3.98 in 2012. The industry’s high growth projected over 2012 is the primary factor leading to the industry having very low risk. The industry’s high barriers to entry, which protect existing industry firms, are another factor leading to its low risk score. As the economy rebounds, industry firms and contractors are both likely to benefit from lower vacancy rates and increased rental rates; these trends are leading indicators of a rebounding housing market. Larger, more-complex projects are set to drive profitability because they provide participants with stable income due to the length of time needed to complete these developments; additionally, these projects are more expensive because they are more difficult to build.

Traditionally, the need for new apartment complexes is often dependent on vacancy rates, with higher rates signaling weak demand or overdevelopment. Occasionally, vacancy rates can rise during periods of strong economic growth and property valuation as developers and property owners look to cash in on the rapid appreciation of real estate prices. This is in part due to low unemployment rates or increased wealth, which have positive effects on household formation rates by increasing the amount of space individuals can afford. Occupants typically start out by renting apartments, which lowers vacancy rates and increases rental rates, then organically advancing to homeownership, which increases property values. Disregarding this trend, vacancy rates are often an important indicator of industry demand because the need for new property rises as vacancy rates fall.

Outlook

Revenue for the Apartment and Condominium Construction industry will continue to increases over the five years to 2017. Price competition from tendering (i.e. written offers or bids to contract goods or services at a specified cost or rate) by prime contractors is anticipated to have less of an impact on profitability through the period. This situation will be in part due to larger developments allowing participants to negotiate with subcontractors, particularly in the next couple years while employment is still weak. Many of these workers may also be willing to receive a smaller income if it means gaining access to a project that will provide income for a longer period of time. In addition, industry firms will have more flexibility to negotiate input costs for supplies due to the larger scale and increased material requirements of these new projects. Also, despite the inflationary impact of high gasoline prices, material costs are expected to remain flat because many supply industries – including glass manufacturers, concrete professionals and steel companies – have excess inventory.

Several forward-looking opportunities do exist for apartment and condominium construction companies. Many of the generational trends that have helped the industry return to growth will continue to define it over the next five. The current mass migration of young adults to city centers will become increasingly important. Industry growth is forecast to outpace US economic growth. IBISWorld forecasts that industry revenue will grow 18.4% to $27.6 billion in 2012. In comparison, revenue expanded an average 4.4% per year from 2009 to 2011. Contractors that can establish solid relationships with developers will benefit from increased invites to tender on a project; those that cannot are at risk of losing revenue and profit. Total industry revenue is expected to surpass its pre-bubble peak of $40.2 billion to total about $42.9 billion in 2017. Technological improvements, including the demand for environmentally friendly LEED-certified buildings, will support industry growth. The continued decline in homeownership, demographic shifts and increases in urban populations will also support growth.

To download full research reports for the industries discussed in this article, click on the report titles below.

Apartment and Condominium Construction, Home Builders

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