The Atlanta apartment market is one of the most hotly debated metros in terms of future performance. Bullish investors point to the area’s status as a regional business hub, vast logistics/manufacturing infrastructure and educated workforce. Bearish investors highlight the long-term structural challenges: historically weak apartment performance, an abundance of housing supply and the propensity to overbuild. My position is this: While Atlanta’s primary structural issues — excess housing and weak employment growth — need time to improve, there is light at the end of the tunnel. Atlanta is on a positive trajectory, as residential supply has been pared back and employment growth has trended higher. If those trends continue, Atlanta will continue to impress, with the strongest gains likely to come in Downtown/Midtown, Buckhead, Central Perimeter and the northern suburbs along the Georgia 400.
Structural themes tend to have long cycles. They take time to build and grow, and they take even more time to undo. The chart below illustrates Atlanta’s pre-recession housing excesses by comparing the number of jobs created annually to the annual total of residential permits. The comparison serves as a proxy for supply and demand of residential housing. From 1999 to 2007, the relationship was out of whack, as the ratio of jobs to permits was either flat or negative. This was primarily driven by the single-family boom. However, more recently, the balance between supply and demand is at much healthier levels. For the multifamily sector, the better balance has allowed occupancy to 5.3 points increase since 4th quarter 2009, to 93.5% at year-end 2014.
Cleaning Up the Inventory
Following the recession, the problem of excess inventory was most severe in the single-family market. From 2004 to 2011, the share of owner-occupied single-family homes among all occupied housing types dropped from 67% to 63%, a result of a wave of foreclosure activity that drove down the overall value of single-family homes. In response, Atlanta became a top market for institutional investors. Single-family homes were purchased out of foreclosure and quickly converted to rentals. The landscape remains basically the same today, as the share of owner-occupied single-family homes remains historically low. For the apartment market, this means both higher demand for rentals and increased competition for tenants. But it also helped to clear the excess single-family inventory at the metro level. At year-end 2014, the median sales price for single-family homes jumped 9.3% year-over-year, to $212,000. Moreover, inventory levels amounted to 3.8 month supply, according to the Atlanta Board of Realtors, suggesting favorable conditions moving into 2015.
Jobs in the Spotlight
The second structural problem facing Atlanta: weak labor market conditions. From 2000 to 2010, the total number of nonfarm employees was essentially unchanged, even though the local population grew by more than 1 million people. As a result, the labor participation rate (the labor force as a percentage of the working age population) fell and unemployment rose, reaching double digits in 2009. During the employment declines, the largest employment cuts took place in the Construction and Manufacturing sectors.
Fast forward to today and clearly employment trends improved in 2013 and 2014. To begin, construction jobs are returning as residential and commercial construction has picked up and offshoring of manufacturing has given way to onshoring. Still, because of the deep cuts during the recession, headcount in both sectors remain below that seen in 2000. Meanwhile, the metro has recorded consistent employment growth in nearly every major employment sector for two years leading to nearly 60,000 new jobs annually in 2013 and 2014. As a result, the unemployment rate sat at 6.4% in December 2014, based on preliminary data from the Bureau of Labor Statistics.
But is that pace of job growth sustainable? Anecdotally, there has been a steady wave of encouraging themes and news suggesting this trend has legs. Examples include:
- Lower oil prices and available credit with favorable interest rates have pushed auto sales to an annualized rate of 16 million units. Due to a lack of unions and reasonable price of labor, this trend is providing a tailwind across the southeast.
- Lower oil prices (again) should boost global trade combined with the Panama Canal expansion should indirectly benefit the outsized trade, transportation, and manufacturing sector.
- The growing tech incubator positioned around Midtown Technology Square should grow Atlanta’s technology employment and presence.
- Recent corporate wins: Mercedes Benz (headquarters), Pulte Group (headquarters), NCR Corp. (headquarters), State Farm (regional hub), Caterpillar plant in Athens and upcoming Porsche expansion.
Sustainability, however, depends on two key assumptions: future growth in labor force and the labor participation rate. Given the shortfall in jobs from 2000 to 2010, the matrix below outlines possible scenarios if Atlanta’s labor market is to normalize following the lost decade.
For perspective, labor participation was 64.4% at the end of 2014, compared to the average historical rate of 68.7% from 2000 to 2013, according to Moody’s Analytics. Moving forward, it seems reasonable to expect the labor participation rate to increase as the economy improves as people rejoin the labor market. However, retiring Baby Boomers will counterbalance some of the gain. So let’s use 63% to 65% in the sensitivity analysis. Next, let’s consider the labor force growth. Historically, the labor force is estimated to have grown by 2.0% per annum during the previous 14 years. The lowest rate of expansion during this time was 1.4% in 2010 and more recently the labor force grew by 2.0% in 2014. Using historical data, a 1.0% to 2.0% growth rate seems reasonable.
Based on these assumptions above, if this indeed a paradigm shift and Atlanta’s labor market begins to normalize, local employment has the potential to expand by 61,000 new jobs per year through 2019.
Downside Risk to the Apartment Market
While we see big improvements to the structural issues, let’s explore the downside risk. In Atlanta’s case, it’s new supply. The multifamily construction pipeline, which was essentially shut off between 2009 and 2011, is picking up again. At the end of 2014, there were more than 11,000 units under way, roughly 9,700 of which were expected to complete in 2015. For comparison, Atlanta has recorded an average of 9,000 new units per year during the previous 20 years. In order for the upside case to hold, it is paramount new supply remains in check. A potentially major factor limiting new supply moving forward is NIMBYism (Not In My Back Yard) related to development activity in the suburban submarket. Whatever the counterbalance ends up being, new completions must consistently remain below the long-term averages.
Asset pricing is the second major risk. With cap rate compression and rising values, investors need to get a sense for how much of the future recovery is already priced into asset values today. After all, investors know it’s all about balance in this late-cycle recovery story.
Submarket Level Trends
Atlanta has been and will most likely remain a bifurcated market. The growth path and employment density clearly favors Downtown/Midtown, Buckhead, Central Perimeter and northern suburbs. It’s in those northern areas where the jobs are, where the new Atlanta Braves stadium is going and where the live-work-play lifestyle is at its best. In 2014, effective rents in Atlanta increased by 6.8%, the fifth largest increase among the top 50 U.S. metros. But the submarkets with the greatest demand drivers saw even larger gains: Downtown/Midtown (6.9%), Sandy Springs (7.0%), Dunwoody (7.2%), Norcross (8.2%), Buckhead (8.3%) and Alpharetta/Cumming (9.6%). These submarkets will need to continue to drive the Atlanta metro’s apartment performances going forward. In addition, these submarkets are poised to sustain job growth; however, the urban core could face short term supply headwinds.
In conclusion, a wide range of possible outcomes exist in Atlanta. Your outlook will ultimately depend on how you answer three important questions:
- What is a sustainable job growth figure?
- To what extent does excess housing still impact Atlanta?
- How many new multifamily units can reasonably be absorbed each year?
Atlanta was down, but it’s not out, as the structural story shifts for the better. Atlanta appears poised for better days, but investors must keep a careful eye that past mistakes don’t get repeated.
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