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Exploring Supply and Demand (Part 1 of 4)

Exploring Supply and Demand (Part 1 of 4)

After years of healthy demand for new apartment units, development activity has ramped up. Nationally, roughly 355,000 new units were under way at the end of 2014’s 2nd quarter. But what does this figure tell us, besides that there’s been a lot of brick and mortar flying around?

Rather than focus on traditional metrics such as inventory expansion as a percentage of existing stock, MPF Research will explore construction levels in terms of future supply relative to recent demand trends. In this article, the first in our four-part series, we looked at the number of units under construction in a given market at the end of 2nd quarter 2014 relative to the average annual absorption during the previous three years. It should be noted, however, that this point-in-time analysis alone is not intended as a predictor of the amount of time it will take a market to absorb all of the units under construction.

Rather, this construction-to-absorption ratio offers simply another way to view apartment development in a specific market. If you look at the bar chart below, San Francisco leads the county with a construction volume that is seven times the average absorption of the past three years – although that number warrants an asterisk mark. On the other end of the spectrum, Detroit and Sacramento have construction volumes that are less than half of the recent absorption average.

annual-absorption

So what does this mean? Well, it depends, of course! Markets like San Francisco and New York rank high only because absorption is traditionally limited by product availability, which in turn is inflating the construction-to-demand ratio. For traditionally underserved housing markets, like San Francisco and New York, pent-up demand should lead to a fast rate of absorption once new supply comes online. On the other extreme, markets like Sacramento and Detroit have little construction … but that doesn’t mean more new starts are warranted, given the economic challenges in both spots. In other words, this ratio is simply one number among many to consider.

Once you get past the outliers on both extremes, this analysis provides a new perspective to view supply. The key, which we will explore later in the series, will be finding the sweet spot between supply and demand.

(Image source: Shutterstock)

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