Does density improve performance?
Rental rates are an effective tool for analyzing a submarket. The theory goes, the higher the rents, the more desirable the area. Since real estate decisions are partially based on submarket analysis, could the same hold true for submarket level density? This piece will explore whether submarket density indicates a lack of pricing power due to stiff competition, or whether it’s a metric, similar to rental rates, which helps define a competitive advantage.
To begin, let’s define density. In this piece, density reflects the concentration of a metro’s existing unit count located in a given submarket. For example, the Oakland/Berkeley submarket contains 40.7% of the existing units within metro Oakland, the highest concentration nationally. (MPF Research submarket definitions are not based on geographic size. Instead, submarkets are based on groupings of ZIP codes for contiguous areas that share certain characteristics such as geopolitical boundaries, apartment composition, and socioeconomics.) Before we dig into performance data, let’s state the obvious: Dense submarkets typically belong to coastal metros, and for this exercise we excluded New York City because it skewed the results.
To measure performance, MPF Research looked at revenue change and occupancy over the previous 10 years (from 4th quarter 2004 through 4th quarter 2014). Then, we compared the results for the top 10 dense submarkets to results for the MPF Research core 100 U.S. metros, a representation of the U.S. as a whole. Below are a couple notable themes:
- First, dense submarkets are more volatile than the U.S. norm, which appears to hurt these areas during periods of contraction but benefit them in times of recovery.
- Second, in terms of annual revenue change, dense submarkets outperformed 83% of the time compared to the core 100 U.S. metros.
- Third, dense submarkets tend to maintain high occupancy. During the previous 10 years, these areas recorded an average occupancy rate of 96.0%, which was 1.5 points higher than the top 100 metros.
- Fourth, dense submarkets have attracted a sizable amount of new supply in this cycle; however, demand has responded and occupancy remains tight.
- Finally, these submarkets are high-priced areas. Effective rents in dense submarkets averaged $1,955 a month, compared the national norm of $1,179, as of 4th quarter 2014.
In conclusion, it appears density works for three key reasons. First, these are high-priced areas, which signifies that they are both desirable locations and are typically accompanied with less affordable single-family housing. Second, these areas are typically located in close proximity to major employment hubs, lifestyle centers, and entertainment venues. Third, density is rare. In fact, there were only 44 out of 373 submarkets observed that contained 10% or more of their respective metro’s unit count. Moving forward, one strategy is to identify a submarket that is currently below the 10% threshold but is trending higher. One such example is North San Jose/Milpitas. North San Jose/Milpitas accounts for 8.6% of San Jose’s existing units as of 4th quarter 2014, however, that figure is expected to grow as the area is undergoing rapid expansion and remains a hot bed for development activity.
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