Small Apartments: Are We Building Too Many?

In the current supply cycle, many new buildings include a large share of studios and one-bedroom apartments. That’s understandable, given the continued importance of millennials as a prime target market this year.

These small units fit Gen Y renters’ needs well, since this group is willing to trade space for a good location and attractive amenities. With supply coming in at a continued good pace, however, the question now is whether small units will continue to perform as well in the near future as they do today.

The unit-mix data in the chart below show recent product delivery trends, and the graph clearly depicts the growing popularity of small units over the past decade. From 2004 to 2008, studios and one-bedrooms accounted for nearly 45% of all deliveries; from 2009 to 2014, that number exceeded 50%. Even accounting for typical data volatility, these figures show a tendency toward the construction of additional compact apartment units.

The evolving unit mix makes sense when considering certain demographic trends. For example, U.S. Census Bureau data show that the number of one-person households increased from about 25 million to more than 32 million in the past 20 years.

These numbers represent a change of nearly three percentage points in the share of one-person households as a proportion of all households. This change is important because most one-person households, who represent more than 35% of all renters today, rent studios and one-bedroom apartments.

The construction of small units is also justified in a market where young households continue to face a slower-than-average economic recovery. While renters prefer locations with easy access to work and transit, those locations usually carry a rent premium. As a result, renters often settle for small, more affordable units.

Not surprisingly, in 2014, vacancies for studio and one-bedroom units remained close to 4.5%, while rental growth was above 3.5%, 50 basis points over that for two-bedroom units and more than 100 basis points above the rental growth for three-bedroom units.

The above data imply that demand for small units should continue to hold strong—at least in the near term. It’s true that young renters will eventually get married, have families, increase their income, and move to larger housing, possibly in the suburbs or closer to good schools. But many of them might still prefer simpler units in central or close-by suburban areas over larger units in outer neighborhoods.

In the end, whether small units continue to perform well depends on the amount of future supply. New units are still being absorbed at a reasonable rate, but construction can get out of hand quickly if developers remain overly optimistic or lenders don’t ration credit gradually.

If that happens, vacancies will jump, rental growth will decelerate, and any advantage small units have over larger units will disappear.

Read the original article here.

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