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Building and building into a boom

Construction of large apartment buildings is rising because builders and real estate investors are willing to look beyond current high vacancy rates and falling rents to make a bet on the future.
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In his abbreviated summary of the economic state of union Tuesday, President Bush rightly focused on the strength of the housing industry, a pillar of growth that shows no signs of weakening after a boom that has lasted for years.

Using sentence fragments that recalled his father’s rhetorical style, Bush declared, “The pace of economic growth in the third quarter of 2003 was the fastest in nearly 20 years.  New home construction: the highest in almost 20 years.  Home ownership rates: the highest ever.”

The next morning, the Census Bureau reported that housing starts rose in December to their highest level since 1984, surprising analysts who had expected a decline. Permits issued for new construction also rose, suggesting that 2004 will be nearly as strong as 2003, which by some measures was the best ever for the industry.

“We really ended the year with a bang,” said Orawin Velz, a senior economist for mortgage financing giant Fannie Mae. “The good times keep going. We are going to have a very good first quarter.”

She predicted housing starts this year would fall no more than 5 percent from last year’s 1.85 million units, which was the strongest in 25 years. “It is possible it doesn’t decline at all,” she said.

For insight into why housing continues to defy expectations of a slowdown, take a look at the boom in construction of apartment buildings, a major factor in December’s strong housing numbers.

Construction of large, multi-unit housing rose last year to its highest level since 1989. Yet, apartment vacancy rates have been rising in most cities due to a weak job market and the affordability of home ownership due to low interest rates. Nationwide nearly 7 percent of apartment units were vacant at the end of last year, up from just 3 percent in 2000 and the highest level since 1989, according to Reis Inc., a real estate research firm based in New York.

Builders and real estate investors are willing to look beyond current high vacancy rates and falling rents to make a bet on the future, said Mark Obrinsky, chief economist of the National Multi Housing Council.

“It was a tough year (for landlords) in 2002 and 2003, and 2004 may be tough too,” he said. “But it’s a cyclical industry, so you have got to figure a way to get through the downturn.”

Mark Zandi, chief economist for, said apartment builders are flooding the market with an overabundance of supply, making life difficult for landlords.

Yet real estate investors are more than willing to fund the building boom, especially when alternative investments like Treasury securities are offering relatively unattractive returns.

“Prices for multifamily properties have held up very, very well in the face of rising vacancy rates and falling effective rents,” said Zandi. “That is because investors are looking past the current weak demand.”

In coming years, apartment owners should benefit from “a very positive demographic tailwind” as the so-called Echo Boom generation ages into its 20s, the prime years for apartment rentals, Zandi said.

“The industry is anticipating a significant pickup in demand, and I think rightfully so,” he said.

Over the near term, demand for apartment rentals is likely to remain weak, because of the growing supply and the shift toward ownership, analysts said. And the market is unlikely to turn around until the economy begins adding a substantial number of jobs, said Obrinsky.

“Home ownership absolutely is an issue,” Obrinksy  said. But the long downturn that has seen the economy shed 2.3 million jobs is a more important reason for the downward pressure on rents, he said.

The weak labor market has caused a lot of “doubling up” as workers in their 20s and early 30s find roommates or move back in with their parents, industry analysts say.

“Everybody’s expectation is that when and if we get strong employment numbers we expect to see an undoubling,” Obrinksy said.

When that happens, many of those workers are likely to seek rental housing, especially if mortgage rates begin rising and “cutting off the flow of people into single family homes,” said Andrew Wright, a senior consultant to Reis, the research firm.

But without employment growth, mortgage rates do not appear to be going anywhere.

After drifting higher in the fall, rates on 30-year mortgages have fallen back to their lowest level in six months and are not all that much above their historic lows hit in mid-June. Federal Reserve policy-makers, who meet next week for the first time this year, are expected to make no change in their commitment to hold interest rates low for a substantial period.

And unless the economy shows strong and consistent job growth over the next several months, odds are rising that the central bank stays on the sidelines until after the Nov. 2 presidential election.