Apartment Values May Have Farther to Fall

Key Highlights

• Multifamily construction permits issued today tend to predict the level of construction activity four quarters later (0.81 correlation). This suggests that permits can be a significant leading indicator for construction activity.
• New construction is closely correlated with apartment prices in real-time. Therefore, we’re using permits as a proxy to predict future prices.?
• New apartment construction has only experienced drastic Year-over-year (YoY) declines one time since 1996. This was during the GFC in 2010.?
• Using new permits as a leading indicator, it appears that we’re about to experience another significant YoY decline. If historical correlations hold, we haven’t found the bottom in apartment prices.?

Introduction

Jacksonville, FL - New apartment construction has only experienced drastic Year-over-year (YoY) declines one time since 1996. This was during the GFC in 2010. This research examines the predictive relationships between the issuance of building permits for multifamily units, the subsequent construction activities, and their interplay with multifamily housing prices. If historical correlations hold, we haven’t found the bottom in apartment prices. All data is sourced from the Federal Reserve of St Louis.

Methodology

Our analysis utilized quarterly data covering several key metrics: the Year over Year (YoY) percentage change in permits issued for multifamily units, in multifamily units under construction (new supply), and the Multifamily Price Index. We employed correlation analysis and time series modeling to uncover leading trends and relationships among these variables. Notably, we investigated the potential of permits issued as a leading indicator for construction activity and its concurrent correlation with the multifamily price index.

Permits as a Leading Indicator

Our exploration into the relationship between construction activity and the Multifamily Price Index uncovered a strong correlation in the raw data. The Year over Year (YoY) percentage change correlation was weaker at 0.33, but still strong enough to indicate a relationship. This positive correlation suggests that as construction of multifamily units increases, the price index tends to rise as well, likely reflecting that apartment demand is strong. In simple terms, demand is high, prices rise, and developers build more to meet the demand and capitalize on higher prices. Notice in the chart below how “Under Construction” (blue) only turned significantly negative during the Great Financial Crisis. It is currently hovering around zero. So the question is, will new construction turn significantly negative for the first time since the GFC? Our best chance for answering this is to find a reliable leading indicator… Multifamily Building Permits

Permits

Our analysis revealed a very strong correlation when permit data was lagged by four quarters ahead of construction data. This suggests that the volume of permits issued today can predict the volume of construction activity a year later. This makes sense intuitively. You have to pull a permit before you can begin construction. The correlation coefficient at this lag reached as high as 0.81, indicating a strong predictive relationship. Notice in the chart below that permits (green) are down nearly 30% YoY. It is reasonable to expect that new construction (blue) will follow.?

Implications?

Using permits as a leading indicator, it appears that we’re about to experience another significant YoY decline in construction. If historical correlations hold, we probably haven’t found the bottom in apartment prices yet. This may be a function of the data that is being reported. Transaction volume has been lower over the last year, and property owners with assets that are worth significantly less than a year ago are reluctant to sell. Therefore, the data likely contains a higher percentage of higher-priced, newer vintage apartments. As more owners are forced to sell in the coming months, I expect we’ll see the data reflect lower valuations.?

by Brian Underdahl, Chief Analytics Officer

Nuvo Capital Partners