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A primary objective of investing in real estate
as an asset class is that it diversifies the total investment portfolio
and reduces risk. Each asset class should be further diversified among
the major property types. Research reveals that apartments comprise 15-20%
of the total market of investment grade real estate. This is further evidenced
by the proportion of apartments in the NCREIF Property Index (NPI) which
is approximately 15%. Most pension funds have only in recent years begun
investing in apartments which illustrates the estimated under-weighting
of apartments in institutional portfolios. We recommend that pension funds
target 15-20% of the real estate investment portfolio as apartments, mirroring
the total market universe.
Total returns for apartments have exceeded most other property types and
have had a more stable income component. The NPI indicates that recently
apartments have had an income return which has only been exceeded by warehouses.
Based on the supply and demand factors projected for the next several
years, it is our opinion that apartments will outperform all other core
property types.
Apartments offer a good inflation hedge because:
- rental growth tends to move upward with construction
cost increases (assuming markets in relative equilibrium), and
- apartment leases are adjusted annually (compared
to the three to ten year terms common in other property types) and therefore,
rental increases are more readily realized.
Apartment performance has been less volatile than
most other property types. This is evidenced by the NPI data and market
experience. Occupancy levels over the long term have rarely dipped below
90% for any significant time period. In contrast, office occupancy levels
have dipped to 80% or less in most major markets. The commodity nature of
apartments tends to produce a more efficient market. Vacancy levels within
a sub-market rarely differ by more than 10% among specific apartment properties,
but can vary widely for office, retail and industrial.
Demand for apartments in the coming years will remain strong although the
consumer demographics are shifting. The population is getting older and
this will affect the available market for apartment renters. The 18-34 demographic
age range is shrinking and the 35-54 range is growing. This means the target
rental market will not only be older but will have more discretionary income
and therefore more demand for quality units. Growth in non-traditional households,
such as singles, unmarried couples, empty nesters, and single parent homes,
will continue. New household formations are projected to remain stable at
1.2 million annually. This statistic has not changed significantly in the
last 20 years.
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