Is the coming apartment glut going to hurt NE LA rents?

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A lot of savvy investors are aware that there is a tidal wave of apartment construction coming towards us. In Hollywood, Glendale and Downtown, there are literally thousands of apartments in various stages of permitting, construction and lease-up.

As an investor buying up buildings in gentrifying parts of LA, all of which are near the aforementioned areas, I have naturally spent some time thinking about whether these new units are going to hurt my rents.

Before getting to my thoughts, let’s all acknowledge that classical microeconomics would deliver a pretty clear answer: Yes. Given a constant demand, an increase in supply is going to result in a decrease in price (rents).

But there are a few other factors to consider:

1. The total increase in supply is actually quite small, relative the total size of the market. LA county has roughly 3.4MM housing units; even if 20,000 units are coming on-line, that’s only adding 0.5% to the total supply;

2. There is a ton of pent-up demand for apartments. During the Great Recession, an entire generation of young adults either crammed themselves into shared accommodations or, even worse, moved back home with parents. As the economy improves and these people find jobs, they are going to want to have their own places, which ought to result in increased demand.

3. Rents are pretty sticky. Except in cases of serious recession, tenants tend not to demand or receive rental concessions while occupying a unit. So, while increases of supply may hurt the price in the spot market (in other words, the market for the small portion of total units which are actually available at a given time), the effect on overall rents is more muted, because the vast majority of units are occupied at any given time.

4. New construction rentals are expensive. All of the developments underway were pro-forma’d by people who believe that new units should get a premium over existing units. And, every single one of these developments have construction loans with covenants that require the developers to achieve certain rent levels from tenants which certain qualifications. The result is that the new units are going to come online at prices that are in excess of what existing units, even nice ones, rent for. And the developers can’t easily cut the rents, without having to explain themselves to their bankers. So, at least over the short-term, the new projects may be competing with their hands tied behind their backs.

5. Most of the new construction units are situated in huge complexes. Many renters (and all of ours!) refuse to live in these “warehouses for people”, because they are so impersonal and corporate. For tenants like these, all those units coming online are essentially meaningless.

So, in light of the above, what’s my personal guess about the direction of rents? I think job growth has a long way to run in this cycle, meaning that demand is going to continue to grow. The scale of new construction coming down the pike is unlikely to be sufficiently large to offset this increase in demand, meaning that rents will continue to increase, albeit at a slower rate than they would have had no new construction come online.

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