SS289: The Impact of New Construction on Existing Properties

SS289: The Impact of New Construction on Existing Properties

When new developments break ground in an established neighborhood, it shakes up the local realestate ecosystem. In this episode, Charles discusses the ripple effects of new development on existingproperties.

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Talking Points:

  • New multifamily construction creates a direct supply shock that temporarily elevates vacancy rates and softens rent growth across existing properties. While brand-new developments directly compete only with Class A buildings, the shock spreads throughout the local rental market via tenant migration and concession competition.
  • When a significant wave of new apartment supply enters a market, it alters the competitive landscape for existing owners in a few different ways:
    • 1. When new construction hits the market, it usually enters the market as Class A properties because of the high costs of construction, land, and materials. After you pay for those things, finishing the units as Class A versus Class B has a minimal cost difference. When a new Class A product is delivered, current area Class A renters are drawn to this inventory, leaving vacant units behind.
    • 2. Concessions. Developers usually need to lease up their new developments as quickly as possible to refinance or sell them. The easiest way of doing this is through concessions, heavy concessions. In most situations, a tenant at a current Class A property will probably save money moving to a new Class A property once concessions are factored in, and concessions can last for multiple years. If the developer is having issues renting their new property, they might keep renewing the concessions. A number of years back, my wife and I were renting a Class A apartment at a 5-year-old apartment complex, and we lived there for 2 years. Upon move-in and upon renewal, they gave us a free month of rent and never raised the rent. These concessions slowly ripple through Class B and Class C apartments as well. As Class A properties offer 3 months of free rent and waive security deposits and other fees, these ripples will grow larger. Class B property owners will find themselves with stagnant or lower rents while also offering concessions and renewal concessions to their tenants.
    • 3. When the apartment supply outpaces the demand and absorption, existing owners of mainly Class A and Class B properties lose pricing power just as tenant acquisition costs rise. Properties face higher marketing expenditures, increased broker referral fees, and greater capital expenditure (CapEx) requirements for unit improvements just to maintain historical occupancy levels.
  • The severity of new construction’s impact depends heavily on where an existing asset sits on the property class ladder.
    • Class A existing properties. They have the highest immediate risk as brand-new builds target identical affluent renters with aggressive nearby lease concessions. Existing Class A managers can offer targeted tenant renewal incentives and upgrade high-visibility amenities to retain their tenants and attract new ones.
    • Class B properties. They have a moderate risk from tenant “trade-up” migration to discounted older Class A properties. Some Class B renters new to the area might skip the Class B properties altogether and go straight to A, since, with this competition, security deposits are waived, along with lower screening standards and lower income requirements, making it easier for more tenants to qualify. Managers should be very careful with increasing renewal rents on existing tenants, or not at all, to minimize turnover while making cost-effective cosmetic upgrades.
    • Class C properties. They have the lowest direct impact from new Class A inventory hitting the market. This is mainly due to the ongoing workforce housing shortage. Additionally, many Class C tenants are not credit tenants, meaning they will have difficulty being approved to rent a Class A or Class B property. Property managers still need to be vigilant about tenant renewals, as some tenants will look to upgrade. This is best done by focusing on quickly correcting maintenance issues while also seeking operational efficiencies and upgrades that will save the property money.
  • In oversupplied markets, the rent premium between brand-new builds and 5-to-10-year-old Class A properties shrinks significantly. This often makes older Class A assets the most vulnerable to tenant turnover until the new inventory is fully absorbed.
  • For more information on strategically offering concessions, check out episode SS271.

Transcript:

Charles
What happens to your apartment building when hundreds of brand new units opened nearby? New apartment construction does not just affect luxury properties. Its impact can spread across the entire rental market. Welcome strategies Saturday. I’m Charles Grillo, and today we’re discussing the impact of new construction on existing properties. By the end, you’ll have a clear idea of how new construction may affect your property and what steps you can take before it starts hurting your properties.

Charles
Performance. Let’s get started. New multifamily construction creates a direct supply shock that temporarily elevates vacancy rates and softens rent growth across existing properties. While brand new developments directly compete only with class A buildings, the shock spreads throughout the entire local rental market via tenant migration and concession compensation. When a significant wave of new apartment supply enters the market, it alters the competitive landscape for existing owners in a few different ways.

Charles
Number one, when new construction hits the market, it usually enters the market as class A properties because of the high cost of construction, land and materials. After you pay for those things, finishing the units as class A versus class B has a minimal cost difference when a new class A product is delivered. Current area class A renters are drawn to this inventory, leaving vacant units behind.

Charles
Number two is concessions. Developers usually need to lease up their developments as quickly as possible to refinance or sell them. The easiest way of doing that is through concessions heavy concessions. In most situations, a tenant at a current class A property will probably save money moving to a new class A property once concessions are factored in, and concessions can last for multiple years.

Charles
If the developer is having issues renting their property, they might keep renewing the concessions a number of years back. My wife and I were renting a class a apartment at a five year old apartment complex, and we lived there for two years. Upon moving and upon renewal, they gave us a free month of rent and never raised the rent.

Charles
These concessions slowly ripple through. Class B and class C apartments, as well as class A properties, offer three months of free rent and wave security deposits and other fees. These ripples will grow larger. Class B property owners will find themselves with stagnant or lower rents, while also offering concessions and renewal concessions to their tenants. Number three when the apartment supply outpaces the demand and absorption, existing owners of mainly class A and class B properties lose pricing power.

Charles
Just as tenant acquisition costs rise, properties face higher marketing expenditures, increased broker referral fees, and greater capital expenditures. CapEx requirements for unit improvements just to maintain historical occupancy levels, the severity of new constructions impact depends heavily on where an existing asset sits on the property class ladder. Class A existing properties. They have the highest immediate risk. As brand new builds target identical affluent renters with aggressive nearby lease concessions, existing class A managers can offer targeted tenant renewal incentives and upgrade high visibility amenities to retain their tenants and attract new ones.

Charles
Class B properties they have a moderate risk from tenant trade migration to discount it. Older class A properties. Some class B renters new to the area might skip class B properties altogether and go straight to A, since with this competition, security deposits are waived along with lower screening standards and lower income requirements, making it easier for more tenants to qualify.

Charles
Managers should be very careful with increasing renewal rents on existing tenants, or not at all, to minimize turnover while making cost effective cosmetic upgrades. Class C properties they have the lowest direct impact from new class A inventory hitting the market. This is mainly due to the ongoing workforce housing shortage. Additionally, many classy tenants are not credit tenants, meaning they will have difficulty being approved to rent a class A or class B property.

Charles
Property managers still need to be vigilant about tenant renewals as some tenants will look to upgrade. This is best done by focusing on quickly correcting maintenance issues, while also seeking operational efficiencies and upgrades that will save the property money. In oversupplied markets, the rent premium between brand new builds and 5 to 10 year old class A properties shrink significantly.

Charles
This often makes older class A assets the most vulnerable to tenant turnover until the new inventory is fully absorbed. For more information on strategically offering concessions, check out episode SS 271. That’s SS 271. I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics at Global Investors podcast.com. If you’re interested in actively investing in multifamily real estate, go to Syndication Superstars and join the waitlist for our one on one mentoring program.

Charles
Again, that Syndication superstars.com look forward to another episode next week. See you then. Have you always want to invest in real estate but didn’t have the time? Didn’t know where to find the deals. Couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties in great locations that provided us with consistent passive income.

Charles
While we wait for appreciation in the future and take advantage of tax laws while we’re waiting. And unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out invest with harborside.com. If you like the idea of investing in real estate. If you like the idea of passive income, partner with us at an event with harborside.com that’s invest with harborside.com.

 

Links Mentioned In The Episode:

  • SS271: Strategic Concessions: When They Help and When They Hurt Your Bottom Line

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