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Real estate's red-hot category: Apartments

Craig Warga | Bloomberg | Getty Images

A lull in the single-family housing recovery this winter made for a surprise comeback in a sector thought to be overbuilt and overblown: multifamily real estate investment trusts (REITs).

After struggling throughout much of 2013, apartment REITs returned a striking 12.75 percent, making this sector of commercial real estate the most profitable for the first quarter of 2014, according to the National Association of Real Estate Investment Trusts. Overall, equity REITs were up just over 7 percent for the quarter.

"People have short memories," noted Calvin Schnure, vice president of research at the association. "We've seen a big increase in construction from the very depressed levels that we had during the depths of the recession, but in terms of overall construction, we're barely back to what a trend pace would be with a national population the size we have in the U.S."

New apartment construction has certainly been robust, with nearly 42,000 units completed nationwide in the fourth quarter of 2013, according to forecasting firm REIS Inc. That was the highest since 2003 and a harbinger of things to come in 2014.

About 1 in 3 new housing units being built are rental apartments, the highest level in 40 years, according to the U.S. Census. At the same time, vacancies continue to drop and rents continue to rise, albeit not as strongly as they had been during the worst of the housing crash.

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"There is also growing recognition of demographic trends that are shaping the housing market, and pent-up demand for apartments especially among 18- to 30-year-olds. Missing are 1 million new households compared to previous economic recoveries, as people live with their parents or double up with roommates," added Schnure.

That demand could be unleashed as the job market improves and more younger Americans are able to afford living on their own. As for competition from single-family housing, which slowed in the first quarter of this year, analysts are not concerned.

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"Affordability gaps moved in favor of homeowners this quarter, reflecting higher rents and lower home prices, on a sequential basis—largely due to a seasonal dip. That said, affordability gaps remain very much titled toward the renter on the West Coast," wrote David Toti and Gaurav Mehta of Cantor Fitzgerald in a note to investors. "We view multifamily supply dynamics as an issue to watch, and not one to fear; we view current supply levels to represent relative market equilibrium."

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As for the REIT stocks, their success in the first quarter of this year is not just a factor of growth in apartment demand, but of market machinations themselves. REITs tend to be less attractive in a rising rate environment, which is why they faltered last year.

Rates this year, however, haven't moved much. In addition, REITs own a very small share of the overall apartment stock in the nation, and what they do own is generally the highest quality properties in the top metro markets. That makes them even more competitive against the owner-occupied housing market.

"People are concerned about competition of multifamily with the improving housing market, but this is really a situation where a rising tide lifts all boats," said Schnure. "The rising tide being the number of people who are going to be looking for a place to stay."

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.