Apartment Building Bubbles as Single-Family Homes Struggles

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U.S. builders ratcheted up new construction in March, but the growth was entirely in apartment buildings. As rental demand shows no sign of abating, multi-family housing starts jumped 27 percent from February and a staggering 82 percent from March of 2012, when seasonally adjusted. These starts are now running at an annualized pace of 392,000, far higher than the 10-year historical average of 238,0000.

"While the sector is often volatile, this surge tallies with the strength of the rental sector and the demand for easily let homes," wrote Paul Diggle of Capital Economics.

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That rental strength was thought to be waning in the wake of the single-family housing recovery, but single-family starts fell in March sequentially, and permits for these homes were also down, signaling a further drop in April. Sentiment among single-family home builders also fell unexpectedly in April, the third straight monthly drop after sizable gains in confidence in 2012.

Clearly, the home building recovery is running into a few snags. Material costs are rising; there's a shortage of construction workers, and builders are struggling to find easily developed lots, Diggle added.

With demand for single-family homes rising, however, there is concern that multifamily construction is overheating. Developers have been rushing to put up new units, but it takes two to three years to complete most apartment buildings, and that means a sudden supply surge is still about a year away.

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"With most data surpassing trailing 10-year averages, supply is clearly on the way. ... The big unknown, in our view, is how desensitized (or not) investors are to the idea," wrote David Toti and Gaurav Mehta, analysts at Cantor Fitzgerald. "Already the No. 1 concern for apartment investors, recent permit/starts data have suggested sharp increases in the delivery of new apartment product in 2013 and beyond. Although we do not yet view this as a danger at the operating level for some time, the perception of a supply spike could cause the stocks to underperform as cash flow growth trajectories are lowered."

Toti and Mehta noted that unlike previous recoveries in which supply initially increases in low-barrier markets, developers today are targeting the highest-tier, coastal, so-called A markets. That is because lenders are more willing to fund projects in these less risky areas, such as downtown Bethesda, Md., where cranes rise above the busy streets. Once considered a suburb of Washington, D.C., Bethesda is now a prime urban market, and developers and REITs such as ederal Realty Investment Trust are reaping big rewards, despite what some call an overheating market.

"We're not concerned about any of that," said John Tschiderer, vice president of development for Federal Realty. "I think a lot of it is location-driven and place, quality of place-driven, and in our investments our locations are strong, based on transit and the quality of what we build."

Apartment vacancies fell to just 4.3 percent nationally in the first quarter, down from 5 percent a year earlier, according to Reis Inc. That pushed rents higher by more than 3 percent year-over-year.

"Analysts have wondered how rents could keep climbing when jobs are being created at a sluggish rate and wage growth has been relatively stagnant," Reis economist Victor Calanog wrote in a recent report. "One answer is that the moribund housing market left households with little choice but to absorb rent hikes, but with the housing market now recovering, does that mean the tide is turning against landlords?"

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—By CNBC's Diana Olick; Follow her on Twitter @Diana_Olick or on Facebook at facebook.com/DianaOlickCNBC

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