It’s been said that health is the greatest single indicator of a person’s overall quality of life. When it comes to real estate, a market’s economic health is also an indicator of its overall profit potential. While there are several indicators of market strength, including job growth, historical vacancy rates, and rent growth, construction permits are also a factor that determine the viability of an investment area.
A construction or building permit is an official authorization, granted for construction projects by a municipal authority that enable the legal development of properties. As such, a market’s monthly building permit report is a good indicator of its overall economic viability…
Let’s go over what these helpful barometers tell us about a market’s overall health by using the U.S. Census definition of a metro area.
Key Factors to Consider
Economics 101 tells us that supply and demand play a huge role in determining real estate’s future value. For the sake of this discussion, construction makes up one part of the supply and demand equation, while household formation constitutes the other.
The Demand Side – Household Formation
The rate of household formation tells investors what the demand (among renters) is for a given real estate market. Generally speaking, the greater number of households that are being formed, the better it is for investors; this is because it signals an abundance of renters currently searching for available rentals.
The good news is that renter household formation is driving vacancy into a favorable area for investors. According to the U.S. Census Bureau, vacancies hit a multi-decade low in 2015. The vacancy rate for three bedroom properties, for instance, dropped from 8.2% (in 2014) to 7.0% in 2015; and finished 2016 at 6.9%.
The Supply Side – Construction Permits
With increased demand, construction permits rise to meet the growing needs of the renters. While construction rates lift the number of available properties for sale, an abundance of available new product provides you with competition, and can place upward pressure on vacancy and downward pressure on rent. Therefore, an excess of apartments and single-family rental assets in a given metro area can have a negative impact.
Here’s the supply/demand dynamic applied to an actual real estate market:
In Indianapolis, the growing renter demand for single-family properties has builders pulling an increasing number of single-family permits over the last four years. Nonetheless, new demand will remain sufficient to push vacancy rates even lower to benefit investors of this metro, as long as a glut of properties isn’t developed by local builders.
Single-Family & Multifamily Building Permits
Recently, much of the new construction has been focused on multifamily projects, according to our Research Services team. But the increased competition from a wave of new apartments shouldn’t worry most single-family investors as, “the national SFR market will remain healthy in 2017…[and] vacancy will continue to tighten on a national basis, reaching the lowest level of the current cycle,” said Steve Hovland, director of research services for HomeUnion.
Furthermore, median prices for owner-occupied homes puts them beyond the reach of first-time buyers, increasing demand for rentals. Accordingly, investors can capitalize on current demand and changing attitudes about homeownership by purchasing SFRs.
What Comes Next?
If knowledge is power, grasping how the SFR market works is money! So learn more about the specific economic conditions set to affect it in 2017 by downloading our full report here.