Apartment living - the new American Dream - by Diane Mazzatto

Diane Mazzatto, CB Richard Ellis - N.E. Partners, LP

The first quarter 2016 REIS Apartment market report stated that 2,065 new class A apartment units were completed in the Hartford metro market since 2010. During this same period, net absorption (demand) totaled 2,220 units, so demand exceeded new supply by over 7.5%. Also, based on the brisk leasing activity at new developments, this insatiable leasing activity continues to exceed developer’s original absorption projections. So, why are renters absorbing apartments at such a rapid pace that has astonished even the developers?

While owning a home used to be part of the American Dream, times have clearly changed and it appears that for many households in Greater Hartford (from many Millennials to the Baby Boomers, and from middle-income to affluent households), apartment living has become the new American Dream.

On the surface, renters are attracted by the new class A construction features such as stone countertops, stainless steel appliances, open floor plans, walk-in closets, elegant bathrooms, central air-conditioning, and many other features. Also, developers are enticing renters by offering amenities designed to enhance their lifestyle beyond the confines of their luxury apartment unit. Some of these amenities include: a furnished clubhouse with a large social space, large TV’s, fitness center, conference rooms, coffee/tea bars, and kitchenettes; an outdoor terrace with a heated pool, chaise lounge chairs, outdoor fireplaces and barbecues, outdoor tables and chairs; pet washing stations; dog parks; basketball courts; electric car-charging stations; vehicle vacuum stations; billiard tables; and many other features.

In the past, homeownership always denoted a sense of financial stability, to afford the down payment, the monthly mortgage payments, and all the other housing costs. Economically, homeownership offered several perks, such as home equity appreciation, equity accumulation via mortgage principal payments, and income tax advantages. On the social side, a household could settle into a community and a school system, have a yard for social events and/or for their prized pet to run freely. Lastly, the personal touches and selections made the house a home, with space for the pool, the basketball court, and their choice of interior design, etc.

For renters, the perception was that monthly rental payments resulted in no equity accumulation. For many, the decision of renting vs. buying was very simple – the monthly rental payments were lower than home ownerships costs. It was just that simple. Or was it?

Many people primarily consider financial homeownership costs when purchasing a home; however, the actual homeownership cost is multifaceted and comprises at least three categories: (1) financial costs, (2) economic costs, and (3) social costs.

Financial costs include the mortgage interest, real estate taxes, insurance, maintenance, and capital replacements. For this analysis, only the interest cost of the mortgage is included in order to exclude any equity accumulation that is void in rental housing. The costs assume that $300,000 is a reasonable price for a newly constructed 1,500 s/f, two-bedroom (or three-bedroom), two-bathroom house. (I actually found a few in that price range.)

This analysis also considers mortgage interest payments based on a $240,000 mortgage (80% LTV), a 3.75% interest rate, and a 30% income tax bracket ($525 per month). Real estate taxes are estimated based a typical tax rate in the market and reflect a 30% income tax bracket for deductions ($429 per month). Home insurance ($125 per month), maintenance ($225 per month) and capital replacement costs ($100 per month) are based on quoted expenses and estimates. The resulting financial costs total about $1,400 per month.

The second tier of expenses, economic costs, include the financial loss from unrealized returns on the down payment, mortgage closing costs, transaction/closing costs (during acquisition and disposition), and brokerage commissions (upon disposition). These are the “hidden” costs of home ownership that are not typically considered when purchasing a home.

For this analysis a 7% investment rate is applied to the $60,000 down payment and a 30% tax bracket is assumed ($245 per month). Closing costs reflect typical market rates and are divided by 60 months to reflect the short-term nature of apartment living ($392 per month). State and local conveyance taxes were reported to total 1% of the $300,000 sale price at disposition and are amortized over 60 months ($50 per month). Have you noticed that the house has not appreciated in five years? That will be discussed later in this article. Overall, the resulting economic costs total $690 per month, rounded.

Social costs would normally reflect the time spent coordinating the contractors and landscaping companies instead of spending that same time at the fitness center, happy hour, or enjoying time with friends and family. Apartment investors typically include an expense of 3% of rental income, or roughly $65 per unit, per month.

At the end of the month, homeownership costs per this example total $2,155.

Now, how does this cost compare with new class A apartment units? Quoted rents for two-bedroom units at the newest developments range from $1,595 to $3,220 per month, with most units ranging from $2,000 to $2,500 per month.

By now, it is evident that total home ownership costs and apartment rental costs are nearly equal, or in some cases, advantageous for renters who have foregone equity losses resulting from periodic pricing declines in the Greater Hartford market.

While the S&P/Case-Shiller U.S. National Price Index has shown residential price appreciation of 31% since the U.S. housing recovery in January 2012, median prices in Hartford County have been tepid at best, recovering by only 1.5% over the past four years, or by only 0.4% per year.

While median home prices in Hartford County bounced around and gave residential brokers and home sellers anxiety, the stock market enjoyed bullish market conditions. Over the past 10 years the Dow Jones Industrial Average (DJIA) appreciated by a total of 57% since 2006, even with the impact of the Great Recession in 2008/2009. Between January 2012 and January 2016, the DJIA appreciated by 40%, while the median home prices in Hartford County appreciated by only 1.5% during the same time frame.

Just think, if the $60,000 down payment were invested in the stock market, it could have appreciated by 40%, or by $24,000 (prior to capital gains taxes) over the four-year period. However, if that same $60,000 were applied to a home purchase, it could have appreciated by only $900 over the same time frame; however, to secure that appreciation one would likely incur sales commissions and closing costs.

Overall, it appears that renters may have had the advantage over the past four to five years, with new luxurious class A apartment units, resort-style amenities, very favorable capital gains, and the time to enjoy a social life. If the future mirrors the past, perhaps apartment living will be viewed as the new American Dream, at least in Hartford County.

Diane Mazzatto is a commercial appraiser for CB Richard Ellis - N.E. Partners, LP, Hartford, Conn.