The Rush to Judgment

By Lewis M. Goodkin

Builders and developers often get excited about new market opportunities, but fail to properly analyze their potential. That was the case with the golf bandwagon of the 1970s, when many developers forgot to segment the marketplace and ask questions like: How many golfers in that local area could afford high greens fees or an expensive annual membership?  The same thing happened with senior housing. Laventhol & Horwath (L&H) got the industry excited about its enormous potential, but most of the product built was simply not affordable for most seniors.  Now, with home building down severely, I fear the same thing will happen with rental housing.

Client after client tells me that they are going to try their hand at building market-rate rentals. That’s because it’s such a slow market for single-family builders and developers. But once again, the opportunity may be over-hyped. Industry publications are filled with multifamily stories, everywhere you turn there’s another seminar on the subject and once again we are on the threshold of over-building a market.

Certainly, market-rate apartment demand will be stronger in the next few years as a result of favorable demographics and consumer psychology. A growing number of people think that it is smarter to rent than to own, so this is becoming a preferred choice for many consumers who could afford to purchase a home. Renting also carries much less social stigma than in the past and is no longer considered merely an incubator for ownership housing. And many people who left rental housing in the past few years were not really qualified to own; after losing their shirts, they see renting as a necessity.

Having said all that, you had better count the mice before you go out and build that better mouse trap!

Consumer market segmentation is a critical exercise for any rental builder or developer. You need to know who makes up the market, the price/rental segments and household types. You need to know what mix of units holds the most appeal, what features will give you an edge on the competition and what recreational amenities are required. You need to know what markets and submarkets offer the greatest probability of success in both the short and long term. You also need to know how many units of each type can be supported in a particular market and what are the best available sites.

You also need to analyze the existing inventory, the new projects in the pipeline and probable competition your project will face upon completion. And don’t let your ego get in the way by minimizing competition.

In markets where there has been substantial investor activity, you also need to weigh the phantom inventory. Many of these properties will be rented at low levels since the owners view a negative cash flow as a necessity until they can sell the product under more favorable market conditions. In other words, they are willing to accept minimal and even no return during the three to five years that they anticipate owning them. This inventory can present formidable competition to new projects because the units often have superior sizes, features and amenities than a comparably priced rental.

With every engagement, we insist that the client pay attention to the many details that most of the competition misses. Don’t merely imitate success, exceed it! And the way to do that means responding to more of the consumers’ needs than the competition does. At the same time, you have to prioritize those features so you can appeal to the market without placing yourself at a cost disadvantage.

Getting into market rate rentals may make a great deal of sense if you are willing to take the following steps:

• Focus more attention on consumer convenience than your own.

• Avoid being caught in the trap of geography

• Be open to opportunities that may be a departure from your preconceived notions of what and where to build

• Don’t rush to market simply to be an early entrant; we have seen many late entries feast off the inadequacies of existing competition.

• And always remember to count the mice!