Applying Supply/Demand Analysis to Your Investment Decisions

[Richard McRae]

The best investment advice I can give to newer investors can be boiled down to one item: PREPARE. One can hardly pull the trigger with any confidence if you don’t know your market well. Without this knowledge, you will persistently close your eyes and flinch as you shoot. As a result, you will only hit your target by chance! This is not the way to stay in the investment game for an extended time. I want to outline one area that is important for you to understand if you want to consistently hit the bulls-eye: the interaction between supply and demand.

Understanding the balance of supply and demand is critical to making informed decisions. Vacancy rates, rent changes, and values, hinge on this interaction. A number of factors must be considered – most fall under two broad categories: supply changes and demographic shifts. 

I won’t try to illustrate all of the forces at work between supply and demand, but I want to provide an introduction to the evaluation of the interaction between population growth (demand) and multifamily starts (supply). Note, I used free data sources in the following example, but there are a number of very good apartment market data sources. A very good demographic source is ESRI. ESRI provides data for virtually any search parameter. An individual report is $50 and could be one of the best investments you make in your underwriting. A couple of apartment data resources are REIS and Pierce Eislen. REIS is the most comprehensive and provides supply analytics, market research, rent comparable information, etc. Pierce Eislen has good rent and sale data, contact information for comparables, and other market level data.

QuickFacts is a great free data source for population changes, household size, median income, renter percentage, et al. As an example, I performed a quick search for Alexandria, VA. QuickFacts indicated a population increase of 10,569 persons from 2010 to 2014. This represents an annual increase of 2,643 persons. QuickFacts also notes that there are 2.17 persons per household, which indicates an annual household increase of 1,218. Finally, applying the renter percentage (QF notes an ownership rate of 43.3%) of 56.7% indicates an average annual demand increase from 2010 to 2014 of 691 households.

Now, let’s compare to increases in supply. Home Facts notes that 1,630 multifamily permits were pulled in 2013. The trailing 10 year average is 579 multifamily permits/year. Based on a comparison of 2013 permits to the average annual increase in households, what do you think happened with rent levels last year? Yes, they went down. From January 2013 to January 2014 (Alexandria Office of Housing: January 2015 Annual Apartment Survey) rent levels decreased 3.3%. Although this rebounded by 4.3% by January 2015, the total increase was only 1.2% annually over two years. If I were looking to invest in this area, I would dig into 2014 permitting data, as well as planned properties in the development pipeline (pre-permit stage). It is also worth noting that apartment rents DO NOT necessarily increase 2% or 3%, which is what most cash flow models are based on. Good underwriting makes informed estimates – not guesses!

It may seem excessive to plow into this analysis, but I assure you: if you understand supply/demand issues at work in your intended market, you will have greater confidence to pull the trigger or put the gun down.

You can be successful as an investor, but it won’t happen if you can’t identify the target and pull the trigger with consistency and accuracy. There is no easy way to make money. It will require research, data analysis, and nerves of steel – but you can do it!

Good hunting!