Middle Market Rental: Hiding in Plain Sight

Title: Middle Market Rental: Hiding in Plain Sight

Date: 5/1/2000

Author(s): Joint Center for Housing Studies

Executive Summary:

New Study Provides First Comprehensive Look At "Middle-Market" Rental Markets

The Joint Center for Housing Research of Harvard University has released a study of the middle segment of the rental market entitled "Middle Market Rentals: Hiding in Plain Sight." This project was jointly sponsored by the Research Institute for Housing America of the Mortgage Bankers Association, the National Multi Housing Council, and the National Association of Realtors. The purpose of the study was to carefully document the analytics of the supply, demand, and market clearing-solution that has evolved in markets across the country for the unsubsidized portion of the market that is above the low-rent segment of the local market that is the target of subsidies but below the "luxury" segment at the top. The markets seem to be working well, a priori, but have not been thoroughly studied in the past. In addition, the Joint Center was asked to address emerging policy issues, such as whether working families in occupations such as teachers, police, and firefighters who rent were faced with undue commuting times to find suitable rental units.

The results of the study suggest that the middle rental market is indeed functioning well, with most families being offered a broad array of market choices without undue sacrifices in terms of income devoted to housing or commuting costs. Moreover, the study reviews the mortgage market that serves middle market rental properties, pointing out that access to credit markets have broadened in recent years and, with the possible exception of smaller multifamily units, are quite competitive. In general, the study points to the need for better data at the micro level to understand the operation of-and investment returns in-of this important market.

What Are Middle Market Units Like?

The Joint Center surveyed several existing data sources and concluded that middle market rentals are found in nearly every local area of metropolitan housing markets. (Boston, Los Angeles, Minneapolis, and Tampa were the markets the study looked at most closely.) This finding clearly suggests that consumers looking for moderately-priced rental units can find such units in a wide range of locations and neighborhood types.

The research also highlights the fact that the vast majority of the rental units servicing the middle of the rental markets in most metropolitan areas is made up of the older rental units. Nationally, half of the stock of middle market rental units was more than 30 years old in 2000. This is not surprising, as the data also show that at the end of the 1990s only about one-tenth of the units in service were constructed during the prior decade. Rather, the study reveals that the bulk of new middle market rental units come by way of "filtering" from existing units. That is, rental units that have served the higher end of the market often migrate "down" to serve the middle market. Also, not an inconsiderable number of properties that formerly were rented at the lower end of the market are regularly "upgraded" to use in the middle market.

Finally, the study points out the important role that the five million single-family homes play in the middle market rental landscape across the country.

Who Does this Market Serve?

Like the housing stock, middle market rental residents are quite diverse in incomes and racial and ethnic composition. Nationally, more than 35 percent of middle market householders are minorities. (The results also point to minorities as the fastest growth group of renters in this market.) Like renters generally, middle market households tend to be young, although 6.1 million middle-aged and 1.1 million elderly householders also reside in middle market rentals.

The Joint Center also was asked to research whether the middle rental market primarily services middle income families. The results show that there clearly is an intersection between the two sets, with nearly half of middle market rental households having moderate incomes between $20,000 and $50,000 nationally. Nevertheless, 24 percent of the residents have household incomes above that range, and 29 percent are low-income families with incomes below $20,000.

Financing and Profitability Issues.

The report examines the viability of constructing and investing in middle market rental units. The Joint Center points out that the 1.6 million new units constructed during the decade of the 1990s illustrates that this is a viable market for investors in such properties. As regards the profitability and performance of such units from an investment perspective, the report offers only limited insights. For instance, it does present some evidence on average operating margins and on the cyclical stability of cash flows on such rental properties.

In addition, the research project addresses all aspects of the financing of middle market rental properties. It surveys the literature and discusses the financial practices for construction as well as purchase money mortgages. While this survey concludes that general financing needs are met by financial markets that have become increasing broad and competitive with the evolution of the CMBS market, it also concludes that construction lending and permanent financing for small units are more "niche markets" with less broad access to capital markets.