Top 10 Reasons Markets Get Overbuilt
Do you live in a city or MSA that has constant multifamily construction going on all over the place and it's got completely overbuilt and you're thinking to yourself why do they keep building? I’ve got 10 reasons why multifamily, or frankly any asset class, goes through overbuilt cycles.
#1 - Developers buy into the false hype about a certain market brought to them by brokers, investment partners, and sometimes their own staff. When hype is coming at developers in all directions, they jump all in to develop ASAP.
#2 - Some developers have what I call the Costco syndrome. You know how when you're in Costco shopping for something specific, but you see something super cool and it's so cheap you have to buy it even though you don't need it? Well, developers are human beings too. When they see a piece of dirt that's so cheap, they can't imagine not buying it, they'll just make it work.
#3 - There are some really savvy developers who own a lot of apartment complexes in a market in which they also own a lot of land. And if they’ve owned it for a very long time that means their basis is super low. And when their basis is super low, during a hot market they can develop at costs that are far less than the competition. That means they can offer lower market rents than the competition.
#4 - So often government municipalities take a very long time to approve these developments. This creates a backup. And as more and more developers submit more and more developments for approval, they'll finally get approved and develop at the same time, which creates an overbuilt situation.
#5 - This is a big one. Most government municipalities don't have online records that show the developments that are actually in the queue to be built. As a result, developers don't have an accurate estimate of how many apartment complexes are being built. Really only the brokers know about the deals that are under contract to be developed, or the ones that are in the due diligence phase, or the ones that have already been approved for development, or the ones that are about to break ground because that's what we do. We're making phone calls every day, all day, trying to drum up business. We hear about the deals that are coming down the pipe. No one developer thinking of developing in a market can contact every developer in the world and ask if they also have plans to develop in that market.
#6 - Many brokers who know about all the developments coming online, and know it's about to become overbuilt, aren't going to announce to everyone it's about to be overbuilt. Two reasons for this. 1) Those brokers may have their own land deals under contract and they don't want to announce of a possible overbuilt situation and lose their deal. And 2) All of the developers or beneficiaries of a development going through and closing would never use that broker ever again if they're the ones responsible for killing the deal.
#7 – There’s too much reliance on property data websites that inaccurately tell a story of the need for more housing.
#8 - Government municipalities, which are often run by folks who don't know real estate, push for more development in their cities without actually knowing and understanding if there is a need. Many cities get caught up in the want for more tax dollars that result from new development and they lose sight of the supply and demand factors.
#9 - Many developers face tremendous pressure to place capital from the investment funds that support them. They need to keep staff busy developing projects so they can pay dividends to their investment funds. And sometimes that pressure makes them develop projects they shouldn't.
#10 - FOMO. The fear of missing out. It's one of the worst feelings for a developer when looking back on a period of time when there was a lot of great development, lots of money was made by others, and thinking to themselves I wasn't part of that.
So you can see how when you have all 10 of these dynamics at play at the same time how easy it is for markets to get overbuilt, which is why it happens over and over again and will continue to happen well into the future.
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