Economic Change

Economic change has been the constant companion of Western economies since the Industrial Revolution. Both economic boom and economic recession can have major impact on apartment operations. The following review of the impact of economic change on apartment complex operation reflects the late 1980's through the late 1990's. The setting is a cluster of 50 competing apartment complexes in one segment of a city. The city is located in a progressive state with a diversified, robust economy and with a large population. The author managed one of the 50 apartment complexes. The author's employer, an apartment management company, operated more than 100 apartment complexes elsewhere in the state.

The effect of economic downturn in the apartment business was first noticed in areas that could be described as very prosperous, where tenants worked in "leading edge" technologies or supported those technologies, and where apartment prices ranged from 200% to 400% higher than typical rents. Those apartment complexes experienced excessive vacancy rates several months before the phenomenon occurred at average priced apartments in other geographical areas. Later, when economic recovery occurred, the high priced areas rebounded several months before the typically priced communities.

While the economy remained strong there was intense demand for one-bedroom apartments. Many people view their residency in an apartment as temporary, until they marry, until they find a better job, until they graduate, or until they save enough money to buy a house. Those individuals, living alone, preferred the privacy of one- bedroom apartments. During the economic recession, demand for one bedroom apartments diminished. Demand for two bedroom apartments increased, particularly for two-bedroom, two-bath apartments, because people began to share rent to reduce the cost of living. Half of the rent for a two-bedroom apartment was less than all of the rent for a one-bedroom apartment.

The recession stabilized land prices and construction costs. Investors seized the opportunity to build new apartment complexes even though the supply of available apartments exceeded current demand and competition was intense. The new buildings filled quickly, partly because they were new and to some extent because the designs fit contemporary customer preferences. It is a challenge to design an apartment complex that will meet customer preference over a life cycle of several decades. A building has a fixed geographical location, but populations and centers of economic activity are mobile, ever shifting. Apartment complexes designed for the high-end market are in trouble if the community in which those apartments are located deteriorates. Apartment complexes designed for the low-end market are brown shoes at the dance if the community experiences robust economic improvement. Economic events that might happen in any case seem to accelerate during periods of economic boom or recession: heavy industry to high tech industry; manufacturing industry to service industry; outsourcing; geographical relocation or shifts to off shore production. Also, over time new roads are built, shopping centers established, new schools are built, and people migrate and immigrate. All of these things leave the manager of a geographically fixed apartment complex struggling with the challenge to adjust. Money invested in apartment complexes must earn a return on investment that is competitive with other apartment complexes and also competitive with alternative investments. Investors sometimes prefer limited returns over certain risk.

The recession produced the best of times for a few apartment complexes that were positioned, by physical design, to offer exactly what tenants wanted at that particular time. The vast majority of apartment complexes experienced excessive vacancy rates. Rent rates could not be increased and actually declined at some of the less desirable complexes. There is debate among apartment management professionals regarding the appropriate response to intense competition and high vacancy rates. Generally, no one favors lowering rent rates. Remedies focus on move-in incentives and increased advertising. Incentives include reduction or elimination of security deposits, reduction or elimination of rent for one or two months, payment of referral fees, short-term leases, and move-in gifts. One apartment complex gave any tenant who moved into an apartment a new refrigerator. Most experienced apartment managers would probably contend that distress rentals generate inordinate downstream costs. When you lower your admission standards you attract a different type of customer. The problem tenant ratio increases. Long-term leases become high risk. There will be an increase in the number of delinquent rent payments. There will be an increase in the requirement to initiate eviction proceedings. Damage to apartments and routine turn-over costs increase. Other tenants may become dismayed with their new neighbors and move out. One can easily observe these events; it is difficult to prove cause and effect. The other side of the argument is that some revenue is better than no revenue. Investors and mortgage lenders look at occupancy rates and financial statements. There is no accounting document that convincingly portrays long term, downstream costs.

Advertising messages and media that produce good results during robust economic conditions may not work at all during an economic recession. There is no slick solution to the advertising problem. The author turned to niche marketing with some success, and benefited from an established, favorable reputation that improved results during the recession years.

During the recession professional management and quality maintenance became very important, but attention to security measures became paramount. As with other businesses competition intensified in the illegal drug trade. Illegal drug purveyors, whose operations previously centered in a large metropolitan area fifty miles from the author's community, suddenly moved into new territory in search of customers. The intrusion generated a crime wave in what we sometimes call "upscale" communities where crime had not previously been a significant factor. Crimes committed included armed robbery, burglary, car-jacking, assault, rape, and murder. The automobile theft rate was staggering. Apartment customers began to shop for apartment communities that offered the best security, the best lighting, and the best protection from automobile theft. The apartment complex managed by the author had been built when criminal activity was not even a remote consideration. The complex could not be re-constructed to provide security. But the author approached the security issue far more tenaciously than the competition and gained a considerable advantage over the competitors by doing so. Security is a "hot button" issue.

During the recession the bill for maintenance, repairs, upgrades, improvements, and security that had been deferred for years suddenly came due. It became necessary to spend a lot of money in a short time to remain competitive and to maintain the value of the property.

When the economy returned to normal, in fact the best economy on record, the community and the apartment complexes within that community did not return to "normal." Everything had changed. Most of the apartment complexes had a new position on the competitive totem pole; some better, some worse.