Monday, February 12, 2007

Demand vs Supply Side

Just a quick thought, as we were analyzing the Tucson apartment market this morning, it brought on a quick thought. Demand vs Supply. Basic economics right? Even, the non-econ will tell you economics is about supply and demand (they're not correct, but I digress) for changing definitions, see this post from Mike Mandel at Economics Unbound.

Well I think in the apartment industry, the big boys (Equity, Archstone, etc) have focused too much on the supply side of the equation. Their mantra has been "supply constrained" markets, aka high barrier-to-entry markets, places where it is hard to add additional supply. The other focus of which only one big boy (Camden) uses, is demand side. In the supply restricted areas (which incidentally aren't all that restricted, see the multifamily permit boom in SF, Oakland, and LA-all popular supply-constrained markets).

The biggest problem for the supply constrained markets, is their inherent volatility. In a study that I did, we identified the most volatile markets from a rental rate perspective and calculated a beta for them. San Francisco, San Jose, Oakland, New York, Boston were the top-5. The interesting finding from all this research is two things. Supply constrained markets are generally more volatile, and definitely more sensitive to economic conditions. This means that appropriate discount rate applied to these markets should be higher because of the greater degree of risk. Current valuation practices do not take this factor into account. In fact, over time, the high growth regions have generally outperformed (using real $2005) the so-called supply constrained areas.

In conclusion, the supply side focus is trendy, but wrong-headed and will leave certain big guys in the apartment industry with a bad hangover in a downturn. Yield management will help mitigate some of this effect, but that won't avoid the storm. It leaves companies like Camden, well placed to outperform its peers.

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