The Age of Multifamily
The Age of Multifamily
The ’10s are the apartment decade. Indeed, multifamily has become the darling of commercial property investors, whose seemingly endless appetite for product has pushed cap rates for Class A properties below 5 percent in many top markets. “Multifamily is the only sector to enter the expansion phase of the cycle so far. Average cap rates for multifamily have also returned to pre–financial crisis levels,” says Gleb Nechayev, senior managing economist for CBRE Econometric Advisors in Boston.
The multifamily sector traditionally leads commercial real estate out of a slump, but this time around, office, industrial, and retail are so far behind you can hardly see them in the rearview mirror.
That said, there are signs that office and industrial may be on the start of an upward climb, says Arthur Jones, senior managing economist at CBRE Econometric Advisors in Boston. Office saw little new construction before the recession, so “without the impediment of excess supply, the rent recovery should start later this year,” says Jones. Still, with a 16 percent national vacancy rate at the end of 2011 and rents about 15 percent below prerecession highs, construction won’t come before 2014, he says.
Exceptions include New York; Washington, D.C; tech centers like San Jose, Calif., and Austin, Texas; and oil-rich Dallas and Tulsa, Okla.
Industrial “has the potential to bounce back a little more quickly,” says Jones. With vacancy rates at 13.6 percent, new construction over the next few years will probably average less than 100 million square feet a year, half the prerecession tally, he says.
Exceptions: Riverside and Vallejo, Calif., and other port and intermodal locations that need big, ultramodern space.
Retail isn’t likely to see much construction activity for five years, says Jones. In fact, “2011 was the first year since the downturn that retail had positive absorption.” Construction in 2011 totaled only 3 million square feet, compared to an annual prerecession average of 60 million square feet.
Hungry investors are now turning to secondary markets and value-added plays that offer the potential of increasing value through renovation and repositioning. “I’ve been surprised at how quickly markets that a couple of years ago were in panic have returned to normalcy,” says Joe Greenblatt, CPM, president of Sunrise Management in San Diego. In Phoenix, where Sunrise manages 3,000 apartment units, occupancies are above 90 percent in Class A properties, he says.
Strong Fundamentals for a Sustained Recovery
For the most part, renter demand justifies investors’ exuberance for multifamily. “National apartment occupancy averaged 94.6 percent at the end of 2011, almost three percentage points higher than the bottom point at the end of 2009,” says Greg Willett, vice president of research for MPF Research in Dallas.
And occupancy growth is buoying rents. “Rent increases approached 5 percent in 2011 and should continue to rise by 4 or more percent this year,” says Ron Witten, president of Witten Advisors LLC, an apartment market research firm in Dallas.
Rapid improvement in apartment fundamentals has occurred because demographics and economic realities are swelling the ranks of renters. According to the U.S. Census Bureau, the population of 20- to 34-year-olds (a prime renter demographic) will grow every year between now and 2030. As employment improves, more of these 85 million Generation Y members are moving out of their parents’ basement and into their own apartment. The notable drop in the home ownership rate from 69 percent in 2005 to 66 percent in 2011 created more than 4 million renter households during that period, notes Nechayev. While he estimates that 70 percent of former home owners rented single-family or small multifamily properties, apartment communities also benefitted.
At the same time that occupancy is rising, multifamily faces a supply shortage. Construction of new multifamily product hit bottom in 2011. Only about 70,000 units—most of it student and affordable housing rather than conventional market rate—were completed just as demand was picking up.
Shovels in the Ground
All these positives are reflected in soaring multifamily prices, especially in larger markets. “Prices have been bid up so much for these properties I can’t imagine cap rates getting much lower,” says Willett. The inevitable next step: new construction.
“Construction is ultimately driven by the growth of effective rents, which correlates to supply and demand,” says Stephen Vecchitto, principal of Miami-based Advenir, which owns and operates property in Florida, Texas, Colorado, and North Carolina. “Development makes sense when you can build to a 7 percent cap rate and then sell the property to an institutional investor.”
Multifamily building permits and starts began to show life in mid-2011, and now “the floodgates have opened up,” says Willett. More than 189,000 units were authorized for construction in the 12 months ending in February 2012. When you factor in the properties that haven’t yet been announced, new construction starts could reach 210,000 to 220,000 by the end of 2012, says Willett. Areas that are already seeing new apartments ready for lease include Texas, the mid-Atlantic region, Salt Lake City, and San Francisco. By 2013, starts could reach 300,000, the average for the 12 years prior to the 2008 downturn. “The 300,000 mark just gets us back to normal,” Willett says.
Smaller markets, especially those driven by oil and technology, are also seeing construction upticks. “We have 1,500 new units coming online and another 1,500 in the pipeline,” says Andy Burnett, CCIM, of Sperry Van Ness, a commercial brokerage in Oklahoma City. Much of the building started after 2008, he adds.
Other markets have been a little slow in starting “because developers want to see growth from several quarters to be sure the numbers aren’t an anomaly before they build,” says Erik Olson, CCIM, with the brokerage and property management firm NAI Maestas & Ward in Albuquerque, N.M. Now, however, Olson expects as many as 1,000 new units under development throughout the metropolitan statistical area by the end of 2012.
Even once-struggling markets like South Florida are seeing construction revive, says T. Sean Lance, CCIM, of NAI Tampa Bay in Tampa. “Over the last 24 months, there have been more than 60 new apartment projects with approximately 25,000 units announced—“although getting a project announced and getting it built are two different things,” he says.
Too Much of a Good Thing?
With development still well below historic levels, it’s hard to imagine that there could be excess multifamily construction any time soon. Yet, a wave of construction projects that were planned and permitted before the downturn may cause a brief oversupply in some markets starting in 2013, notes Emily Goodman, CPM, regional property manager for CORE Realty Holdings Management in Greensboro, N.C. She estimates that at least 2,200 new multifamily units are either under construction or proposed in the Piedmont/Triad area of North Carolina. That’s a lot in a market with only about 59,000 existing conventional units, according to Charlotte-based research firm Real Data. Once these “legacy” projects are complete, however, the time needed to plan, approve, and finance projects may create a temporary dip in building, says Willett. That could temper oversupply risks. So could continued difficulty obtaining financing. “Equity providers have pulled back on new development deals, and construction lenders, while aggressive on the best projects with the best borrowers, remain cautious,” says Witten.
If talk about Fannie Mae and Freddie Mac pulling back on or even out of multifamily lending becomes reality, subsequent market tightening could be severe. “If the GSEs stop lending, that could lower multifamily values by 10 percent, at least until a private market emerges,” predicts Todd Clarke, CCIM, president of NM Apartment Advisors in Albuquerque, N.M. Rising costs could also crimp construction. “Development margins are so thin now that any increases in fees, construction materials, or labor could also halt building,” Clarke says.
Longer-term threats to multifamily prosperity are more likely to come from unrealistic rent-growth projections, says Willett. Unless wage growth picks up, rents that rise too fast could outpace residents’ ability to pay and fuel a flight to home ownership. Add inflation to the mix, and “rent growth could be a challenge later in the decade,” he says.
While uncertainty about jobs and financing may slow apartment expansion, the same uncertainty makes renting a good alternative for consumers who aren’t confident in their future, says Greenblatt. “As long as the market doesn’t get too overheated,” he says, “multifamily prospects are very strong.”