Investors remain drawn to multifamily assets.
By Beth Mattson-Teig |
Rising interest rates may
prompt apartment buyers to modify expectations and strategies, but these
factors haven’t diminished their desire for multifamily properties — at least
not yet. The voracious demand that has fueled transaction activity and
capitalization rate compression across the multifamily sector in recent years
appears steadfast in many markets. “We are seeing sales volume that is equal to
or slightly greater than the same time last year,” says John W. Stone, CCIM,
principal, managing director of Multifamily Services/Foreign Investments at
Colliers Arnold in Clearwater, Fla. “There is no shortage of bidders. There is
no shortage of cash. There is no shortage of want.”
apartment sales activity surged during the first half of the year with $49.4
billion in properties trading hands — a 55 percent increase compared to the
same period a year ago, according to Real Capital Analytics. However, sales
volume spiked during the first quarter due to a large Archstone portfolio sale.
Extract that sale from the mix, and apartment sales rose a more modest 9
percent, according to RCA.
has been commercial real estate’s strongest magnet, drawing a wide range of
investors during the past several years. The sector was the first to recover
from the recession and the combination of solid occupancies, strong rent
growth, and available financing have attracted investors seeking properties
that deliver steady cash flow. Yet industry experts are beginning to question
whether that demand is sustainable in light of rising interest rates and lower
expectations for rent growth. Some institutional buyers have already pulled
back due to the cap rate compression that is occurring among core properties in
think 2014 will be a slower year because those higher interest rates are going
to impose themselves on the deal structure sooner or later,” Stone says. “You
can’t keep lowering your yield requirements and think somehow you are going to
for now, the demand to buy apartment properties remains robust. Competition for
deals has some buyers willing to adjust return expectations and price higher
capital costs into a purchase in order to close deals. “Nine out of 10 buyers
who come to the Tampa Bay market looking to buy apartments go home without
anything,” Stone says. So, buyers are willing to absorb higher capital costs in
order to clinch acquisitions in a still competitive market, he adds.
Fundamentals Spur Demand
remains strong across the board from the relative safe haven of stabilized
class A properties in major metros to value-add and opportunistic buys among
class B and class C properties where investors see more upside to boost rents
and realize higher yields. That continued appetite for apartments is not
surprising to some industry veterans. “There is almost an instatiable drive for
yield since alternative yields are so low, and the dynamics of the apartment
market are still strong,” says George Tikijian III, CCIM, president of Tikijian
Associates, a multihousing investment advisory firm in Indianapolis.
demand is supported by very accessible financing and strong underlying
fundamentals. “I think investors like the stability of multifamily in
comparison to the other asset types,” agrees Thomas McConnell, CCIM, director
of Marcus & Millichap’s National Multi Housing Group in Elmwood Park, N.J.
National multifamily occupancy at midyear remained steady at 4.3 percent. The
accelerated pace of rent growth that the industry has enjoyed in recent years
has moderated, but not enough to scare off buyers. Asking rents rose to $1,110
per unit in second quarter — a 2.3 percent year-over-year gain, according to
multifamily development is on the rise, it remains relatively controlled and
focused mainly in areas where there is high demand and high growth. In
addition, recovery in the single-family housing market is not expected to
create a drag on performance in the apartment market going forward.
Historically, when the single-family market has been healthy, the multifamily
market has been healthy for the same reasons. Job growth generally sparks new
household creation — for both home ownership and demand for rentals.
apartment market in San Diego is “as good as it gets,” says Terry Moore, CCIM,
director and principal at ACI Commercial in San Diego. San Diego’s stable
rental market is attractive due to its diverse economy and barriers to entry
for new development, including restrictive zoning and high fees. “Slow growth
forces and NIMBY-ism have combined so that in 28 of the last 30 years our
county has not built enough new apartments to satisfy demand,” Moore says.
Apartment vacancies in San Diego are below 5 percent, which is standard for the
area, and rental increases are higher than the inflation rate.
those attractive qualities, San Diego is a tough market to enter for outside
investors. Ninety percent of the apartment stock is valued less than $2 million
with properties that typically range between 5 and 15 units, most of which are
bought by local investors. “The bulk of the fortunes made in San Diego
apartments are in renovating 1970s assets and raising rents more than 10
percent,” Moore says. That has been a common theme for a generation and is
still prevalent in today’s market, he adds.
example, Moore sold a nine-unit property last spring that had not been
renovated in more than 20 years. The property received multiple offers and
ended up selling above list price with a signed purchase agreement within two
weeks. The new owners completed renovations and raised rents by more than 20
percent within six months. “It is still a seller’s market. There are still more
than 20 buyers for every seller,” Moore says.
Price Correction Ahead?
its continued performance, the apartment sector is not immune to the effects of
rising interest rates and higher capital costs for buyers and owners. Since
mid-May the 10-year Treasury rate has increased about 100 basis points from 1.9
percent to nearly 3 percent as of mid-September. Higher interest rates
naturally raise questions about the subsequent impact on operating income and
cap rates. Interest rates going up normally means that cap rates are going up.
“We know that’s coming. It just hasn’t happened yet,” Stone says.
second quarter, garden apartment properties sold for an average price per unit
of $85,046 and an average cap rate of 6.5 percent, while mid- and high-rise
apartments sold for an average price per unit of $201,515 and an average cap
rate of 5.2 percent, according to RCA.
theory is that a rising interest rate environment means that the economy is
improving, which will allow buyers to justify paying premium prices. Buyers
could argue that they will now be able to underwrite more aggressively with
expectations that they will be able to push rents higher more quickly. The
problem is that apartments are already coming off a streak of rent increases,
and most industry experts are projecting fewer rent increases in 2014. Rents in
class A properties in particular have increased considerably during the past
few years and are now bumping up against the ceiling in many markets.
we still expect some rental rate increases, they are not going to be the 5, 6,
and 7 percent increases that we saw two years ago,” Stone says. Now owners are
just hoping to get annual increases of 2 to 3 percent, he adds.
competition will keep pressure on pricing, a shift is inevitable, especially if
rates continue to rise. The rising interest rates have yet to impact cap rates
in markets such as northern New Jersey. Thus far, cap rates remain near
historical lows in every county, generally averaging in the mid-6 percent range
and dipping below 5 percent for top properties in the best locations, McConnell
notes. However, that shift will eventually occur as both sellers and buyers
adapt to the higher rates and adjust expectations. “Some of the properties I
sold in the low interest rate environment in first quarter wouldn’t sell at the
same price today,” he adds.
Quest for Yield Continues
for properties coupled with higher interest rates is prompting buyers to adjust
both return expectations and investment strategies. Buyers are continuing to
venture into secondary markets in hopes of finding more favorable pricing.
Although major markets such as Los Angeles, Washington, D.C., and New York City
are still posting the highest sales volumes, there is a notable increase in
sales in secondary markets such as Charlotte, N.C., Jacksonville, Fla., and
buyers can’t find what they want at a price they are willing to pay in Tampa or
Orlando, Fla., they are going to Jacksonville, which historically has been
overlooked by investors, according to Stone. As a result, Jacksonville has
claimed some of the highest per unit sale prices in the state during the past
18 months, with 26 properties sold during the first half of the year for a
total price of $446.7 million, according to RCA.
are also shopping for properties that offer more opportunities to boost net
operating income. “Right now, class A assets are pretty stable, but they don’t
have a whole lot of upside left,” Stone says. Class B properties have more
potential to improve occupancies and raise rates. In addition, class B and
class C properties are likely to gain favor among investors because there is
more opportunity for rent growth. “There are value enhancements that you can
make to improve your rental structure and stabilize your occupancy,” Stone
sales among class C properties are heating up in markets such as Phoenix. In
2012, Phoenix-based Gerchick Real Estate closed $45 million in multifamily
sales and the firm expects to double that this year. “This market is incredibly
active,” says Linda Gerchick, CCIM, designated broker and team leader at
Gerchick Real Estate in Phoenix. Some investors have been tired of waiting on
the sidelines and are ready to make a move, which is driving demand. The desire
to buy investment property with good cash flow is another attractive incentive,
is experiencing a flurry of rehab and retrofitting activity among older
properties. The improvements make the rents “go over the roof” and properties
have been selling “like crazy,” Gerchick says. That demand is driving prices
higher. In the past year, prices for class C properties have doubled from
$17,000 per door to $36,000 to $38,000 per door. Gerchick is currently
negotiating with a California buyer who is interested in purchasing a 72-unit
property in Phoenix that has been rehabbed and will likely sell between $38,000
and $40,000 per unit, she says.
investors still have abundant capital to place and apartments remain an
attractive choice. “Activity has not trailed off. There is still a great deal
of demand from buyers, really across all segments,” says Tikijian. Tikijian
sold 14 apartment properties in 2012 and expects to close on a comparable
volume in 2013. “I see nothing on the horizon that will reduce the demand to
invest in apartments,” he says. “If interest rates continue to increase, it
could have a negative impact on pricing, but it won’t necessarily curb
Mattson-Teig is a freelance writer based in
Demand Drives Development
economy’s continued recovery has launched a new wave of development in the
activity is ramping up across the country in markets ranging from New York to
Oregon. More than 100,000 new units are expected to be completed this year, and
that resurgence is just the start of a new era of building over the next few
years, according to Reis.
development drought appears to be over in markets such as Las Vegas where the
future is looking brighter for both apartment owners and developers.
“Developers are bullish for the next several years with some 10,000 units
either planned or in the pipeline,” says Garry Cuff, CCIM, vice president at
Colliers International in Las Vegas. The improving economy, including the
addition of approximately 20,000 new jobs over the past year, has helped to
fill existing apartments in the Las Vegas metro area, which spans a total
inventory of about 160,000 units. Occupancies for class A properties currently
stand at 94 percent, while class B and class C properties are only slightly
lower at 93 percent.
unforeseen downturn in the national economy or negative geopolitical event in
the world, multifamily properties should perform very well compared to the past
several years and I see Las Vegas climbing out of the basement compared with
other parts of the country,” Cuff adds.
there are some concerns that the added inventory may have a negative impact on
occupancies, most metros are likely to see those new units absorbed relatively
quickly. Many of the properties are coming online at occupancies of 85 percent
or more, indicating that demand for apartments remains strong, according to
investors, urban redevelopment projects are presenting an opportunity to tap
into growing demand from renters to move into revitalized downtown
neighborhoods. In Indianapolis, for example, recent redevelopments include
transforming historic Bush Stadium into the new Stadium Lofts. The first
138-unit building opened earlier this summer. Such conversions are ideally
suited to the growing demand for urban living. “Our downtown market has been
the strongest market by far for years,” says George Tikijian III, CCIM,
president of Tikijian Associates, a multihousing investment advisory firm based
there are about 5,000 apartment units located in downtown Indianapolis with an
estimated 2,000 new units that will be added over the next 12 months. Although
that activity will likely create some oversupply in the short-term, Tikijian
expects renters to absorb those units by 2015. “All of the factors that have
caused high demand for apartments over the last few years are still in place,”