Moving Into Multifamily

Investors relocate capital to attractive apartment sector as fundamentals improve.

Although recent media attention has focused on the ups and downs of single-family residential housing, last year's biggest real estate deal - in fact the world's biggest real estate deal to date - actually took place in the multifamily sector. Tishman Speyer offered MetLife $5.4 billion for Manhattan's Stuyvesant Town - an 11,000-unit, 110-building multifamily complex housing about 25,000 people.

Although the multifamily sector often flies beneath the radar of many investors, its combination of stability and upside has made apartment properties one of the best and most tempting real estate investments. And today's combination of high single-family home prices, limited multifamily stock, and burgeoning demand demographics points to improving multifamily fundamentals for many markets.

As an investment, apartment properties have outperformed the stock market for the last five years, according to both the National Association of Real Estate Investment Trusts and the National Council of Real Estate Investment Fiduciaries. In 2005 the apartment sector achieved its best annual return since 1984 - 21.15 percent compared to the market's 20.06 percent. During that same year, $86.9 billion of apartments traded, a 72 percent increase compared to 2004, according to the National Association of Realtors.

Photo caption: The 276-unit Alexan Miramount luxury apartment complex located nine miles southeast of Austin, Texas, was completed last summer.
Photo credit: Opus West Corp.

Last year apartment investors reaped returns at about 17 percent, which was similar to other property types, according to NCREIF. Preliminary reports indicate that far more apartment properties changed hands than any other property type except for office. During the first 10 months of 2006, nearly $70 billion worth of apartment properties traded, with institutional acquisitions already surpassing the total for all of 2005, according to Real Capital Analytics, a New York-based research firm. About 30 institutional investors each acquired $100 million or more in apartment properties in 2006.

Although rental-housing niches such as student and seniors housing continue to grow, few investors are pursuing them. Instead, many traditional multifamily investors are focused on developing mixed-use projects in infill locations and will continue to do so throughout this year. Since some cities make affordable housing a condition of the zoning approval, some of these properties will include an affordable-housing component.

The value-added strategy of acquiring and repositioning class B and class C apartment properties has been extremely popular for the past three years and is not expected to wane this year. However, the condominium conversions that ignited many markets, particularly in Florida, have slowed significantly, and the absence of condo converters has made room for conventional apartment investors in markets such as Tampa and Orlando, Fla., and Miami.

While the conversion slowdown is returning some units to the market, cities with strong population growth will not be affected greatly, according to industry experts. In fact most commercial real estate experts give multifamily a thumbs up for 2007 based on its all-around improving fundamentals. As a result investor interest in apartment assets should continue to grow stronger this year, as the sector benefits from an expanding renter population, strong job growth, and slowdowns in single-family housing.

Improving Fundamentals
Confidence in the current rental market is strong and expectations for this year are even higher, according to the National Association of Home Builders/Fannie Mae Multifamily Rental Market Index released in late November 2006.

More than 60 percent of MRMI respondents said that apartment demand rose during 3Q06, and 70 percent said that effective rental rates increased. Additionally, almost 70 percent of multifamily developers and owners said they felt good about continued demand due to a large volume of calls from prospective renters.

Strong fundamentals are evident in nearly every U.S. apartment market. Out of the 75 markets tracked by the New York-based research company Reis, 60 markets boasted positive absorption and 55 noted falling vacancy rates. A whopping 73 markets recorded effective rent gains.

Vacancy during 3Q06 fell by 20 basis points to 5.4 percent - the lowest level since 4Q01, according to Reis. Vacancies are expected to continue to decrease despite the fact that development has strengthened and condo conversions have slowed.

During 3Q06, 16,300 rental units came online, but all of them and more were absorbed as net absorption reached nearly 22,000 units. During that same period, only 7,400 units were converted to condos, far below the 1Q06 and 2Q06 levels of 29,800 units and 19,300 units, respectively. Further comparison shows that the 3Q06 conversion rate was scant in comparison with the market's peak of 54,700 units in 3Q05, according to Reis.

The decrease in conversions, coupled with a muted development pipeline in comparison to previous development cycles, is impacting asking rents and effective rents. Asking rents and effective rents grew at their fastest rates in 2006 since the national market's peak in 2000, according to Reis. Third-quarter 2006 marked the sector's 18th consecutive quarter of asking rent gains, which rose 1.3 percent, according to Reis, while effective rents climbed 1.4 percent as landlords reduced concessions. Asking rents will increase 3.4 percent and effective rents will grow by 3.6 percent this year, Reis forecasts.

Rendering caption: After slightly more than three years of construction, Scottsdale Waterfront, the first condominium tower in Scottsdale, Ariz., was ready for occupancy in Feburary.
rendering credit: Opus West Corp.

Coastal Markets Attract Investors

Location is a crucial investment factor and continues to be a tricky matter. High-barrier-

to-entry markets such as Baltimore, Boston, Washington, D.C., Fort Lauderdale, Fla., Los Angeles, Long Island, N.Y., Miami, New York, Orange County, Calif., San Diego, Seattle, and San Francisco historically have produced higher rental growth and lower vacancies when compared to low-barrier-to-entry markets such as Atlanta, Dallas, Denver, Phoenix, Raleigh-Durham, N.C., and San Antonio, according to a RREEF study.

From 1990 to 2006, for example, the average vacancy rate for high-barrier markets was just 3.8 percent compared to 6.9 percent for low-barrier markets. Similarly, high-barrier markets achieved rental rate growth of 3.8 percent, while low-barrier markets achieved 3.3 percent, according to RREEF. Capitalization rates in high-barrier markets averaged 5 percent compared to an average cap rate of 5.6 percent in low-barrier markets, the study also shows.

Having four of RREEF's top high-barrier markets located in California provides a reason why the state's cap rates are among the lowest in the country, according to Real Capital Analytics. Apartment transactions that closed during 3Q06 in Orange County, for example, had an average cap rate of 4.9 percent and sold for an average of $195,882 per unit. Farther east toward the desert, the Inland Empire has had an average cap rate of 5.4 percent and an average price per unit of $147,151.

Despite the low cap rates and high unit prices, there's still a lot of upside to be found in Southern California. For example, the Inland Empire's apartment market is expected to see occupancy and rental rate growth increases in 2007 as the population expands by 3.2 percent - the largest amount of all markets evaluated - and job growth will top 3.2 percent according to Sperry Van Ness' multifamily Top 10 Markets to Watch report. Vacancy is predicted to drop to 4.2 percent as rents grow 4.7 percent to reach an average of $1,053 per month.

Orange County's vacancy rate is expected to drop to a countrywide low of 3.2 percent and effective rents are forecast to grow 5.1 percent to $1,481, which is the biggest increase for all markets evaluated in SVN reports. Like the Inland Empire, Orange County will add more than 22,000 jobs and 22,000 new residents. Investors should look to Fullerton, Calif., for significant upside as renters in Buena Park, Calif., and North Anaheim, Calif., are priced out of the market and move to Fullerton.

Northern California's apartment market also has strong momentum. For example, cap rates in both San Francisco and San Jose averaged 5 percent at the end of 3Q06, according to Real Capital Analytics, with an average price psf of $286,867 and $183,715, respectively.

San Jose and San Francisco posted the strongest gains in asking and effective rents for most of 2006, according to Reis. And in terms of asking rents during 3Q06, San Jose led the nation with an increase of 2.6 percent.

Both San Jose and San Francisco's downtowns are undergoing significant revitalization and a number of mixed-use infill projects are under construction. At the same time, job growth has returned to the region. San Jose will add 10,000 new jobs - most of them in the service and professional sectors - and welcome 8,500 new residents, according to SVN. The high cost of living in the Bay Area bodes well for apartment owners. A decreased vacancy of 3.7 percent over the coming months will allow owners to boost asking rents by 4.9 percent, bringing the average rent to $1,380 per month.

San Francisco also has rebounded from the dot-com bust and many people have returned to jobs in the city, seeking homes near transit lines or close to downtown. Rental signs are coming down, as are vacancies and concessions. The city's marketwide occupancy is expected to reach 3.8 percent by mid-2007, while effective rents will jump 5.4 percent to $1,668 per month, according to SVN.

Rendering caption: Edgewater, a San Francisco multifamily property will break ground this spring.
Rendering credit: Michael Sechman and Associates

Investors Warm to Sun Belt Opportunities

Many investors consider the coastal markets, especially those in California and Florida, to be seriously overheated and have gravitated to Las Vegas and Phoenix in hopes of getting quality assets at higher cap rates.

In Las Vegas, for example, the average cap rate for deals closed in 3Q06 was 6 percent, according to Real Capital Analytics, while the price per unit was $94,522. Phoenix's average cap rate was slightly lower at 5.9 percent, with the average price per unit of $89,533.

Las Vegas ranks as No. 3 on SVN's top apartment markets list, while Phoenix and Tucson, Ariz., fill spots nine and 10 on the list. All three markets are appealing because they will continue to experience significant population and job growth. Las Vegas, for one, is expected to add 57,000 new residents over the next six months and lead the nation in employment growth of 3.8 percent. Development in the city is limited primarily to high-rise, high-end condos, but 1,800 new apartment units will come online this year. Therefore, the vacancy rate is forecast to hover right around 4 percent. But new development is not expected to curtail rental rate growth of 3.7 percent.

Other investors are following the demographic shifts that clearly favor Sun Belt markets in Georgia, Texas, and the Carolinas. Some of the fastest-growing metro areas over the past two to three years have been Atlanta, Dallas-Fort Worth, Denver, Phoenix, and Raleigh-Durham, N.C. Without exception, these cities are experiencing strong job growth and population increases as corporations exit expensive locales to take advantage of the quality work force and a low cost of doing business offered in Sun Belt markets. Moreover, these markets will offer better returns to investors in the coming months as fundamentals improve.

For example, in Dallas-Fort Worth cap rates averaged 6.9 percent at the end of 3Q06, and the average price per unit was a real bargain at $67,215. Similarly, Denver's average cap rate was slightly lower at 6.6 percent and the average price per unit was $101,568, according to Real Capital Analytics. Unfortunately, the demand has encouraged developers to start building again. Various sources measure the development pipeline at more than 10,000 units.

Farther east, Raleigh-Durham offers such impressive growth opportunities that it nabbed the No. 8 position on SVN's top apartment market list. Almost 18,000 new jobs are forecast for the coming year for the metro area, and 38,000 people are expected to move to the city.

A large student population and a growing employment base have created significant demand in Raleigh-Durham, pushing vacancy to 7.5 percent and driving rental rate growth of 3.4 percent. The city has absorbed 2,000 units over the past two years, but there is concern that the 3,000-unit development pipeline is a little pudgy.

Even the amount of new development that is planned nationwide for 2007 can't cast too large a shadow on the apartment market's future. About 92,000 units are expected to be completed this year, 2,000 more than last year. Although condo conversions reverting to rentals may add to that total, completions still will fall short of 1990s' levels.

All in all, the economic indicators paint a pretty picture for apartment performance and will tempt investors throughout the year. Opportunities for strong returns exist in several markets. Investors just have to be willing to look hard and move quickly.

David Baird

David Baird is senior vice president and national director of multifamily for Sperry Van Ness in Las Vegas. Contact him at (702) 765-6005 or What\'s Driving the Apartment Sector?Demand for rental housing is showing no signs of slowing. The United States is projected to add 11.6 million new households between 2007 and 2015, an average of roughly 1.5 million new households each year. This rate is 15 percent higher than the 1.3 million new households created each year since 2001. Most of the growth in household formation can be attributed to the echo-boomer generation, who range in age from 20 to 24 years, and strong immigration, which both positively impact the apartment sector, according to a RREEF report. Echo boomers account for around 30 percent of the U.S. population or 76.3 million. This group is critically important to the apartment market: Roughly 75 percent of this age group calls an apartment home and historically has lived in apartments. In the 1990s, this age cohort shrunk significantly but started to grow again in 2001 as echo boomers - children of the baby boomers - came of age. Similarly, immigrants make up a large portion of the renter population. Roughly 4 million immigrant households live in apartments today, and immigrant households are expected to contribute a greater proportion to future apartment demand, according to the National Multi-Housing Council. By 2010, another 500,000 immigrant households are expected to live in rental units. In addition to echo boomers and immigrants, many Americans may end up in apartments as the cost of homeownership increases. Homeownership costs about 30 percent more a month than renting, according to the NMHC. That affordability gap plus high housing prices are causing fewer apartment residents to become homeowners. In addition, many existing homeowners have mortgage payments that grow as short-term interest rates increase. The impact of the interest rate hikes already is apparent: The number of foreclosures during the first 10 months of 2006 (766,058 properties) was 19.6 percent more than the number of foreclosures for all of 2005, according to, a California-based real estate investment advisory firm and publisher of property foreclosure information. While foreclosures and weak home sales aren\'t anything to cheer about from an economic perspective, the multifamily sector certainly will benefit, and those rewards will be passed on to investors.


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