Moving Into Multifamily
Investors relocate capital to attractive apartment sector as fundamentals improve.
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
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
is a crucial investment factor and continues to be a tricky matter.
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
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.
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.
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.
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.
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.
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
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.
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.
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
Warm to Sun
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.
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.
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.
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.
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.
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.
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
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.