Buyers battle and sellers win as investors fight for apartment properties.
Multifamily properties have been a hot commodity in recent years. And potential threats on the horizon in terms of looming interest rate hikes and a growing development pipeline have yet to cool investor enthusiasm.
“If you talk to any multifamily specialist across the country, particularly in the Sunbelt and on the coasts as well as in Chicago, the demand is through the roof,” says T. Sean Lance, CCIM, ALC, a founding partner at Vertica Partners in Tampa, Fla. That is certainly the case in Florida where capital is flowing into the state from domestic buyers as well as foreign investors from South America, Europe, and Canada.
Strong fundamentals and positive economic and demographic trends that support renter demand have stoked buyer interest. “Multifamily investment and transaction activity is still extremely strong throughout Florida, especially in all the major MSAs and with all asset classes,” Lance says. Occupancy rates in most major metros in Florida are hovering at or above 95 percent and rents continue to push higher across the board. The same scenario is playing out in cities across the country.
A number of factors are bolstering occupancy, including a downward trend in home ownership since its peak in 2004. The national home ownership rate stood at 64.7 percent in second quarter 2014, its lowest level in nearly two decades, according to the U.S. Census Bureau.
Many in the industry believe there is a shift, particularly among the millennial generation, that favors renting over home ownership. Younger people who saw their parents’ nest eggs evaporate when home prices went south are now less interested in home ownership, notes Jim Young, CCIM, an agent at KW Commercial in Austin, Texas. Other people are finding it more challenging to purchase homes due to the new lending guidelines for single-family homes. That shift is driving more demand — not just for high-end, resort-style apartment complexes — but all across multifamily property types, Young says.
New Construction vs Demand
The strong demand coupled with minimal new construction between 2009 and 2012 has created historically low vacancy rates and strong rental rate growth. The national apartment vacancy rate remains extremely tight at 4.1 percent, well below the long-term national vacancy rate of 5.4 percent, according to data from Reis Inc. On a year-over-year basis, asking rents and effective rents grew by 3.2 percent and 3.4 percent respectively in 2Q14, according to Reis.
Those trends, combined with the abundant capital in the market and historically low interest rates, have created a recipe for tremendous buyer demand for multifamily properties, Young says. For example, a value-add class C property near downtown Austin received 17 offers when it was listed for sale earlier this year. In order to be considered, buyers had to put down $100,000 in nonrefundable funds that went hard on day one. “I don’t recommend that my clients go after those deals, but there are certainly a lot of those deals going around,” Young says.
Concerns about greater investment risk due to the spike in construction does not seem to be deterring investors. Between 180,000 and 200,000 new units are expected to be completed in 2014, according to Reis. That volume is well above the historical long-term average of roughly 120,000 units per year, which is based on data Reis has collected since 1999. As such, Reis is predicting that occupancies will likely begin to rise as early as third or fourth quarter this year. Meanwhile, rent growth is expected to stabilize at around 3 percent.
“Although there is not as much upside in multifamily, we are still looking at positive growth trends,” Lance says. Markets such as Florida are seeing both population growth from in-migration as well as new job growth, which bodes well for the housing market overall. Younger people appear to have a greater desire to rent rather than own a home, and homeownership rates are the lowest they have been in years, Lance notes. “I think those are all important metrics that people are taking a look at,” he says.
Buyer vs Buyer
Even though the returns are starting to get a bit more meager as increases to rents and net operating income have declined, apartments are still viewed as a relatively safe place for people to park dollars compared to alternative investments, says William G. Leffew, CCIM, a senior vice president in the Louisville office of Bellwether Enterprise, a mortgage banking company. One of the challenges that exist in many markets is a limited supply of available properties for sale. “The deals are almost a little picked over here in Louisville,” Leffew says. In particular, value-add situations where buyers could pick up a property at a lower price, make improvements, and then raise rents are more difficult to find.
However, many would agree that investment properties are in short supply across the spectrum, from large institutional-quality properties down to small mom-and-pop rentals. Case in point is Amherst, N.Y. The market is very hot and very tough for buyers to get into, notes Robert A. Liebeck, CCIM, a broker associate at MJ Peterson Commercial Real Estate in Amherst. Liebeck specializes primarily in selling four-unit to 40-unit apartment buildings. “There is a complete shortage on the supply side. There are no really good properties actively on the market, and most of our sales are going privately with off-market transactions,” he says.
Liebeck recently brokered the sale of a four-unit property in Amherst. He had 25 showings and four solid offers within a week of the property hitting the market. The sale of the property closed in two months at $60,000 per unit — $10,000 per unit above the asking price and well above the 2006 sale price of $48,500 per unit. “There are very few sellers willing to sell unless they get a very good price,” he adds.
Competition has created pricing pressure in many markets across the country. “The Los Angeles multifamily market remains extremely hot with ever-increasing cap rate compression and tight inventory,” says Wolf Baschung, CCIM, CPM, president of MW Real Estate Group and director at KW Commercial in Los Angeles. Buyer appetite far outpaces supply. On the west side of Los Angeles, for example, a 5 percent cap rate or higher seems a thing of the past, notes Baschung. In most primary areas of Los Angeles rent-controlled B product is now trading at about 4.5 percent. Non-rent-controlled newer construction properties are rare and trading at cap rates of about 3.5 percent.
In August, Baschung sold a 1950s-built eight-unit property in the West Side Palms submarket for $1,685,000 or a cap rate of 4.34 percent. The seller owned the property free and clear and opted to roll the proceeds from the sale into a 1031 exchange. The seller ended up buying a seven-unit building in the El Segundo submarket of Los Angeles, which was priced at $2,540,000 or a 2.9 cap rate. This was probably the lowest cap rate on record, Baschung notes. In this particular case, the buyer bought all cash. “The investment mindset was that hard assets are a safe harbor in view of perceived future dollar weakness from Federal Reserve dilution of the monetary supply,” he adds.
Nationally, apartment cap rates have been hovering at an average of about 6.2 percent for the past year, according to Real Capital Analytics.
New Supply vs Fundamentals
The spike in new construction has many in the industry wondering how it will impact key fundamentals, and ultimately investor returns in the near term. So far, the impact of that new development varies from market to market. Texas, for example, has experienced a surge in new construction in key cities such as Dallas, Houston, and Austin. However, those cities also are seeing robust job and population growth that are helping to absorb the additional supply.
“In momentum markets such as Dallas, Atlanta, and Phoenix, I don’t think you are going to see as much impact on rent, because you have all of this job growth,” Leffew says. “However, in a middle market like Louisville where year-over-year job growth was 1,900 — you add 4,000 units to that mix and you are going to see some impact.”
For example, Louisville has nearly 1,000 units being built within a 2-mile radius in the city’s east end area. Those developments include the 360-unit Idlewild Apartments, 304 units at the Meridian on Shelbyville and 242 units at Claiborne Crossings. The good news is there is a two- to three-month lag period between completions. Claiborne Crossings has opened and is leasing well, while the other two are still under construction. This tempered delivery has kept lease-up at a good pace, Leffew adds.
Florida also has seen development come roaring back. Many of the new projects are infill in nature and are commanding record high rents. “The question remains as to whether or not the market can sustain all of these units and how this will affect renter demand and rent growth,” Lance says. Time will tell, but the absorption rates and effective rents at this stage for projects already delivered have been very good — thanks in part to the pent-up demand from the the lack of new construction that occurred during the recession. “The next wave of deliveries through 2015 will be a much better indicator of sustainability of rents and occupancy,” he says.
For now, the surge of development is actually providing fresh inventory for investors. The newly built class A product is being scooped up by institutions such as pension funds, equity funds, and real estate investment trusts — sometimes before construction is even completed and properties are stabilized. Buyers are purchasing newly completed projects, as well as stepping in as joint venture equity partners on developments. “There are a lot of people with a lot of capital and not a lot of opportunities to deploy that capital,” Lance adds.
Wanted: Apartment Sellers
One of the biggest complaints for apartment investors and brokers alike these days is that there is not enough for-sale property to satisfy buyer demand. According to data from Real Capital Analytics, apartment transactions through the fi rst half of 2014 reached $45.6 billion, which is actually a 9 percent drop in activity compared to the same period a year ago. “The level of sales activity is not necessarily refl ective of the demand for the product. I think it is more a refl ection of the supply in the marketplace,” says T. Sean Lance, CCIM, ALC, a founding partner at Vertica Partners in Tampa, Fla. Finding willing sellers has become a bigger challenge in markets such as Texas where the apartment market has attracted out-of-state investors, as well as international buyers from China, Japan, and Canada. Many sellers see both the rental rate increase and the continued capitalization rate compression as reasons not to sell, notes Jim Young, CCIM, an agent at KW Commercial in Austin, Texas. “It becomes diffi cult in the class A market to fi nd buyers who can meet some of the demands of the sellers in Austin,” Young says. He was recently contacted by a developer that is building a large class A property near downtown Austin. The group plans to put the property on the market at a 3.5 percent cap rate, he says. Whether or not anyone is willing to pay that rate remains to be seen. If the developer doesn’t get the premium asking price, the group is content to hold the property, he adds. Some investors have adjusted their return expectations in the past year, while others are expanding their search to look at secondary cities. For example, the aggressive buying and very low cap rates on the East and West coasts have pushed some buyers into the Midwest in search of more favorable pricing. Buyers are looking at cities such as Louisville, Ky., Nashville, Tenn., and Indianapolis where they can get a better yield for their dollar compared to New York or Los Angeles. In Florida, investors are looking outside of major metros such as Miami, Orlando, and Tampa to smaller markets such as Sarasota, Bradenton, and Ft. Myers. “More than ever the market is at an interesting infl ux as investors debate whether now is the best time to sell, while demand and fundamentals are so strong, or to continue to press their luck to squeeze even more returns from their current investments,” Lance says.
By: Beth Mattson-Teig (Commercial Investment Real Estate)
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