The apartment sector today is in a good place—a very good place—and the future looks just as good, according to a survey conducted by National Real Estate Investor.
“We’re not in a boom market,” says Nick Ryan, CEO of The Marquette Companies, a Naperville, Ill.–based real estate firm with a portfolio of 11,000 apartment units. “We’re in a strong, healthy market that’s going to last for a long period of time.”
The survey, which solicited opinions from 1,001 completed surveys, including 947 respondents involved in the multifamily sector from across the nation, uncovered high levels of optimism. From occupancy and rental rate growth to development levels and financing availability, respondents report favorable conditions for the apartment sector.
“We believe this cycle has room to run for both the economy and the apartment industry,” said Timothy J. Naughton, chairman, president and CEO of AvalonBay Communities Inc., in the REIT’s most recent earnings conference call. “Job growth is really only at the point now where the economy has just recovered the 8 million jobs it lost from the last downturn. And while cumulative job growth so far this cycle is similar to last cycle, it’s only about one-fourth of what we experienced in the ’90s, when we had a longer economic cycle. And so from our standpoint, the labor market is up [and there’s] plenty of capacity to support economic growth.”
Most attractive regions
The NREI survey asked respondents to rank regions in terms of attractiveness from a multifamily perspective. Respondents rated four regions on a scale of one to 10 with one being least attractive. The regions were: West/Mountain/Pacific; South/Southwest/Southeast; Midwest/East North Central/West North Central and East.
Unsurprisingly, the West/Mountain/Pacific region received the highest ratings from respondents. It had an average rating of 7.87 with 11.5 percent of respondents ranking it 10, 22.2 percent ranking it ninth and 22.6 percent ranking it eighth.
The responses are in line with NREI’s ranking of the top 10 multifamily markets in the nation. Half of the list was located in California, and seven of the 10 markets were located on the West Coast (all of which is consistent with NREI’s previous article on top multifamily markets).
The runner-up was the East region, and the least attractive region was the Midwest/East North Central/West North Central with an average ranking of 6.57 percent. Just 1.9 percent of respondents ranked this region as a 10.
Despite these findings, apartment players contend that there are opportunities in every region. Steadfast Income REIT Inc., for example, is focused on growth markets in the middle of the country rather than on the coasts. The non-traded REIT owns 65 communities in 11 Midwestern and Southern states, and recently acquired properties in Dallas and Chattanooga, Tenn.
“Forty percent of Steadfast’s portfolio is in Texas, and those markets have outperformed even our expectations,” says Ella Shaw Neyland, president of Steadfast Income REIT. “All the markets we’ve picked have outperformed our expectations.”
Nearly six out of 10 respondents anticipate that national apartment occupancies will increase over the next 12 months. Roughly 22 percent say they’ll decrease, and 20 percent expect no change.
As of February 2014, the occupancy rate was 94.3 percent, according to Axiometrics Inc. That represents a slight increase from January 2014.
The Marquette Companies’ portfolio is well above 94 percent occupied, according to Ryan. “Demand has allowed us to push rents,” he notes, adding that the company posted 7.1 percent NOI growth in 2013.
Nearly 82 percent of survey respondents think rents will increase over the next 12 months, while 10.7 percent predict no change. More than half of the respondents think rental rates will increase one to five percent.
“When you look at the apartment segment, just look at the rent growth, rents are only about 5 percent nationally above prior peak, which occurred six years ago,” Naughton noted during AvalonBay’s recent earnings conference call. “And [in terms of] cumulative rent growth, this expansion—again, while [it’s] two-thirds of what we saw in the 2000s—is only about 20 percent of what we experienced in the 1990s.”
Axiometrics reported that national annual effective rent growth decreased slightly in February to 2.8 percent. The Dallas–based research firm says annual effective rent growth has been moderating at the national level for the past two years, though many metropolitan statistical areas (MSAs) in California, Florida and Texas continue generating rent growth of more than 5 percent.
“With the extremely strong rent growth seen in 2010 and 2011 it was inevitable that it would begin to moderate, which has been the case now for about two years,” Jay Denton, vice president of research for Axiometrics. “By historical standards, however, the apartment market is still strong, especially in some coastal areas and regions of robust job growth, like Texas. We pointed out recently that oversupply could become a concern in some markets. Affordability could also be an issue with so many high-priced units coming to the market. The next few quarters will be telling as deliveries continue to increase.”
February’s effective rent growth rate of 2.8 percent, while still positive, was almost three quarters of a point lower than 3.53 percent reported in February 2013. Despite this overall slowing trend, 21 of the top 121 MSAs experienced annual effective rent growth greater than 5 percent.
Metros in Florida, California and Texas continued as top performers for February. For the eighth consecutive month, Washington, D.C., ranked as one of the weakest MSAs with annual growth at –1.5 percent. However, Philadelphia and New York are not far behind with growth rates of –1.3 percent and –0.3 percent, respectively.
AvalonBay Communities, which has communities on both the East Coast and West Coast, reported rental increases of 3.7 during the first quarter 2014 compared to the previous year and 20 basis points sequentially over the prior quarter. Naughton said the REIT’s West Coast markets continue to lead with same-store rental revenue growth of roughly 4 percent in Southern California, 5 percent in Seattle and 8 percent in Northern California.
The Mid-Atlantic region also performed “modestly better than expected” with same-store growth relatively flat year-over-year and up 20 basis points sequentially. The D.C. Metro region is starting to benefit from a more stable, near-term outlook for the federal budget, which has reduced economic uncertainty and led to improved business confidence.
Brian Natwick, president of Crescent Communities’ multifamily group, believes rental rates will increase over the next 12 months, but he doesn’t think they’ll growth at the same feverish pace.
“We’ve seen year-over-year increases of more than 5 percent,” he says. “That’s above average, and I think we’ll revert back to average increases in the 3 percent range.”
When it comes to apartment development, Goldilocks had the right idea. More than four out of 10 respondents said the current amount of apartment development was “just right.” A little over 28 percent said there was too much, and 18.1 percent said there was too little.
Ryan is one such multifamily developer who feels the amount of development is appropriate. “Generally development is in balance,” he says. “There are pockets where there might be oversupply, but not many. And some markets are still underserved.”
Marquette Companies plans to break ground on a 30-story apartment project in downtown Houston this summer. Dubbed Block 52, the 360-unit high-rise is a joint venture with Hunt Properties. In addition to Block 52, Marquette also is developing a 19-story project in Chicago’s West Loop between downtown and Greektown called Catalyst.
Likewise, Crescent Communities has 4,300 units under development in Florida, Georgia, North Carolina and Tennessee. Five properties are in lease-up, and Natwick says foot traffic and leasing velocity has exceeded expectations. To that end, rental rates are above pro forma.
Neyland, meanwhile, is slightly concerned about overbuilding in the luxury urban apartments, where most of the development is concentrated. She points to recent data from Axiometrics, which found that the number of units being delivered in that market that are renting for $1,000 or more has grown rapidly compared to the rest of the apartment market, resulting in slower rent growth.
For example, the average monthly rent for a brand-new apartment in Dallas was $1,320 early this year, according to Axiometrics statistics, which is available to only the top 10 percent of renter income. On a national basis, new product is priced somewhere between $1,000 to $1,600 per unit, depending on location, unit mix, amenities and other factors. The vertical/urban product (such as high-rises) coming online this year will be above that range, and for already expensive markets like Washington, D.C., and Seattle, prices will be $300 to $400 higher still.
Over the past several years, the majority of multifamily development has been focused on urban areas. However, a number of developers are now working on suburban properties as well.
“From a demand standpoint, we agree that there continues to be some urbanization … we don’t think people exclusively want to live downtown,” Naughton says. “There’s still demand in the suburbs. I think you’re even starting to see employment and office space start to absorb reasonably well in some of the suburban markets.”
Naughton says supply has shifted in response to the demand. “If you look just within our market footprint, projected supply over the next couple of years significantly outweighs what we’re seeing and what we expect to see in the suburbs [versus] the urban submarkets,” he notes.
“And so we think there [are] some urban submarkets that will continue to outperform,” adds Naughton, “but we think there are many suburban submarkets that will outperform just based upon what’s happening at the margin from a demand and supply standpoint.”
Moreover, Naughton says AvalonBay Communities has seen better development values in the suburbs over the past 12 months to 18 months since capital has “really been chasing” urban opportunities.
Investing in multifamily
Fifty-five percent of respondents say they plan to acquire multifamily assets in the next 12 months. Of the main real estate sectors, apartments are the most attractive from an investment standpoint. On a scale of one to 10, the multifamily sector scored a 7.96, followed by industrial at 6.6 percent. Office is the least attractive sector, according to respondents.
“I rank apartments a 10,” Neyland says. “I’ve been in the apartment business for 35 years, and we’re entering an era where apartments are even more attractive. Year ago, people viewed apartments as the housing of necessity rather than choice. But renters are now picking them as a choice. It’s a lifestyle choice that is driving demand, and compared to other sectors, apartments are much more desirable.”
Ryan agrees. “In my opinion, multifamily is clearly the most attractive asset class. Multifamily offers really nice risk-adjusted return. It’s just a good place to put your money.”
The majority of respondents—58.6 percent—a expect cap rates to increase over the next 12 months, while 22.4 percent of respondents expect no change in cap rates. Five out of 10 respondents think the increase will be 50 basis points or less.
“There’s an expectation that if interest rates go up, cap rates will go up too,” Ryan explains. “But in general, I think the consensus is that they’re going to be pretty steady, and if they do go up, it won’t be anything drastic.”
Neyland doubts cap rates will shift at all. “Even if interest rates move, investor demand is going to keep pressure on cap rates.”
Financing more available
Nearly 73 percent of respondents expect lending activity to increase in the next 12 months. And nearly six out of 10 respondents say capital is more widely available today than it was 12 months ago. Roughly 30 percent say it’s unchanged, and 7.1 percent say it’s less available.
Commercial and multifamily mortgage bankers closed $358.5 billion of loans in 2013 according to the Mortgage Bankers Association’s (MBA) 2013 Commercial Real Estate/Multifamily Finance Annual Origination Volume Summation. In terms of property types, multifamily properties saw the highest origination volume with $136.9 billion.
Commercial bank and savings institutions were the leading investor group for whom loans were originated in 2013, responsible for $100.5 billion of the total. CMBS issuers saw the second highest volume, $79.8 billion, and were followed by life insurance companies and pension funds; Fannie Mae; REITS, mortgage REITS and investment funds and Freddie Mac.
“There’s money out there for the right properties,” Ryan says. “Banks have solved a lot of their problems, and insurance companies are lending again.”
Ryan says mortgage debt is more widely available, as is construction financing. “But I wouldn’t say it’s easy to get,” he adds. “They’re not lending to people who don’t know what they’re doing. Lenders are still requiring developers to provide personal guarantees on construction loans.”
Survey respondents are split when it comes to their expectations of loan terms over the next 12 months. While 44 percent expect loan terms to remain unchanged, 46.4 percent expect loan terms to loosen, so it makes sense that respondents are equally split on loan-to-value ratios. Forty-eight percent expect LTV ratios to increase, while 45.6 percent expect them to remain flat. “We’ve seen LTVs increase slightly, but nothing out of the ordinary,” Natwick says. “I think lenders are very disciplined, and that discipline is governing supply and keeping it in check. Lenders continue to look for the three Ss: strong sponsor, great site and an amazing story.”
Study Methodology: Between Feb. 20 and March 3, NREI subscribers were emailed requests to participate in an online survey. The effort resulted in a total of 1001 completed surveys, including 947 respondents involved in the multifamily sector as investors, developers, brokers or lenders. Overall, 45 percent of respondents listed their titles as owner/partner/president/chairman/CEO/CFO. Geographically, 45.6 percent of respondents operate in the East, 43.8 percent in the West, 41.9 percent in the South and 36.1 percent in the Midwest.
This article was republished with permission from National Real Estate Investor.