Daily Archives: December 31, 2013

New Year Demands New Investment Strategies

By John S. Sebree - vice president/national director, National Multi Housing Group, Marcus & Millichap – MultiFamilyExecutive.com contributor

With most opportunities exhausted in major metros, apartment investors in 2014 will be left to pursue alternate markets or hold periods for higher yields.

Amid pitched competition that has driven down cap rates, identifying assets that will provide targeted returns will increasingly force multifamily investors to adopt new investment strategies during 2014.

Purchasing properties with below-market rents, subsequently strengthening occupancy and raising rents, and then selling the property for a handsome profit was a winning strategy coming out of the recession, but no more. Most of this type of opportunity in major metros has been exhausted, leaving investors to determine where to turn next. Some are making a transition to a “buy-and-hold” approach to investing, acquiring targets that will provide stable income streams for the next five to seven years and serve as a hedge against the potential onset of inflation.

Some Seek Riskier, Higher-Yield Properties
Meanwhile, other investors are broadening their search for properties that have higher risk profiles and greater potential for significant value appreciation. Many secondary and tertiary submarkets of major metros hold properties that fit this profile, and an increasingly large share of deal volume in most markets will occur in these areas. In addition, secondary and tertiary metros continue to gain favor with investors in their search for properties with higher yields than their counterparts in the nation’s most prominent urban centers. The smaller metros in the Midwest, in addition to thriving areas such as Austin, Texas, will see significant inflows of equity capital during 2014, and debt providers are sure to follow closely behind.

Austin, in particular, stands out as the type of market that out-of-area investors will gravitate to in greater numbers in the year ahead. Unlike secondary metros that lack a diverse set of economic drivers to generate rental housing demand, Austin can boast government employment, a major university, and a booming tech sector as key economic engines. Austin’s economy will strengthen further over the next year, with local gross domestic product forecast to surpass $100 billion for the first time in history. Meanwhile, vacancy may rise to a more normal level next year as the metro records another surge in completions, making asset and submarket selection an imperative consideration for investors.

In Florida, capital will continue to migrate north from the three-county South Florida region to the center of the state and Jacksonville in the northeast corner. Deal volume in Jacksonville has been notable recently for the increased presence of large investors and institutions seeking core holdings that provide higher returns. As a wide-ranging metro area with several hubs of economic activity, Jacksonville will continue to attract large investors in the years ahead. Expanded access to debt, meanwhile, will also enable smaller investors to complete more transactions.

Good Returns, Strengthening Economies Encourage Investors
The strength of the investment markets in all metros rests heavily on investors enjoying continued access to the capital markets. From an equity capital standpoint, new capital continues to emerge in the multifamily segment, spurred by the lack of adequate returns available in other asset classes. Debt capital is also expanding, and, in many metros, lenders are competing keenly to provide acquisition funding. Higher interest rates appear certain at some point in the near term and will most likely affect pricing on low-margin properties, meaning primarily Class A assets. Properties on the lower rungs of the quality scale, however, will not see any price adjustments in the near term.

Strengthening metro economies will also boost apartment operations and encourage investors. Through October 2013, more than 80 percent of the jobs lost nationwide during the recession had been replaced, and many metros have already added more jobs than were lost during the downturn. The surprisingly robust number of workers hired nationwide in October despite the federal government shutdown that month erased many doubts about whether the economic recovery is sustainable. Economic growth and job creation will gain momentum in 2014 as demand for goods and services rises.

Finally, the recovery in the single-family home market may potentially raise vacancy and lower rent growth in several metros in 2014, but several offsetting factors are also in force that will prevent a broad-based flight to homeownership. The rise in 30-year mortgage rates during 2013 has likely relegated many marginally qualified prospective home buyers to the rental segment. Also, a lack of new homes being built at affordable “entry points” will thwart home buying aspirations.

Why 2014 Will Be a Holder’s Market

By Les Shaver - MultiFamilyExecutive.com

Just because it seems like cap rates can’t go down any farther, and many formerly favorable markets will be flooded with supply, that doesn’t mean everyone wants to sell.

There are many good reasons to buy and hold too. And, they are many of the same reasons the apartment sector has been a favorite of investors over the past few years.

Pent-up demand from Echo Boomers (with 21.8 million individuals ages 18 to 34 living at home in 2012, according to the Census), and the promise of economic growth in 2014 and 2015 mean the apartment market hasn’t hit its ceiling.

“Although the rate of acceleration is slowing and pricing is a concern, apartment fundamentals are still generally healthy,” says Lili Dunn, chief investment officer for Greensboro, N.C.–based Bell Partners. “Rental housing benefits from strong demand driven by robust rental household formation, which is fueled by demographic trends and, to a lesser extent, job growth.”

Economists believe the apartment market still has a lot of upside over the next four or five years, at least, pointing to about 2.2 million new jobs created in 2013.

“That is a recovery,” says John Sebree, director of Calabasas, Calif.–based Marcus & Millichap’s National Multi-Housing Group. “It’s a lethargic recovery. But it’s still a recovery that’s gaining speed. This year, depending on whom you talk to, we’re anticipating 2.7 million to 3 million new jobs. These new jobs will continue to increase the formation of new households.”

And, Dunn doesn’t think there will be an oversupply of apartments to sap the demographic-driven demand. She points out that the supply in the pipeline is expected to decline after hitting 300,000 units in 2014, and thinks supply concerns are overblown. “New supply is also still within reasonable levels of long-term averages,” she says.

While many well-heeled investors are starting to dispose of their apartment holdings and chase yield in other asset classes, some economists think weaknesses in those other sectors—such as office and retail—will help apartment investments maintain their value.

“Some people are still risk adverse about other property types and are taking a long-term hold approach to this,” says Ryan Severino, senior economist and associate director of research at New York–based Reis.

With these economic tailwinds, Severino doesn’t expect to see a market implosion like the one that occurred in the late 2000s, where condo converters, not buying on a cap-rate basis, pushed prices to unsustainable levels.

“Even in the markets where cap rates are rising, it isn’t like 2008 and 2009, where we had a massive expansion in cap rates that clobbered the market,” Severino says. “I don’t think you’ll see that performance from the underlying economy or see demand erode like that [again].”

Brokers and market researchers are concerned about where pricing is heading, but aren’t exactly planning for an Armageddon-like scenario.

“Unless something blows up, I don’t see a hard crash,” says Dan Fasulo, managing director at New York–based Real Capital Analytics (RCA). “But I guess, who does see a hard crash? By just looking at line graphs we [have] leveled off. Cap rates aren’t moving lower. The rate of increase in pricing is slowing. You can expect more of that over the next couple of years.”

Why 2014 Will Be a Seller’s Market

By Les Shaver - MultiFamilyExecutive.com

Jared Kushner hadn’t been running New York–based Kushner Cos. long when he noticed something problematic in early 2007: He could no longer justify buying apartments.

“I remember sitting with my dad and saying we couldn’t make sense of the buys in the markets—buying at 4 caps and financing at 6 percent,” Kushner says. “The dynamics really didn’t seem to make sense for multifamily.”

So, the Kushners made a decision. “We basically said, if we’re not buyers, we’re sellers,” Jared says. “We were able to market the portfolio and get an extraordinary price.”

The timing was impeccable. Kushner sold 17,000 units in 86 complexes to AIG and Morgan Properties in June 2007 for $1.9 billion. In 2008, the economy fell into recession. By 2010, acquisition pricing looked a lot better to Kushner (as it did to other opportunistic buyers around the country). So, over the past four years, the company has scooped up $3.5 billion worth of assets as the younger Kushner expanded the firm’s footprint beyond the Garden State to his new home in New York City, plus seven markets around the country.

Early on, Kushner found a number of buying opportunities. “The last couple of years have been a phenomenal time because [interest] rates have been low, cap rates have been high, and the spread seemed to make sense for us to be very aggressive buyers,” Kushner says.

But that dynamic is changing as more investors chase yield off the beaten path. “We haven’t been able to find the opportunities in the seven national markets that we’re in,” he says. “Gardens have been trading at prices beyond where we are comfortable. So, we’re super focused on New York City, which is a market that seems to have no end in sight for how it will continue to perform.”

Kushner certainly isn’t alone. As single-property transactions and cap rates head to near-record levels, interest rates perk up, and inflation fears hover, some industry analysts (and even a few executives) have started to ask themselves the same question the Kushners pondered in 2007—Is now the time to think about selling?

As it seems with every question in real estate, there’s no easy answer.

Disposition Decision
Some indicators say it’s 2007 again. As of the third quarter of 2013, cap rates came in at 6.2 percent nationally. “That’s every bit as low as 2007,” says Dan Fasulo, managing director at New York–based Real Capital Analytics (RCA).

With $22 billion of sales volume in the third quarter of 2013 and $30 billion in the fourth quarter of 2012, the apartment market was reaching the lofty volume it hit during the last boom. In fact, single-property deals are at an all-time high.

Part of that might be from a lack of supply on the market. That situation could actually make dispositions appealing for opportunistic sellers in 2014, especially for those that made value-add acquisitions (and have now stabilized those properties) during the recession.

“Now is a very good time to sell because of the number of buyers in the marketplace,” says John Sebree, director of Calabasas, Calif.–based Marcus & Millichap’s National Multi-Housing Group.

You can put Lili Dunn, chief investment officer for Greensboro, N.C.–based Bell Partners, in the opportunistic category. Bell, which completes about $1 billion in transactions a year, seizes good opportunities to buy and sell. But, in the near term, the company expects to be a net seller.

“Pricing is back to peak levels,” Dunn says. “There seems to be a dislocation between cap rates and projected growth rates in some areas. It is a great time to take advantage of markets that have peaked and/or assets that have maximized operating performance.”

While some companies, like Bell, can be opportunistic sellers to prune their portfolios, there is an argument to be made that this may be a better sales environment than owners may see in the next few years. So, if large institutional investors want to sell, now is the time. Already, some are leaving the market. Bloomberg reports that Washington, D.C.–based Carlyle Group “is reducing holdings of multifamily housing as rent growth slows from a post-recession surge.”

Many of these investors may be looking to park their money in other classes, such as office and retail. In fact, Fasulo sees more upside in office and retail, where rents are still 20 percent to 30 percent lower than peak.

“I think the market will be hard-pressed to continue its momentum,” Fasulo says. “As far as double-digit gains in pricing, I think that game is pretty much over. Your serious players in the market are expecting debt costs to be higher going forward, with little room to raise rents higher.”

Though there’s not a lot of evidence of it so far, rising interest rates could eventually pull cap rates up. Ten-year Treasuries jumped from 1.6 percent in May 2013 to 2.6 percent at press time. If cap rates eventually follow, buyers might have to make a decision.

“Sellers have expectations of where prices should be,” Kushner says. “The question is, do cap rates widen out and do people keep hitting those prices and settling for less return on investment relative to risk?”

If buyers eventually balk at those decreasing returns, sellers might have to make price adjustments. Overdevelopment could eventually add more supply to the market, also forcing sellers to adjust.

With supply ramping up, you might face more competition from other sellers over the next few years than you might in the near term,” says Ryan Severino, senior economist and associate director of research at New York–based Reis. “If you’re in a position to harvest those gains (from a value-add situation) and redeploy that capital into something else that might present better return options going forward, now is not a bad time to do it.”

Top 10 Rent Growth Markets of 2014

By Lindsay Machak - MultiFamilyExecutive.com

Industry experts project that some of the largest metro areas will see some of the largest rent growth next year. Yet some hot secondary metros, such as Denver and Nashville, are also among the top markets for 2014.

Seattle will continue to grow in 2014 and is expected to see the biggest percent change in rents, according to New York-based Reis.

San Francisco will push rents by about 4.7 percent next year, according to the MPF. The Bay Area’s job growth market continues to improve, as the unemployment rate dropped from 6.9 percent in July to 6.1 percent in September, according to the Bureau of Labor Statistics.

Meanwhile Texas markets Austin, Dallas and Houston are each showing strong fundamentals heading into the new year. Job growth in all three markets will give the boost they need to push rents by about 3.9 percent next year. While some people may fear Austin is seeing too much development, most mangers aren’t worried about it. As far as Dallas and Houston, both markets are seeing rapid development, and are among the hottest secondary markets in the nation.

The Top 10 Rent Growth Markets for 2014:

1. Seattle: 5.8
2. San Francisco: 4.7
3. Denver: 4.6
4. San Jose: 4.5
5. Nashville: 4
6. San Diego: 4
7. Austin: 3.9
8. Dallas: 3.9
9. Houston: 3.9
10. New York City: 3.8

Lindsay Machak is an Associate Editor for Multifamily Executive. Connect with her on Twitter @LMachak.

8 Threats to Apartment Owners in 2014

By Les Shaver - MultiFamilyExecutive.com

As the rest of the economy has foundered, apartment owners have surged coming out of the recession. But the good times might not last forever. Here are eight things that could wreck their joyride.
1. Fannie Mae and Freddie Mac
It’s been more than five years since the speculation about Fannie Mae and Freddie Mac started, yet they remain a vital source of liquidity in the sector, especially in secondary and tertiary markets (where other lenders are less likely to go). “Fannie and Freddie are the most dominant lending sources in our industry,” says John Sebree, director of Calabasas, Calif.–based Marcus & Millichap’s National Multi-Housing Group. “If that is changed, it will have an effect on our values and our ability to finance properties.”
2. Unemployment
The apartment sector has seen great rent growth over the past few years without its customers enjoying real income growth. If the sector wants to continue to grow, employment, and wages, must increase. And, if things regress, the industry will suffer. “You put unemployment and the economy in the macro bucket,” says Dan Fasulo, managing director at New York–based Real Capital Analytics. “They’ll be hovering above everything we do and directly impacting values.”
3. Rising Interest Rates
When interest rates rise, they reduce investor-levered returns, which obviously hinders valuations. “The interest-rate market, and how much interest rates increase and over what period of time, will have a huge effect on value,” Sebree says. “If Treasuries jump 100 or 120 basis points, that will have an effect on cap rates.”
4. Overdevelopment
Simple supply and demand dictates that when more apartments show up in your neighborhood, it generally decreases the value of those properties that were there already. “Supply is an issue at the submarket and neighborhood levels,” says Ryan Severino, senior economist and associate director of research at New York–based Reis. “It’s not a uniform thing.” But in markets with oversupply, valuations will take a hit.
5. An Exodus of Capital
Already, some players, like Washington, D.C.–based Carlyle Group, are trimming their apartment holdings. If the movement gets bigger, it could hurt values. “Capital is moving out,” Fasulo says. “Your smart money players, chasing yield compression in the market, are already playing in the other sectors where there is a bigger spread.”
6. Inflation
Inflation will hit apartment owners, but, ultimately, the sector is in a good position to handle higher prices. “If we look at what inflation will do, it will increase rents, but it will increase expenses and interest rates [too],” Sebree says. “It will probably increase values, as well. If inflation happens at a higher rate than what many are predicting, the investors that have locked in long-term debt will be in better shape than others.”
7. Political Threats 
When Bill de Blasio was elected the next mayor of New York City last month, apartment owners in the city, including Fasulo (who owns units in Brooklyn) took note. “The mayor of New York has a lot of power to impact change very quickly,” Fasulo says. “Understanding the positions of the new mayor-elect, I’m not sure I’d make a bet that operating expenses for New York City apartment owners would be going down.”
8. Geopolitical Issues
Apartment industry executives, like everyone else, are susceptible to what happens in the outside world. If gridlock in Washington or recessions in other countries plunge the U.S. into recession, multifamily owners suffer. “One of my greatest concerns that I believe will impact apartment values and fundamentals is uncertainty about global economics and our government policy,” says Lili Dunn, chief investment officer forGreensboro, N.C.–based Bell Partners (though she remains hopeful the economy will remain along its path of moderate growth).