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- Meeting Summary
- Will rents continue to rise?
- Will the homeownership rate continue to decline?
- Is a “renter nation” real?
- Is there enough liquidity in the market?
- Will cap rates go up again?
- What should I be paying more attention to?
Several hundred senior-level apartment executives gathered in Scottsdale, AZ, last week for NMHC’s Apartment Strategies/Finance Conference and Spring Board of Directors Meeting. Hot topics of conversation ranged from the availability of capital for apartment acquisition and development to the growing number of legislative and regulatory proposals in circulation with serious business implications for the industry.
Further stimulating the discussion were presentations by best-selling author Richard Florida and Politico Editor-in-Chief John Harris. Florida, who recently published a new book titled The Great Reset, spoke about housing’s role in recalibrating society and the economy for post-crash prosperity. And as the U.S. continues to shift toward a knowledge-based economy, rental housing will become increasingly important in nurturing the growth of that new economy.
Focusing on the more immediate, Harris talked about the current political climate and how that will impact the outcome of the presidential election in the fall. (It’s going to be close.) But more than that, he stressed that the stakes grow higher the longer that Congress remains at an impasse, leading up to and beyond election season. “We cannot live with gridlock without doing serious harm to the country,” he said.
While no one has a crystal ball, conference and meeting participants and presenters offered up significant insight into what they see in the year ahead for the apartment industry. (Full slide presentations are available at www.nmhc.org.) Read on to get your most burning questions answered.
Yes, but growth will temper. Continued low levels of new supply have led to a great bounce back in rents as demand outpaces new construction. According to one panel of apartment executives, the new supply shortfall may be larger than once thought—as many as 700,000 to one million units—because many deliveries in recent years have been in the affordable, rather than market-rate, section of the market. Moreover, much of the current apartment stock dates back to the 1970s and is becoming obsolete, creating additional demand for new supply.
Between the positive demand fundamentals and good access to capital at attractive rates, new apartment development has taken off. According to data from Axiometrics, there are currently 540 projects under construction in the 196 markets the company tracks; however, more than 2,500 projects are in some stage of planning. (Click here to access the presentation slides.)
Select areas have seen such large upticks in units planned and units under construction that they could turn into hot spots for potential overbuilding. In particular, certain submarkets of Phoenix, Seattle and Washington, D.C., appear somewhat at risk.
“You need to look at submarkets to gauge overbuilding,” said Ron Brock, Jr., vice president and director of sales for Pierce-Eislen. “The first wave of deliveries will be absorbed, but the aggressive number of units in planning could create problems.”
But, overall, new completions are a very low percentage of total inventory—less than one percent. Plus, for one reason or another, not every project in the pipeline will get to completion; merely 42 percent of multifamily projects in planning make it to groundbreaking.
However, the headroom on rents is shrinking—and not just in markets where the rent versus own cost spread is narrower—causing some downshifts between the various apartment classes. As Ron Johnsey, president of Axiometrics, explained, many Class A renters are experiencing sticker shock. They want to control their housing costs, so rather than pay the higher rents, “they start moving around the food chain,” he said.
Yes, it should. However, the single-family for-sale market is starting to rebound and traditional detached single-family housing remains very affordable. For example, there are a number of markets where the spread between cost to rent and cost to own is narrowing. In Atlanta, Orlando and Phoenix, for example, monthly homeownership costs have fallen below average rents.
However, as Jay Lybik, vice president of market research for Equity Residential, pointed out, apartment firms should be cautious about national single-family affordability measures. Many assume down payments of 10 to 20 percent, which is unrealistic for the majority of first-time buyers. Not only has low down payment FHA financing become a primary source of mortgage capital for home buyers, requiring buyers to put down three to five percent to secure a mortgage, but many households simply lack the savings necessary for even these lower down payment levels. Citing research from the Brookings Institute, Lybik underscored the fact that just 20 percent of all households can come up with $2,000 in cash in 30 days. (Click here to view Lybik’s slide presentation.)
“The theory of national affordability ignores the real parts of what it takes to own a home,” he said.
But don’t expect wannabe homeowners to settle for traditional apartments. Many of these households—mostly families with children—seek single-family homeownership because traditional apartment product cannot meet their lifestyle needs. Single-family rentals often fit the bill though.
The single-family rental market has gotten a lot of attention in the wake of the federal government’s recently launched pilot REO-to-rental program. Single-family rentals make up roughly one-third of the occupied rental stock. However, the sector attracts different residents than the apartment sector and the business side is managed much differently, as it is a highly fractionalized market with many mom-and-pop owners.
Moreover, the single-family rental cycle works differently than the apartment cycle. Vacancy rates, for example, have an inverse relationship with apartment vacancy rates. Currently the single-family rental market vacancy rate is 8.9 percent compared to 5.1 percent for the multifamily market. At the end of the day, a single-family rental home isn’t a direct substitution for an apartment rental.
Maybe. Given the demographic trends currently in play, 600,000 to 800,000 additional prime renters per year are being added to the overall renter pool. The bulk of them are from Gen Y, which means they are young, mobile and increasingly burdened with student debt; the average young adult is carrying between $25,000 and $30,000 in student loans. This combination of factors is pushing them to delay major life and purchase decisions like getting married or buying a home.
Another way to look at it is that the average age of the first-time buyer is 30. Right now the bulk of Gen Y hasn’t reached that age yet, meaning the potential first-time buyer pool won’t begin to meaningfully rise until 2015. This sets up strong demand fundamentals for multifamily rentals for the next five to 10 years.
However, Matthew Lawton, executive managing director for HFF, warned that Gen Y’s attitude toward homeownership may change with time, as they find jobs, get married, pay off debt, etc. Citing a Zelman & Associates’ survey of REIT residents, he said that 42 percent of residents indicated that they want to own homes in the future; 35 percent currently had down payment money. “This is something we need to be cautious about,” Lawton said.
While the Millennial generation is clearly the future of the apartment business, some important sub-segments within that group are emerging.
For example, more females than males are becoming college graduates. Thirty-four percent of females aged 25 to 34 have bachelor degrees or higher compared to 27 percent of males in that age cohort. Moreover, young females have remained more independent through the downturn, with fewer females returning to live with their parents post-college. As one executive remarked, “Boomerang kids should be called ‘boomerang boys.’”
“If we are going after a college-educated profile, we are going to start to see in our communities—if we haven’t already—more and more female renters as a percentage of resident pools,” said Lybik.
This type of demographic shift is influencing new product development. Beyond just smaller units and more flexible floor plans, the next generation of renters wants upgraded common areas—hotel lounge-style lobby areas, rooftop decks and fire pits—and expects both higher levels of web connectivity and customer service.
But as Adam Ducker, managing director for RCLCO, pointed out, it’s not all about the young 20-somethings. After all, the number of 22-year-old prime renters is set to peak in 2012.
Ducker identified six emerging market segment opportunities that spanned from the single-person empty-nester renter to the mobile home park as the new multifamily community. (Click here to find out about all six.) Serving new renter profiles will involve rethinking the industry’s traditional approach to apartment product development and management; it’s clear that the next generation of renters needs more flexible options and higher levels of service.
This last point was something that Jonathan Holtzman, chairman and CEO of Village Green Companies, hammered home during a CEO roundtable. While the apartment business has largely been a transaction-oriented business, Holtzman said that is changing dramatically; the industry should be looking at the hospitality business to figure out what the next generation of renters will expect from the industry.
“They are not a renter,” he said. “They are a customer and you should call them that.”
Yes, for now. There is a wall of private capital that wants into the multifamily space. More than 250 private equity funds currently are looking to do multifamily deals—57 of which are apartments-only funds, while the balance are diversified funds looking for a slice of the multifamily action.
“Our investors can’t get enough of multifamily,” said Steve Pogarsky, vice president of multifamily acquisitions for BPG Properties/Madison Apartment Group. “We have to contain their enthusiasm.”
Life companies also continue to up their investment in the multifamily space; they invested $11 billion in sector in 2011. While their target exposure to multifamily real estate had been 15 to 20 percent of their portfolio, the major players have upped that to roughly 25 percent.
“It’s just getting the deals done that’s the problem,” said Mark Hafner, managing director for investments at Greystar Real Estate Partners. “You have a supply-demand imbalance,” he said, pointing out that out of $166 billion in commitments in 2011, just $44 billion closed. For now, a lot of so-called “dry powder” is collecting on the sidelines, waiting for the right deals.
Beyond acquisitions and dispositions, the construction lending market is also going through a transformation that may tap the brakes on the apartment sector’s activity and growth.
“There’s plenty of equity, but it’s construction debt that will be the governor,” said HFF’s Lawton. Big banks are making few bets and building platforms with larger developers for better one-stop shopping. Many big projects also are getting “clubbed” together as handfuls of investors mitigate risk in a project by joining forces. And because big banks don’t have syndication departments anymore, companies are spending a year or more talking to various lenders to cobble together a deal.
Like Lawton, Moran and Company President Mary Ann King said she believed this condition will cause deal flow to slow. “Before we spread our wings, we’re going to get clipped,” said King.
But Tom Booher, executive vice president at PNC Real Estate, said he’s seeing regional banks ramp up on their construction lending. Some of the most aggressive terms on construction he’s seen have been for smaller deals in Midwestern markets like Cincinnati, Columbus, Indianapolis and Toledo.
While there’s adequate capital in the market today, the question is whether it’ll be there tomorrow. Ensuring that there’s a stable source of capital available for the sector is critical not only for new development and acquisitions but also for refinancings; between $50 billion and $70 billion in multifamily debt matures annually over the next five years. Much of the capital in the market cannot handle this volume, leaving the GSEs as the go-to source for financing and securitization in the market.
However, a number of legislators intent on fixing Fannie Mae and Freddie Mac’s single-family housing problems have crafted proposals that could significantly affect the GSEs’ multifamily lending businesses.
As a first step in ensuring that the $2 trillion multifamily industry continues to have access to capital to meet increasing rental housing demand in market nationwide, NMHC released a draft outline of a proposal to privatize the GSEs’ multifamily activities at the Board of Directors Meeting. The document sketches out a framework for spinning out Freddie and Fannie’s multifamily businesses as stand-alone entities. The plan outline also calls for the retention of a federal credit guarantee, a necessary provision to attract global investors, as well as government compensation for the guarantee and a strong regulator to oversee the new entities, among other provisions.
NMHC continues to develop the proposal with input from key stakeholder groups and will release more details as they are available. The end goal will be to provide lawmakers and regulators with a road map for solving part of the GSE problem. The proposal outline is available at www.nmhc.org/goto/GSEproposal.
Yes, but when is anyone’s guess. Today’s low-interest rate environment, growing investor interest in the apartment sector and improving debt market continue to apply downward pressure on cap rates. As rates have compressed, many apartment firms have shifted their investment strategies, looking for better yields through disposition, new development and rehab activities.
However, Mark Parrell, CFO for Equity Residential, said he was less concerned with figuring out when cap rates would increase—eventually they will—and is more focused on paying attention to what economic factors would drive an increase.
“If there’s a lot of growth in the economy, cap rates going up won’t matter all that much,” Parrell said. “But if they go up because of stagflation? That’s bad for our business.”
While low cap rates reflect a significant volume of activity, many of the best deals appear to already have been had. Consequently some apartment firms and investors in the space are beginning to broaden their focus in hopes of attaining higher yields. There’s still an urban focus, but deals aren’t limited to downtown markets; there’s also activity in mixed-use, quasi-urban markets in inner-ring suburbs.
“There’s a premium and more protection in urban centers,” said Moran and Company’s King. “Renters want to be there and the money wants to be there.”
While focus remains tight around uber urban centers, more investors are finding bright spots in so-called core markets that many in the industry would likely consider a secondary or even tertiary market. Jay Jacobson, director at Wood Partners, offered the example of a recent deal in Sunrise, Fla. The project boasts views of the Everglades, suggesting a relatively rural location, but the deal was labeled as urban infill core. “The definition of core is changing,” he said.
Costs. When the apartment market hit bottom in 2009, multifamily starts had fallen roughly 75 percent since 2006, and construction costs had decreased 25 percent during the same time period. As single-family and multifamily starts recover to a projected 1.2 million in 2013, the cost index is likely to bounce back to 2006 levels. These higher costs will not only eat into the additional income generated from rising rents, but they will actually necessitate rent growth higher than what’s currently projected. (For a look at the details, clickhere for the slides.)
“Construction costs are the 1,000-pound gorilla in the room,” said Wood Partners’ Jacobson.
Development cost increases trace to a variety of factors. Cheap land deals are scarce nowadays, so land costs are going up. At the same time, the current uptick in construction activity is stressing manufacturers’ capacity to deliver products. Many made drastic reductions in plant capacity during the downturn and are hesitant to ramp up too quickly, which is adding premiums to goods and services.
While costs are rising across the spectrum of product types, they are rising more quickly for certain products. As an example, one executive pointed to the Charlotte, N.C., market, saying that costs for stick-built construction were up four to six percent compared to wrap product cost increases of six to eight percent; more concerning was the 10 percent spike in costs to deliver podium product.
Consequently, more apartment firms are spending more time investigating product types that are more cost-conscious and easier to deliver—podium versus wrap, wrap versus high-rise, etc. This type of price sensitivity is also driving the types of deals that get done, as developers look to minimize potential cost increases by getting in and out of projects faster.