Times are great in the U.S. apartment market, but as the supply pipeline grows, a few leading firms are looking outside the U.S. for investment opportunities. A panel at the NMHC Annual Meeting in January in Palm Springs, CA, examined three key markets: Canada, Mexico and the United Kingdom.
Canada: No Real Purpose-Built Rental Communities
Canada is a country with 35.6 million citizens and a virtually non-existent purpose-built apartment industry. Instead, their rental market is comprised largely of small investors who buy 10-20 condos and rent them out. It’s staggering, both compared to the size of the portfolios U.S. firms own and manage as well as what is actually built and how it’s managed.
First, the product is very different. The condos most Canadians rent have outdated designs and no amenities - think dingy workout rooms, bare-bones lobbies, mom and pop managers and very unsophisticated marketing.
“There are opportunities for design, development and management,” said Mark Humphreys, CEO, Humphreys & Partners Architects, LP. “They’re extremely sophisticated in the condo market but are easily 10-15 years behind the U.S. market in rental housing.”
For instance, they love poured concrete. “They will build three- to four-story buildings out of poured concrete,” explained Jonathan Holtzman, CEO of Village Green Companies. “And when someone suggests they make it a rental property, they’ll say the numbers don’t work.”
“We can bring our construction expertise to them,” noted Humphreys. “We are teaching them five-story wood-frame construction.”
Holtzman added that they have sophisticated pension funds and life insurance companies, without the quarterly earning pressure of our REITS, so they are long-term investors and have lower yield thresholds. They’ve been on a buying spree, pushing down cap rates, but, “I think the buying is over, and now it’s all about development and they don’t know how to build. They are trying to figure out how to expand their portfolios and that’s where they are looking to U.S. firms.”
Holtzman offered a key piece of advice. “It’s a different country, so to understand the different aspects, we thought it was critical to team up with a local company.” His firm is actively exploring managing and eventually buying and developing, “because Toronto is a 20-minute plane ride from us and is a great international city in and of itself.”
United Kingdom: Another Market Discovering Purpose-Built Rentals
The story is comparable in England, where that country’s renters also rely on privately owned condos as the primary source of rental housing. In London alone, you have 900,000 market-rate renters with no real inventory of conventional apartment properties.
“The country is screaming out for apartments even though it’s generally tenant friendly,” said Kenny Emson, NMHC’s SVP of Finance and Administration and a U.K. transplant. “They don’t have the room to build housing and will have to go vertical, and while in the past, the government has focused primarily on single-family housing, now that’s changing.”
The mayor of London is a big proponent of purpose-built rentals, according to Humphreys, who is also active there.
Greystar entered the market two years ago. “As recently as 15 months ago, we had one employee working out of Starbucks, said Mark Hafner, Senior Managing Director for the firm. “Now we have 260 employees, 55 at the corporate level and the rest on site.” His firm owns 14,000 units and has acquired $2 billion worth of assets in the past year.
The firm started with student housing based on strong fundamentals and a belief that the country was about 15 years behind the U.S. in sophistication of product and operations. That combination, plus the fact that the country was experiencing capital distress because of the global financial meltdown, gave the firm a lot of upside potential at an attractive entry point.
“Now there is more liquidity, higher values and cap rates have compressed,” says Hafner, “so we’re more focused on the operational side.”
Hafner warns, however, that while some investors are scared by the country’s tenant protections, their labor laws are a bigger deterrent. “In the U.K., employees convey with the property,” he explained. “So the staff that’s been mismanaging the property is now your staff.”
Mexico: A Development Play, but Outsized Returns Potential
Looking closer to home, Seth Martin, President of the Pritzker Realty Group, explained why his firm sees a lot of opportunity in Mexico.
The country has had a 20-year run of stability, has completed a reform agenda focused on making it more productive and competitive, it has a youthful population (median age in Mexico is 27 versus 37 in the U.S.), and it’s a manufacturing-based economy. Mexico graduates more engineers than Germany, and it’s seeing a lot of manufacturing moving in from Asia.
“And the entire country of 118 million has six purpose-built multifamily properties,” said Martin. More importantly, he noted, the country’s housing policy literally shifted overnight to reject sprawl and to emphasize urban core development.
They want to build 60,000 units a year now in Mexico City, where Pritzker is focusing, and they are looking for help, according to Martin. Some of the challenges, however, include the inherent risks associated with development and the fact that there is no credit market for construction loans, so everything is on an unlevered basis. In addition, like Canada and the U.K., the market is full of shadow market competition and those investors have lower return objectives because they are using their units primarily as a store of value.
Hafner added that Greystar is also focused on Mexico, noting that since Mexico is the U.S.’s primary trading partner, as we grow, they grow.
Addressing the headline risk often associated with the country, Hafner noted the reform program the government has just completed. “It would be analogous to us getting tax reform, a balanced budget and testing all their teachers by 2016,” he said.
“We expect outsized returns because of the headline risk and because it’s an emerging market,” said Hafner. And he added that there is exactly one property management firm in the country.
He also noted that their financial infrastructure, like their residential product, is 20 years behind ours. They’ve just recently let their pension funds invest in real estate. “Once that financial system begins to modernize and bring pools of capital together, it will create more opportunity,” he explained.
There is also cultural change afoot as the traditional extended family is breaking up and more young professionals are looking for a nice place to live on their own. An increase in cross-border traffic, as students return to Mexico after studying in the U.S., is also driving change as those students come back home. They don’t want to live with mom and dad, and they want housing like they had in the U.S.
Although the country has an 80% homeownership rate, “it’s a law of numbers,” said Hafner. “There are 23 million people in Mexico City. There are definitely some renters there.”
John Burstein, Principal of Mexico Retail Properties, who has 13 years of experience in Mexico, offered some advice to firms seeking to enter the market. “Focus on mixed-use,” he said.
“People want to be in a single environment for work, shopping and living because of traffic and safety concerns,” he said. “The future for Mexico is residential, retail, office and even hotel together, and when combined, all those different components capture a premium.”
Other lessons learned:
- You have to avoid corruption. We lose deals because we don’t pay bribes, but you need a platform of dedicated employees aligned with you.
- Local relationships are critical. We wanted to control the company and didn’t partner with local operators who might not be aligned with us. In doing so, we embedded a lot of local relationships with local companies.
- Employee education and ownership in platform to ensure alignment
- Have patience
While much of the 2015 NMHC Annual Meeting was focused on the global capital flows coming into the sector, leading-edge firms are also focused on the real opportunities outside our borders.