On the face of it, the robust demand the apartment industry has enjoyed lately appears somewhat inconsistent with our economy. But, on closer evaluation, the seeming disparity isn’t so clear after all. Mild job growth and favorable demographic trends actually support the recent performance of multifamily, and issued permits, starts, and construction trends all reflect a sizable upward trend. Nonetheless, investors may question how far the sector has moved in the expansion cycle, as well as the impact of new supply and an improving single-family industry on apartment performance.
In some markets where new supply has been introduced or rising rents have bumped up against an affordability ceiling, mild leasing incentives have crept back into the marketplace. In addition, single-family sector fundamentals now exhibit consistent improvement, offering a competitive housing alternative.
With significantly higher levels of new supply coming on line over the next two years, investors should be aware of a metro’s employment momentum; submarket vacancy rates for existing Class A product, which may or may not be low enough to compete effectively; and growing housing affordability relative to new development. The concentration of new development in expensive mid- and high-rise properties located in core urban areas implies that the education and income levels of the local population will be crucial to success.
Financing Avenues Grow
The GSEs are providing the bulk of apartment mortgage loans, and new legislation to change that seems unlikely anytime soon. As apartment development ramps up, construction financing is readily available in some markets and for developers with solid financial relationships and successful track records.
Apartments, in particular, remain a perennial favorite among investors who favor stable cash flows and desire a lower-risk profile and a more-liquid capital market relative to other product types. A high degree of risk aversion led investors to pay a premium for properties in preferred and primary markets as well as Class A apartments. Core investors may still prefer the safety and cash flow of top-tier communities in gateway markets, but revenue gains will slow in metros where Class A apartments post sub-5 percent vacancy and several years of steepening rents now outpace wage gains. Increasingly, investors seeking higher yields have gravitated to secondary and even tertiary markets.
On balance, increased liquidity will aid in financing new mortgages, restructuring loans, and driving capital into real estate, now viewed as a compelling alternative to the low-yielding bond and volatile equity markets.
The Fed Steps Up
The Fed’s recently announced open-ended program of quantitative easing, along with an extension of “Operation Twist” through the end of the year, delivered a forceful message of support to investors. If the Fed takes additional steps to increase the velocity of capital, such as paying banks no interest for parking money or easing reserve requirements, these actions could have an even more direct impact on the recovery.
Hessam Nadji is senior VP and managing director of Calabasas, Calif.–based Marcus & Millichap Real Estate Investment Services.