MF Highly Sought, Not As Available

Multifamily rental occupancies in Northern New Jersey appear to be stabilizing in the mid-90% range, approximately 2 percentage points lower than the long-term average. In essence, New Jersey rental fundamentals have moved in sync with the nation--and outperformed the national average. Current statistics signal continued strength.

While employment pressures and housing purchases have led to a more volatile swing at class A properties compared to class B/C communities, both have seen occupancies return to parity. For landlords, this is a positive sign that downward rental adjustments are no longer necessary. Equilibrium of demand is returning, and the expiration of home ownership incentives should further improve multifamily occupancies.

Rents at class A communities have fallen by 10% to 15% since their peak in 2007, but still remain in line with inflation, when referencing back to rent levels in the early 2000s. A rapid two- to three-year run-up in rents starting in 2003 occurred as the labor market swelled and the new construction pipeline switched to for-sale housing. Significant condominium conversions, especially along the waterfront markets, further impacted the supply-demand imbalance. The housing boom came to a halt and the economy slowed, forcing landlords to provide two and even three months of free rent to stabilize their properties. When their hopes that the market would improve in the 12 months following the signing of a new lease did not materialize, landlords dropped their asking rents by a percentage equivalent to the free rent.

These adjusted rents have needed little further correction, and free rent is being used more sparingly. This is a tell-tale sign that the rental market is firming and concessions likely will give way to rent growth in the coming year. Economists and government forecasting agencies backstop this projection, stating that employment will be neutral in 2010 following by positive trends in 2011. As the economy recovers, multifamily housing will benefit from its shorter lease durations allowing the ability to raise rents more quickly than other property types.

In Northern New Jersey, there has yet to be a sale of an apartment building in excess of $10 million in 2010. This is off from a total of five deals in 2009, and an average of 16 deals per year from 2004 to 2007. With this asset type still considered "the only game in town," investors and advisors charged with placing money must bid aggressively to win the few properties put up for sale.

This lack of offerings and an influx of new investment dollars from private investors and institutional money managers have created a rapid price appreciation for core assets--the primary target of this type of institutional investor. Value-add investors are pursuing class B/C properties, seeking higher rates of returns and an opportunity for upgrading and repositioning.

The popularity of multifamily as an investment type stems from the stability of returns and the availability of financing at attractive rates. Multifamily has the advantage of plentiful debt being offered by the government-sponsored agencies Freddie Mac and Fannie Mae, at loan-to-values as high as 80%; commercial real estate mortgages are topping out at 60% to 65% LTV. Lower interest rates, ranging from 4.6% to 5.5% on five- to 10-year term loans, also support lower cap rates. Additionally, the ability to be interest-only for the first two years allows investors to be debt leverage neutral when cap rates are in the low five percent range. They can maintain that position once amortization begins in the third year by taking a positive outlook toward rental rate growth.

Notably, cap rates for the most desirable, recently constructed multifamily assets along the coastal cities moved downward from the 7% range to sub-5% during the first quarter of 2010. Washington, DC; Edgewater, NJ: and Boston, MA are among the East Coast markets that have seen assets price at this level. These low yields are justified by investors willing to buy into the premise of improving fundamentals. They are making purchases on annualized trailing three-month performance versus the actual trailing 12 months, which would capture market softness during the spring and summer of 2009.

In Northern New Jersey--especially at luxury communities in Hudson County, which have the highest rent levels in the state--low cap rates, translate into per-unit values that can approach $500,000. This has become a hurdle for some investors, as it nears the value of the units should they be sold as condominiums. Such price levels limit potential profits as well as the flexibility of a condo exit strategy. Additionally, Fannie and Freddie have a threshold on the maximum value they will lend against. Valuations in excess of replacement cost have not been a deciding factor, due to limited development opportunities in the state and the irreplaceable nature of most apartment communities.

For the balance of 2010, we see the demand for the type of stable, predictable returns offered by multifamily combined with the scarcity of available product to continue to drive very aggressive cap rate pricing. By most accounts, fundamentals have stabilized, and the worst for the economy is over. As the recovery begins to take hold and job growth begins, there will be a significant positive impact on the existing multifamily housing stock. Therefore, there is a unique opportunity for sellers to capitalize on the extraordinarily low cap rate environment, while buyers can benefit from future rental rate growth by purchasing at the bottom of the cycle.

Brian Whitmer is director of Cushman & Wakefield's Metropolitan Area Capital Markets Group in East Rutherford. The views expressed are the author's own.