No Slowdown In Sight for 2013

In spite of a sluggish economy, weak job growth and a slightly improving for-sale home market, the prevailing positive trends that have fueled the multi-housing sector's impressive growth over the past 18 months will continue well into 2013 and beyond.

Annual apartment rent growth continues to run at impressive rates and industry leaders note that developers are now scrambling to bring new product on line. In fact, most believe that a construction wave is on the horizon to meet strong demand in major coastal markets, although this impending spike will mirror normal construction activity that took place prior to the 2007 recession.

According to second-quarter figures released by MPF Research that analyzed the top 100 metro markets in the country, effective rents for new apartment leases rose 1.2% in the second quarter and 4% from a year earlier. Greg Willett, vice president of Carrollton TX-based MPF, says that while rent growth was strong in the second quarter, it was down from the 4.8% posted at year-end 2011. The occupancy rate for multifamily rose to 95.2% at the end of the second quarter, up from 94.9% posted in Q1 and 94.4% at the end of 2011. In 2009, during the recession, the occupancy rate bottomed out at 92%.

“We've seen the momentum slow a bit as compared to the past couple of years,” Willett says. He relates that the near-record occupancy levels reflect that “we're so full now that there are a lot of markets where there's just no room for significant further absorption until we start delivering more product."

The slight downturn in rent growth could be explained by two emerging demographic trends—more renters taking advantage of low home prices and low lending rates in the for-sale sector, as well as some renters being priced out of the market after two to three years of significant increases in rental rates.

In the past 12 months, the top 10 markets for rent growth in the US, according to MPF, were San Francisco, 12%; San Jose, 10.3%; Charlotte, NC, 6.8%; Oakland, CA, 6.3%; Boston, 6.2%; Austin, TX, 6.1%; New York City, 6.0%; DenverBoulder, 5.7%; Raleigh-Durham, NC, 5.4%; and Hartford, 5.0%.

Mark Obrinsky, chief economist for the National Multi Housing Council, says, "The fundamental point for the apartment industry right now is that new demand continues to outpace new supply. Even though we're stuck in a kind of a sluggish job market, we're seeing a greater interest in renting as opposed to owning among large sectors of the population, especially young people."

He adds that you have to go back to early 2001 to see the kind of demand for apartments that the market has been experiencing in the past six quarters.

And that's not lost on investors. Marcus & Millichap reports that apartment sales volume totaled $24.9 billion in the second quarter of 2012, a nearly 39% increase as compared to a year earlier. The average price per unit rose 6.6% to $101,000, which pushed cap rates down 30 basis points to 6.2%.

Multifamily construction has increased in 2012 and will likely continue into 2013. Obrinsky says that during the 10-year period from 1997 to 2006, the industry averaged approximately 300,000 apartment units. New construction eventually fell off a cliff from 266,000 units in 2008 to 97,000 units in 2009. It's since risen to 104,000 in 2010, 167,000 in 2011 and is on pace to finish this year at about 220,000.

“We're still a long way from what the average had been for this 10-year period, and the thinking is that we'll need at least that many to meet the kind of demand we've been seeing,” Obrinsky says.

Marcus & Millichap reports that new construction completions will total about 85,000 units. That, says John Chang, vice president of research services, in his "Economic and Apartment Outlook," is about half of what is needed to accommodate anticipated demand. At the end of this year, the brokerage firm expects the national apartment vacancy rate to fall another 30 basis points to 4.4%, the lowest rate in 11 years.

Hessam Nadji, managing director of Institutional Property Advisors, an M&M company, says that most of the new construction in 2012 and next year will be located in prime markets, and most of that will be of the luxury, high-rise variety. Nadji, who is also a managing director of Marcus & Millichap and directs the firm's National Multi Housing Group, predicts that will create a shortage of market-rate rental housing in the years to come.

Major apartment owner/developers, and REITs in particular, are raising funds through the capital markets to finance property acquisitions and new developments. For instance, AvalonBay Communities recently reported that it has 20 communities under development and expects to start between $1 billion to $1.2 billion in new projects this year. It also plans dispositions and acquisitions of between $250 million and $350 million each in 2012, and anticipates raising up to $900 million of new debt and equity before the year ends.

Ric Campo, chairman and CEO of Houstonbased Camden Property Trust, says that due to low construction activity from 2009 through 2011, the uptick in new construction will only serve to fill the hole left during that three-year period. The occupancy rate for Camden's portfolio, which consists of 200 properties totaling nearly 68,000 units, averaged 95.3% at the end of the second quarter. He adds that if the nation's rate of job growth increases, the demand for rental housing will require developers to continue to bring on new product in 2013 and beyond.

With that in mind, Camden has currently committed to approximately $850 million in new development. At present, some $550 million is in lease-up or under construction, with another $300 million expected to begin before the end of this year.

Campo adds that in 2013 the company has more than $300 million in new projects it could begin as well. Camden has budgeted approximately $250 million for property acquisitions in 2012, with another $100 million under contract at the moment. So far, it has raised about $600 million in common stock.

In the second quarter of this year, construction began on Camden Lamar Heights in Austin, TX, a $47-million project that features 314 apartment homes. Construction continued at Camden City Center II in Houston, a $36-million project with 268 apartment homes, and at the $110-million Camden NOMA in Washington, DC, which will have 320 apartments.

The firm is also building two JV projects— Camden Amber Oaks II in Austin, a $25-million venture with 244 apartment homes, and Camden South Capital in Washington, DC, an $88-million project that will offer 276 apartments.

While all the fundamentals point to ramping up new development pipelines, Campo relates that there is still a lot of risk, such as the continuing problems in the Eurozone and anemic US job growth.

“Today I have lower leverage and more cash, the rents are growing faster and all of our developments are leasing up faster at higher rates and higher yields,” Campo says. “But I won't go out on a limb and get my development pipeline bigger than I feel comfortable with, given the uncertainty of the market.”

Thomas Bozzuto, CEO and chairman of the Washington, DC-based Bozzuto Group, says that it took the multifamily industry a while to return to pre-recession market levels. "In most parts of the country, rents have now reached the point where they're above or materially above where they were pre-recession," he says. The company's portfolio is at least 95% occupied and is averaging annual rent growth in the 4%-to-5% range.

Bozzuto, who currently serves as chairman of the NMHC, says that in 2010 his company started construction on only a 200-unit development for its own account. In 2011 it ramped up and began construction on 1,700 units mainly in the Washington, DC/Baltimore region and thus far in 2012 the firm has put a shovel in the ground for approximately 1,100 units. In addition, it plans to launch another 800 units either by year's end or in early 2013.

In July, Bozzuto and Washington, DC-based joint venture partner JBG Rosenfeld Retail made a big splash when they closed on a $28-million purchase of 20 acres of land in Gaithersburg, MD where JBG Rosenfeld will build 260,000 feet of retail, while the Bozzuto Group will develop 538 apartments above retail.

The Downtown Crown project envisions two mixed-use buildings with residential rising above the retail, two multi-tenant retail buildings, two freestanding restaurants, a bank and a grocery store. Leases signed to date include a 53,000-square-foot Harris Teeter and a 40,000-square-foot L.A. Fitness. The companies plan to break ground by the end of summer.

Bozzuto reveals that his firm expects to close on a project very soon on Connecticut Avenue in Washington, DC in a joint venture with Giant Food. The plan is to demolish a former Giant Food store to build a new Giant Food location and 145 residential units as well as other retail space.

“The one negative on the horizon that makes everyone a little nervous is the potential for overbuilding,” he says. “We're all worried about the economy recovering fast enough to absorb all the units being delivered, so we've continued to tie up sites. We probably have 2,000 to 2,500 units in our pipeline. They are, however, sites that one would want to own in any economy and, for the most part, they're sites that have longer development periods. So, we may have a little lag on starts and we may be starting fewer projects in 2013 than we did in 2012."

David Rifkind, principal and managing director of George Smith Partners Inc. based in Los Angeles, says there is great interest in developing ground-up multifamily at infill markets within about 25 miles on the Pacific and East coasts. He adds that competition is fierce among commercial banks in the respective regions to finance the construction of these new projects.

“We're doing quite a few,” he says, “probably 5,000 units of ground-up multifamily in Southern and Central California in loans that we've originated.” He adds that the same market trend exists on the East Coast as well, with developer interest focused on prime coastal urban markets.

“When you're going outside of core markets, it is much more challenging to get construction financing,” Rifkind says. “It's very market specific.” Some of the prime markets on the Pacific Coast include San Francisco, Los Angeles, San Diego and Ventura County, as well as Seattle and Portland. On the East Coast, the prime markets include New York, Boston, Washington, DC and even some select Florida cities.

Rifkind agrees with NMHC's Obrinksy, who says that even as new construction has increased in 2012, "higher demand for apartment residences still outstrips new supply with no letup in sight" and that despite the need for new apartments, acquisition and construction financing remain constrained at all but the best properties in the top markets.

In its latest Quarterly Survey of Apartment Market Conditions, NMHC stated that only 16% of its respondents reported capital being available across all markets. The survey found that 65% said acquisition financing was available only for properties in top-tier locales, while 52% found the same held true for construction financing. For the first time in a year, more than half of respondents (55%) believed financing was tighter in the second quarter, 43% indicated no change in lending conditions, while only 2% said that financing was loosening.

Rifkind cautions that while funds are available for new multifamily properties outside of the core markets, they don't come with the same favorable terms. "I don't want to make it sound like you can get financing only in a top coastal market," he clarifies. "But the scrutiny under which the project and the sponsor are under in non-core markets is extreme, and you need a very strong story and strong support for building there."

Nadji says that his firm has seen significant improvement in the past 12 months in availability for acquisition, redevelopment, renovation and new construction dollars. He notes that competition is keen among commercial banks, private equity lenders and life insurance companies.

MPF's Willett says his firm anticipates "more of the same" for the sector in the short term and not any drastic changes in the occupancy rate or rent growth numbers. He believes that the introduction of new product, based on what is already under construction and in the pipeline for 2013, will increase.

“We think that's all absorbable and that occupancy will stay around where it is right now,” he says. “It will also be basically the same story on rent growth. For the rest of the year the annual number will hover right around that 4% mark and in 2013 maybe just a hair under that—3.5% to 4%."

Of course, the housing market could benefit greatly by a pickup in economic and job growth. Obrinsky points out that immigration slowed during the recession and should rise once economic conditions improve, which will also positively influence apartment leasing demand.

“There are still a lot of people who are living at home or in roommate units longer than they might have in the past,” he notes. They don't feel like they can afford to rent by themselves, or they might be concerned about job security, so they feel a little better off financially with one, two or three roommates. If the job market picks up they might be more inclined to split up and have their own apartments.”

While the for-sale residential market has shown signs of hitting bottom, with stronger sales, multifamily industry analysts contend that the latest housing figures do not in any way reflect a paradigm shift by consumers from rentals to owning a home.

In fact, the homeownership rate, which reached a record level of 69.2% at the end of 2004, has been steadily declining since then and currently stands at 65.5% at the end of the second quarter 2012.

Obrinsky says that the improvement in the for-sale housing market has been gradual and has come in small doses. While its performance will be watched closely, the relatively recent improvements in home sales "have not put much of a damper on demand."

Campo believes that a recovery in forsale housing will benefit the overall economy in terms of new job creation and, contrary to some theories, will not necessarily signal the beginning of a downturn in the multifamily sector. "I don't think there's going to be a giant sucking sound of people moving out of apartments to single-family housing," he postulates.

“There might be movement out of single-family rental to single-family ownership, he continues. “That said, the multifamily business, with both the economy and the single-family market improving some, could be on a pretty good run for the next three to five years.”

Bozzuto believes that an improving forsale sector will create liquidity, which in turn could help multifamily and decrease the homeownership rate even further. "I don't think we'll see the homeownership rate ever go back to the levels of 2006 and 2007, at least not for a very, very long time," Bozzuto says. "I think we'll see the homeownership rate continue to drop to the low 60% range."

He contends that homeownership would be even lower if some owners could sell their houses for what they believed they were worth "and would be lower still if some of these kids could get out of their parents' basements."