PHILADELPHIA—The lion's share of new apartment deliveries over the past few years has been in the class A arena, a trend that isn't likely to be supplanted. However, while Kevin Finkel, EVP at Philadelphia-based Resource Real Estate, certainly understands the rationale behind this emphasis, he sees a disconnect between the product coming on line and the product seeing the strongest rent growth—and, therefore, investor returns.
GlobeSt.com, which recently reported on the class A concentration in new deliveries, caught up with Finkel to get his take on the bifurcation he sees in the multifamily market. An edited version of that conversation appears below.
GlobeSt.com: Does the emphasis on class A deliveries have an effect on investor appetite, for both class A and class B properties?
Kevin Finkel: There's no doubt that the amount of supply we're seeing coming on line today is more than we've seen in the past 15 years. However, if you look at the broader scope, we are way under the volume of apartments that were being delivered in the 1970s and 1980s. In the 1970s, 4.87 million apartments were delivered, and there were 216 million Americans at that time. There were 4.2 million apartments delivered in the '80 s, and the US population was 238 million. In the 2010s, it's expected that we'll have under two million deliveries, and there are 321 million people living in the US. There's not a lot of supply coming out right now, even though it seems like there is because over the past 15 years we haven't seen any cranes. The reality is that we're not delivering nearly the number of apartments that are needed by the population.
Why is everyone developing class A? They're doing so because building apartments is very, very expensive today. Land prices have gone up some 80% in five years. Construction costs have gone up 25%. It's so expensive to build, and then you have all of the new state and city regulations that are imposed. Everything being delivered today is class A, and disproportionately we see those deliveries being urban, downtown. We think that has a lot to do with density restrictions in affluent suburbs. These suburbs do not want apartments, and they've been able to protect their school districts from apartment dwellers by imposing these very strict density limitations.
What's happening is a bifurcation of the apartment markets, where you see the class A deliveries almost exclusively and you see rent growth start to flatten, but flatten at a very good rate. It's still very respectable in terms of where you see class A rents today. They're just leveling off because you're getting quite a bit of supply.
A year ago, average rent growth was 5.3%, which is just off the charts good. Right now we're at about 4.1%, and this lowering is really being caused by what's going on in the class A space. We've seen rent growth coming down in class As with still very good absorption, except in a few markets like New York City, which has been wildly supplied. Most other apartment markets have been doing a pretty good job of absorbing all of this class A product. But it's really not affecting the class B apartment growth rate very much at this point. The gap between class A rents and class B rents is pretty thick, and that's because the wage disparity is pretty thick.
GlobeSt.com: Although rent growth is slowing for class A, for class B it's still comparatively strong.
Finkel: Absolutely. We don't see a strengthening in class B rental rates, but if there's a slowdown, it's very minor. And rent growth continues to be very strong, north of 4%. In an environment where there's no inflation, or maybe even negative inflation, that's pretty spectacular. And in the class B sector, the strongest point for rent growth is renovated properties.
We talked about the millions of apartments built in the '70s and '80s; there's significant demand for those apartments. If those apartments haven't had significant renovations, they're still getting rent growth, but not like those that have already undergone significant renovations. By “significant” we're not just talking about a new appliance package. We're talking about new cabinetry, a new leasing center—the whole package.
GlobeSt.com: We're also talking about investors that have the capital to make significant renovations.
Finkel: That's right. Typically the heavy value-add people are the smaller, more local investors, who tend not to have the capital to do it. The larger investors that have a lot of capital tend not to have the appetite for heavy value add. If you could combine the two—have a lot of capital, and a lot of expertise—in this market you could do quite well.
But there's a difference between heavy value-add and light value-add. There are people that call themselves value-add guys, but they're really not doing much. They're putting in a new appliance package, but that's not necessarily what these properties need. They need more. If you have a property that's 30 to 40 years old, that isn't enough to get the return on investment that you need. To get the real return on investment, you have to do a much more holistic renovation on these properties. When you invest with a value-add apartment, you have to ask yourself, “What does that mean? Are they just polishing the asset, or are they actually renovating it?” That's a question that many investors have to ask: how deep are you going?
GlobeSt.com: To bridge the gap, are we seeing more partnering between investors with more capital and local operators?
Finkel: You've always seen that. But it's difficult for the big-money operators to commit to large renovation projects when they don't have as much control as they like. Generally, you will see more partnering going on in lighter value-add deals, because the control is just not there for the money partner.
GlobeSt.com: Are the major apartment REITs doing this?
Finkel: Not really. When you look at most of the major publicly traded REITs, they're not generally very interested in value add. There are some, but the vast majority are looking for stabilized, cash-flowing assets that are newer. Often the sellers of these older assets are the REITs that want to recycle their capital into newer, more stabilized properties. The value-add guys are a more fragmented bunch.
Steady gains in the US economy have resulted in net positives for the multifamily sector—will this wave continue for the foreseeable future? What's driving development and capital flows? Join us at RealShare Apartments on October 19 & 20 for impactful information from the leaders in the National multifamily space. Learn more.
PHILADELPHIA—The lion's share of new apartment deliveries over the past few years has been in the class A arena, a trend that isn't likely to be supplanted. However, while Kevin Finkel, EVP at Philadelphia-based Resource Real Estate, certainly understands the rationale behind this emphasis, he sees a disconnect between the product coming on line and the product seeing the strongest rent growth—and, therefore, investor returns.
GlobeSt.com, which recently reported on the class A concentration in new deliveries, caught up with Finkel to get his take on the bifurcation he sees in the multifamily market. An edited version of that conversation appears below.
GlobeSt.com: Does the emphasis on class A deliveries have an effect on investor appetite, for both class A and class B properties?
Kevin Finkel: There's no doubt that the amount of supply we're seeing coming on line today is more than we've seen in the past 15 years. However, if you look at the broader scope, we are way under the volume of apartments that were being delivered in the 1970s and 1980s. In the 1970s, 4.87 million apartments were delivered, and there were 216 million Americans at that time. There were 4.2 million apartments delivered in the '80 s, and the US population was 238 million. In the 2010s, it's expected that we'll have under two million deliveries, and there are 321 million people living in the US. There's not a lot of supply coming out right now, even though it seems like there is because over the past 15 years we haven't seen any cranes. The reality is that we're not delivering nearly the number of apartments that are needed by the population.
Why is everyone developing class A? They're doing so because building apartments is very, very expensive today. Land prices have gone up some 80% in five years. Construction costs have gone up 25%. It's so expensive to build, and then you have all of the new state and city regulations that are imposed. Everything being delivered today is class A, and disproportionately we see those deliveries being urban, downtown. We think that has a lot to do with density restrictions in affluent suburbs. These suburbs do not want apartments, and they've been able to protect their school districts from apartment dwellers by imposing these very strict density limitations.
What's happening is a bifurcation of the apartment markets, where you see the class A deliveries almost exclusively and you see rent growth start to flatten, but flatten at a very good rate. It's still very respectable in terms of where you see class A rents today. They're just leveling off because you're getting quite a bit of supply.
A year ago, average rent growth was 5.3%, which is just off the charts good. Right now we're at about 4.1%, and this lowering is really being caused by what's going on in the class A space. We've seen rent growth coming down in class As with still very good absorption, except in a few markets like
GlobeSt.com: Although rent growth is slowing for class A, for class B it's still comparatively strong.
Finkel: Absolutely. We don't see a strengthening in class B rental rates, but if there's a slowdown, it's very minor. And rent growth continues to be very strong, north of 4%. In an environment where there's no inflation, or maybe even negative inflation, that's pretty spectacular. And in the class B sector, the strongest point for rent growth is renovated properties.
We talked about the millions of apartments built in the '70s and '80s; there's significant demand for those apartments. If those apartments haven't had significant renovations, they're still getting rent growth, but not like those that have already undergone significant renovations. By “significant” we're not just talking about a new appliance package. We're talking about new cabinetry, a new leasing center—the whole package.
GlobeSt.com: We're also talking about investors that have the capital to make significant renovations.
Finkel: That's right. Typically the heavy value-add people are the smaller, more local investors, who tend not to have the capital to do it. The larger investors that have a lot of capital tend not to have the appetite for heavy value add. If you could combine the two—have a lot of capital, and a lot of expertise—in this market you could do quite well.
But there's a difference between heavy value-add and light value-add. There are people that call themselves value-add guys, but they're really not doing much. They're putting in a new appliance package, but that's not necessarily what these properties need. They need more. If you have a property that's 30 to 40 years old, that isn't enough to get the return on investment that you need. To get the real return on investment, you have to do a much more holistic renovation on these properties. When you invest with a value-add apartment, you have to ask yourself, “What does that mean? Are they just polishing the asset, or are they actually renovating it?” That's a question that many investors have to ask: how deep are you going?
GlobeSt.com: To bridge the gap, are we seeing more partnering between investors with more capital and local operators?
Finkel: You've always seen that. But it's difficult for the big-money operators to commit to large renovation projects when they don't have as much control as they like. Generally, you will see more partnering going on in lighter value-add deals, because the control is just not there for the money partner.
GlobeSt.com: Are the major apartment REITs doing this?
Finkel: Not really. When you look at most of the major publicly traded REITs, they're not generally very interested in value add. There are some, but the vast majority are looking for stabilized, cash-flowing assets that are newer. Often the sellers of these older assets are the REITs that want to recycle their capital into newer, more stabilized properties. The value-add guys are a more fragmented bunch.
Steady gains in the US economy have resulted in net positives for the multifamily sector—will this wave continue for the foreseeable future? What's driving development and capital flows? Join us at RealShare Apartments on October 19 & 20 for impactful information from the leaders in the National multifamily space. Learn more.
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