Apts. in Top-Tier Suburbs Bring Top-Tier Returns

RICHARDSON, TX—The conventional wisdom on risk-adjusted returns for multifamily assets has been mistaken, says MPF Research. The truism that apartment properties in CBDs will produce the highest returns is at odds with an MPF/YieldStar Research study showing that affluent suburbs within high-growth metropolitan areas produce the greatest rewards for any investment period.

The study examined apartment investment returns on privately owned, institutional grade real estate across the top 50 markets using data from the National Council of Real Estate Investment Fiduciaries. Real estate was grouped into suburban or downtown locations in metros with high or low levels of job growth.

Suburban real estate was then divided into two groups: those with monthly rents above the metro average and those with rents below the average. Those with higher rents posted the highest risk-adjusted returns over a three-year, five-year, 10-year or 15-year period, with top-tier suburbs beating out top-tier CBD assets by 30 basis points in the case of a five-year hold, according to MPF's report.

The key, according to MPF, is to measure the relative risk along with the returns, which the MPF report did, using the Sharpe ratio. Bottom line: “assets located in the high-rent, superior job growth suburbs produced comparable returns to assets in 'good CBDs,' but with less risk,” the report states.

If these results seem surprising, the report states, “it's because previous urban/suburban studies failed by lumping all suburbs together. The problem is that not all suburbs are equal. In fact, one group—low-rent suburbs in slow-growth markets—has proven consistently inferior to all others.”

Regardless of rent level, “the clearest factor in shaping NCREIF returns was a rather simple one: the economic health of the parent metro,” according to the MPF report. “Slow-growth markets produced meaningfully weaker returns than high-growth markets,” despite a considerably higher rate of new apartment construction in the high-growth metros.

The CBD misconception is, in part, fueled by other misconceptions, according to the MPF reports. For example, “recent supply trends disprove the theory that CBDs offer a high barrier to entry. In fact, 'good suburbs' have proven to be the most challenging for developers.”

The majority of the most desirable suburbs have restrictive zoning and public resistance to multifamily housing, “whereas most cities have incentivized downtown redevelopment in recent years,” the report states. The report also suggests that many investors could be overestimating the impact of single-family housing in the “good suburbs” and conversely underestimating the impact of lower retention rates in the urban core.

The study results don't support either a “suburban sprawl development strategy” or a strategy geared toward buying in bulk across the suburbs. Instead, according to the report, “the data clearly points to high-barrier suburbs—areas where development is limited to infill opportunities, areas with proximity to high-paying jobs, plentiful amenities (retail, dining, etc.) and scarce single-family alternatives.”

MPF notes that the study may not persuade urban proponents to change their tune. They'll note that transaction-based appreciation likely exceeds appraisal-based appreciation in many CBDs. “That is a fair point, but nonetheless, it's evident that fundamentals (income, rents, supply) are not the driver of appreciation; investors' perception of risk is,” the report states. “That has driven development and acquisition strategies in this cycle.”

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.

RICHARDSON, TX—The conventional wisdom on risk-adjusted returns for multifamily assets has been mistaken, says MPF Research. The truism that apartment properties in CBDs will produce the highest returns is at odds with an MPF/YieldStar Research study showing that affluent suburbs within high-growth metropolitan areas produce the greatest rewards for any investment period.

The study examined apartment investment returns on privately owned, institutional grade real estate across the top 50 markets using data from the National Council of Real Estate Investment Fiduciaries. Real estate was grouped into suburban or downtown locations in metros with high or low levels of job growth.

Suburban real estate was then divided into two groups: those with monthly rents above the metro average and those with rents below the average. Those with higher rents posted the highest risk-adjusted returns over a three-year, five-year, 10-year or 15-year period, with top-tier suburbs beating out top-tier CBD assets by 30 basis points in the case of a five-year hold, according to MPF's report.

The key, according to MPF, is to measure the relative risk along with the returns, which the MPF report did, using the Sharpe ratio. Bottom line: “assets located in the high-rent, superior job growth suburbs produced comparable returns to assets in 'good CBDs,' but with less risk,” the report states.

If these results seem surprising, the report states, “it's because previous urban/suburban studies failed by lumping all suburbs together. The problem is that not all suburbs are equal. In fact, one group—low-rent suburbs in slow-growth markets—has proven consistently inferior to all others.”

Regardless of rent level, “the clearest factor in shaping NCREIF returns was a rather simple one: the economic health of the parent metro,” according to the MPF report. “Slow-growth markets produced meaningfully weaker returns than high-growth markets,” despite a considerably higher rate of new apartment construction in the high-growth metros.

The CBD misconception is, in part, fueled by other misconceptions, according to the MPF reports. For example, “recent supply trends disprove the theory that CBDs offer a high barrier to entry. In fact, 'good suburbs' have proven to be the most challenging for developers.”

The majority of the most desirable suburbs have restrictive zoning and public resistance to multifamily housing, “whereas most cities have incentivized downtown redevelopment in recent years,” the report states. The report also suggests that many investors could be overestimating the impact of single-family housing in the “good suburbs” and conversely underestimating the impact of lower retention rates in the urban core.

The study results don't support either a “suburban sprawl development strategy” or a strategy geared toward buying in bulk across the suburbs. Instead, according to the report, “the data clearly points to high-barrier suburbs—areas where development is limited to infill opportunities, areas with proximity to high-paying jobs, plentiful amenities (retail, dining, etc.) and scarce single-family alternatives.”

MPF notes that the study may not persuade urban proponents to change their tune. They'll note that transaction-based appreciation likely exceeds appraisal-based appreciation in many CBDs. “That is a fair point, but nonetheless, it's evident that fundamentals (income, rents, supply) are not the driver of appreciation; investors' perception of risk is,” the report states. “That has driven development and acquisition strategies in this cycle.”

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.