Prices have increased by 18% this year and are 8% higher than pre-pandemic levels.
By Lynn Pollack | October 21, 2021 at 07:00 AM
Sales of commercial real estate assets in the US hit record-breaking highs in the third quarter, thanks largely to activity in the apartment and industrial sectors.
Real Capital Analytics’ latest US Capital Trends report shows that deal volume hit $450 billion in the first three quarters of the year, a high watermark for commercial real estate generally. Deal activity has not approached that level since 2007, prior to the Great Financial Crisis.
According to Green Street’s all-property index, prices have increased by 18% this year and are 8% higher than pre-pandemic levels. The firm has issued a strong “buy now” signal as cap rates continue to slump, noting that fundraising by real estate private equity firms this year has “smashed records” and predicting that continued competition will lead to higher property prices in 2022.
“Investors could benefit from acquiring assets in nearly all property sectors,” Green Street notes in a recent analysis. “The perfect storm of incredibly low bond yields, high volumes of capital flowing into private equity, and open debt markets where financing rates are near unprecedented levels, will spur continued price increases for commercial real estate.”
Activity was largely fueled in the third quarter by individual asset sales in the apartment and industrial classes, which comprised 60% of total activity, per RCA data. Apartment deal volume in particular was the standout, with quarterly figures higher than the average annual numbers for the asset class between 2008 and 2011.
Cap rates in popular Sun Belt metros and secondary coastal markets are ranging from the mid-3% to low-4% range, according to Green Street data. The firm notes that deal flow is picking up for Class A properties in coastal markets, with Seattle, DC and Los Angeles seeing prices approaching more normal levels. There are also “signs of thawing” in New York and San Francisco.
“In the near term, rapidly improving operating fundamentals, and accommodative capital markets will bolster apartment values,” Green Street analysts noted in the recent report.
Year-to-date activity also hit a new record for industrial, which has been buoyed by surging e-commerce growth and warehouse/logistics demand. Values for industrial properties have surged by 39% over the last year, and the spread in industrial cap rates between coastal and non-coastal markets “has never been this tight,” Green Street analysts noted in a recent report. The largest industrial sale so far this year is Costco Wholesale’s $345 million acquisition of a 1.6 million square foot facility in Ontario, Calif.
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Spreads between bond and property yields are generous enough to absorb higher long rates in the short term, Investcorp wrote.
By Paul Bergeron | November 05, 2021 at 07:12 AM
The multifamily sector entered the pandemic on solid footing, and despite challenges brought on by the pandemic, it has the potential to continue to outperform in the years ahead, according to Investcorp.
Despite treasury yield increases, apartment cap rates are projected to stay low in the next couple of years, supporting an increase in capital values.
“The economic recovery continues in earnest, but this is raising questions about quite how transitory the current high rates of inflation are,” wrote Michael O’Brien Co-Head of Real Estate North America, Head of Residential Vertical, at Investcorp.
“Core inflation will likely stay elevated, which should force the Fed to push up rates. And while rising Treasury yields are projected to squeeze the yield gap enjoyed by apartments, given the strong prospects for NOI growth in the apartment sector, apartment yields are projected to stay low.”
Spreads between bond and property yields are also currently generous enough to absorb higher long rates in the short term, O’Brien said.
The current spread between apartment cap rates and 10-year Treasury yields is 186 basis points, above the 2001 to 2021 average of 200 basis points.
“Lower vacancy rates and accelerating rental growth will support apartment income. A substantial recovery in net operating income will mean that yields see little change over the year, despite strong investor demand.
“The industry is underpinned by strong fundamentals and it has shown resilience during these disruptive times. As such, despite the uncertain long-term implications of the pandemic, it should not affect the dynamics of supply and demand. Demand for multifamily property is expected to remain strong and will continue to outpace supply.”
O’Brien noted that younger generations saddled with student debt will find home ownership unattainable. And while the recent crisis has led to even more millennials and Generation Z living at home with their parents, they will eventually move out and become a strong pool of new renters.
“Furthermore, the expansion of remote working means that people have more flexibility over where they live, which will likely favor cities where the cost of living is relatively more affordable.”
On the supply side, while the pace of new construction has picked up meaningfully compared to the lows seen a decade ago, this is projected to not be enough to make up for current housing shortfalls, O’Brien wrote. It is estimated that 2.3 million homes are needed each year over the next 10 years to balance the supply/demand imbalance.
“Until construction ramps up, housing shortages will persist, increasing demand for the rental market. The multifamily sector is projected to continue to perform well as it has over the past two decades.”
He said that rental growth for apartments is also projected to continue to outpace inflation, making it a good hedge against the pressure of rising prices.
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There likely won’t be another spike in rents, but rent growth is likely to persist for the long-term.
By Kelsi Maree Borland | October 18, 2021 at 07:25 AM
Last year, apartment rent growth was a tale of two cities, or at least two types of cities. Rents plummeted in major metros—in some cases by double digits—and jumped in small cities and suburbs—in some cases by double digits. This year, rents rebounded back in the big cities and continued to grow in emerging markets. This new period of rent growth is likely to be the new normal over the next 12 months.
“We have this supply-demand dynamic. All of the reports I am reading say the same thing: we have never seen anything like this before, and I think it will persist for a long time,” Blake Okland, vice chairman and head of multifamily investment sales at Newmark, tells GlobeSt.com. “The wind is so behind our back as it relates to supply in the submarket.”
Prior to the pandemic, there was a national supply-demand imbalance that had driven a near decade of multifamily rent growth. That dynamic didn’t change during the pandemic. Now, it is creating a foundation for a new cycle of rent growth, at least for the next 12 months. “We are not even a year into this dynamic,” says Okland. “Multifamily shows the best in a downturn. It is a very needs based asset. I think that the thesis for multifamily has continued to gain adoption both domestically and globally. It has become an increasingly desired and safe destination for capital.”
While rent appreciation is going to continue, it won’t be the dramatic double-digit growth numbers from the last year. That growth was the result of rapid and sweeping changes in migration patterns. “Without another migration spike that we saw last year, I think it is reasonable to say that we won’t see as outsized of an increase in rental housing,” says Okland.
Okland adds that the rapid rent growth this year was due to a limited leasing activity in 2020. “This year, I think the growth was enhanced by coming off of a very choppy leasing season,” he says.
Okland’s anticipation of continued rent growth is specific to institutional-grade product. “The stats are not the same for people that are in workforce housing multifamily. Those tenants don’t enjoy the same mobility geographically,” he adds.
Still, the strong demand for multifamily assets and the supply shortage across the country support continued rent growth. “There is a newfound optimism around rents,” says Okland. “This could be more sustainable than you would think; this is not just a one-year trend in reaction to question marks around pricing power following COVID.”
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Apartment resident retention rates went on a wild ride during the course of the past year or so, but the ability to hold onto renters at lease expiration now is returning to more typical levels for the country as a whole.
Looking at what happened for leases that expired in 1st quarter 2021, 53.7% of households opted to stay in place, rather than move. That figure exactly matches results seen when averaging the share of households renewing their leases in the initial quarters of 2018, 2019 and 2020.
Earlier, resident retention levels at lease expiration had moved drastically, reflecting the impacts of COVID-19 on household living preferences and the resulting shifts in apartment pricing that occurred in the market.
Retention soared when COVID-19 first emerged, as households hunkered in place. The U.S. retention rate got as high as 58.4% in April 2020.
As 2020 progressed, renter needs evolved, and many properties began to experience more resident churn. Among the renters working from home, some households opted to move to other neighborhoods or even other metros, taking advantage of the opportunity to save money. In other cases, some households jumped on the chance to upgrade to larger or better-quality apartments, once pricing slipped among a block of the more upscale properties.
At its weakest, US apartment resident retention got down to 51.1% in December 2020.
Class C Properties Outperform
Lower-priced Class C properties are chronically in short supply across much of the nation, limiting the choices of those who might want to move from one of these communities to another. In turn, Class C projects usually sustain the highest resident retention rates. That was true again in 1st quarter 2021, when Class C resident retention came in at 61.9%.
For the middle-priced Class B stock, retention usually looks much like the industry’s overall average. A 53.4% share of Class B renters with leases expiring in early 2021 opted to remain in place.
High-priced Class A developments normally experience the most renter churn, with results impacted in part because residents of existing luxury projects often are tempted to move into just-completing properties that are offering rent discounts during initial lease-up. Within the Class A stock, resident retention when leases expired during 1st quarter was limited to 47.6%
Big Differences Register Across Metros
While the average resident retention rate is back to normal, notable differences in performance exist from one metro to another.
Retention is way up in some comparatively affordable metros where apartment demand is proving solid at the same time that limited new supply is coming on stream. In the most notable examples, 1st quarter 2021 retention is up 8 to 9 percentage points from the average levels posted for the same period of 2018 through 2020 in Detroit and Riverside/San Bernardino.
The increase comes in at 5 to 6 percentage points in Sacramento, Providence and Greensboro/Winston-Salem, while retention bumps reach roughly 4 to 5 percentage points across Columbus, Salt Lake City, Memphis, Cincinnati and Virginia Beach.
At the other end of the performance spectrum, resident retention has plunged in expensive metros where sizable rent cuts are encouraging households to move around. In much of the Bay Area, resident retention in January through March 2020 was off the level that was normal in the early months of the previous three years by 11 to 12 percentage points.
Retention declines of 6 to 7 percentage points registered in Seattle, Los Angeles and New York, while it also was much tougher than usual to hold onto existing renters in Oakland, Miami, Orlando, Austin and Newark/Jersey City.
Greg Willett is the Chief Economist at RealPage
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While a now-improving economy might suggest that the worst is behind us for missed rent payments, there’s still some downside risk.
COVID-19 became a real thing for lots of people on March 11, 2020.
Over the past year, many of us at RealPage have referred to the date as Tom Hanks Day, since it’s when America’s Dad shared that he and wife Rita Wilson had contracted the virus. It’s also when the NBA shut down pro basketball play and when the World Health Organization first classified what was happening as a global pandemic.
As with so many things, then, the US apartment market entered a fundamentally different period one year ago today.
Starting on March 12 and then proceeding through most of April, many apartment renters froze in place. Searches for new accommodations dropped drastically from year-earlier levels, and new-resident lease signings plunged. At the same time, retention of existing renter households at initial lease expiration soared to record heights. Said bluntly, people stopped moving and hunkered down.
One year later, key stats for the apartment market are in much better shape than what was initially feared back in March 2020.
Demand Is Robust
After apartment leasing activity took a giant hit in Spring 2020, people began to move around once more around mid-year. Apartment demand soared in the 3rd quarter and held well above what’s seasonally normal as 2020 drew to a close. By the end of the year, absorption of market-rate units in the country’s 150 largest metros was up to roughly 296,000 units, only a hair under annual results in 2017 through 2019.
Demand remains above the seasonally typical volume in the first few months of 2021. More than 30,000 units were absorbed in January and February, a time period when cold weather normally limits the net increase in occupied apartments to just a handful of units.
With demand proving stronger than many expected, US apartment occupancy has avoided any damage. The February 2021 average occupancy rate of 95.4% for the U.S. is basically unchanged from the February 2020 figure of 95.5%.
Renters Are Paying (Mostly)
Unprecedented layoffs in March and April 2020 triggered fears that many households would no longer be able to pay their rent. That didn’t happen, at least not in the professionally managed apartment properties sector of the rental housing stock.
According to National Multifamily Housing Council research--to which RealPage contributes data--the share of households meeting their rent obligations ranges between 93% and 95% for each month since the initial U.S. outbreak, in most months off no more than 2 percentage points from year-earlier results.
While a now-improving economy might suggest that the worst is behind us for missed rent payments, there’s still some downside risk. Households suffering financial stress certainly need the rental assistance that is part of the Biden administration’s American Rescue plan. However, RealPage analysts have concerns that forgiveness of back rent owed could lead households to deprioritize meeting their rent payment obligations.
Pricing Power Is Mixed
Effective asking rents for new-resident leases generally dropped as COVID emerged, sliding a little in most locations but much more in select spots, especially expensive gateway cities.
How you feel about today’s pricing power is influenced by where you are, since there’s a huge spread in the results between the country’s top and bottom performers. Annual rent growth is great in metros like Riverside, Sacramento, Phoenix, Tampa and Atlanta. On the other hand, the hole remains deep in New York and the Bay Area, and there’s also lots of work to do in Seattle, Boston, Washington, DC and Los Angeles.
In the latest stats, month-over-month rent growth proved very solid during February. Markets that had displayed momentum previously are continuing to do quite well, and green shoots are beginning to show up in the places that had taken the biggest pricing hits earlier.
We’re Still Building
There is a lot of apartment product in the pipeline. Ongoing construction coming into 2020 totaled roughly 583,000 market-rate units, and this year’s scheduled deliveries reach just over 400,000 units, surpassing annual additions delivered throughout the past few years.
Activity has cooled off a little over the course of the past year, with both starts and new multifamily building permit approvals down by 10% to 15%. Still, that’s a minor dip compared to what happened in the 2008 to 2009 recession, with the numbers remaining high by long-term historical standards.
Developers remain eager to build in the suburbs, especially across fast-growing Sun Belt areas. While there’s less capital available for urban core construction, don’t write off that segment of the stock. Conversations about building more downtown towers are in process, as a project that gets going in the immediate future is likely to be delivering in a much-improved leasing environment.
Property Trade Volumes Are Coming Back
Information from Real Capital Analytics shows a moderate decline in the nation’s apartment sales volume during 2020, mainly reflecting that trades paused during the summer months. There was a brief period when many took a wait-and-see position, holding off until some clarity on valuations could be established. However, sales came roaring back during the final quarter of 2020, and the typical sales price--about $176,000 a door--basically didn’t move from its pre-pandemic level. Cap rates even compressed by another couple of ticks during the course of the year.
The stack of capital available for apartment investment remains huge, probably even bigger than it was pre-pandemic as some money that had been designated for other types of real estate now could go to apartment buys. Anyone on the sidelines waiting for fire-sale prices on distressed assets appears to be out of luck, with maybe the exception of a few small properties with mom-and-pop owners.
Operations Continue to Evolve
Apartment operators had to move fast to adapt to the changes that COVID brought to day-to-day practices on site and in the back office. After addressing safety issues for both employees and residents, the first moves often were to introduce or expand virtual leasing capabilities and to address rent payment options.
Lots of changes continue, as operators are assessing how their resident profiles are evolving and how the needs and preferences of their customers are shifting. Use of technology to move processes offsite is accelerating, and many operators are taking a hard look at expenses and how those costs might be trimmed.
By Greg Willett
Greg Willett is the Chief Economist at RealPage
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Laura Klauser sometimes finds herself looking at home listings online and can’t help but laugh.
“When I look at the cost of buying a place, especially on my own, it’s not doable,” said Klauser, 33, who rents an apartment in Avondale and works as a freelance makeup artist. “I’m currently in a place where I’m splitting rent with someone, so my living expenses are a lot lower.”
Klauser is among the almost 1 in 5 millennial renters who believe they will never own a home, according to a recent report from ApartmentList.com. Up from 12% a year ago, 18% of U.S. renters ages 24 to 39 said they expect they will always rent, and 74% of those renters said it’s because they cannot afford to buy a home.
Some attribute the rise to the COVID-19 pandemic and its impact on housing. With ongoing moratoriums on evictions, a surge in home sales and falling rents, the volatility of a rapidly shifting market have some millennials questioning the need for such a life-altering financial investment.
“I don’t want to be financially tied to something, just in case,” said South Shore resident Kelly Williams, 36. “I worry about things like that, sometimes probably more than I should. For now, this feels safe.”
Millennials are infamously saddled with student debt and have little savings. As the generation that came of age during the Great Recession and the housing market crash, millennials might see the notion of owning a home as riskier than it was for older cohorts.
“I have friends that are paying (the equivalent of) a mortgage in student loan debt or paying their rent in student loan debt,” Williams said. “How can they even think about buying a place and saving up enough money to put down a payment?”
Compared with almost 48% of millennials owning a home in 2020, 78.8% of baby boomers owned homes last year — the highest generational homeownership rate, according to the ApartmentList survey.
The silent generation, comprised of retirees mostly in their late 70s and 80s, dropped to 77.8%, as some sold their homes in favor of group living or moving in with family. Within Generation X, which includes adults between 40 and 55, almost 7 in 10 own homes.
By the time they reach 30 years old, 42% of millennials have bought a home, compared with 48% of Gen Xers and 51% of boomers at the same age.
The generational divide is greater for Black millennials, only 20% of whom owned homes in 2020. White millennial homeownership in the U.S. stood at 51%, while older Hispanic millennials are actually achieving homeownership at a higher rate than previous generations as they approach their 40s. Asians in their late 30s continue to lag behind older generations, but those in their early 30s are slightly ahead of their boomer counterparts.
Millennials have begun to close the gap, with half of new mortgages going to millennial buyers. But 4 in 10 of those surveyed by ApartmentList.com said the COVID-19 pandemic had a direct impact on their plans for homeownership, delaying or putting into question their search for a home.
Home prices have risen during the pandemic as shrinking housing inventory matched by high demand means homes are selling faster — and often above the asking price. Meanwhile, millennials have been hit particularly hard financially during the pandemic, with a higher rate of job loss and longer stretches of unemployment.
And the report does not express much enthusiasm for the notion that Generation Z — those 23 and younger — will reverse the trend.
“The economic inequalities that contribute to low millennial homeownership are strengthening, not weakening,” the report concludes.
Meanwhile, renting remains, for many, an easier option. Millennials and those in Generation Z have kept rent demand high, said Ben Creamer, founder and managing broker of Downtown Apartment Company.
“They are a generation that doesn’t mind renting because they like the flexibility it offers,” Creamer said. “And they are also fine with waiting to buy a home until they can afford the lifestyle they want.”
Rent prices have been falling during the pandemic, which means renters can afford larger apartments or buildings with nicer amenities, Creamer said.
Chicago is among the most affordable U.S. cities for renters, according to a January study by ApartmentGuide.com. The study looked at how many two-bedroom apartments were available in 2020 for below-average rent, and Chicago placed No. 24 behind cities including Toledo, Ohio; Plano, Texas; Lexington, Kentucky; Denver; St. Paul, Minnesota; San Diego; and Los Angeles.
Using data from ApartmentGuide.com and Rent.com’s listing inventory, the study found average rent for a two-bedroom apartment in Chicago was $3,102, and that 63% of available two-bedroom apartments were priced below that, said Brian Carberry, ApartmentGuide.com managing editor.
In Long Beach, California — the No. 1 city on the list — 93% of two-bedroom apartments were listed for below-average rent. Conversely, ApartmentGuide.com ranked Wichita, Kansas, as having the least affordable apartments in the U.S., with only 16% of apartments offered below its average rent.
Rents in Chicago dropped 4% in 2020, Carberry said. He believes there will be a rebound in rent prices, but eviction moratoriums and housing regulations prompted by the pandemic make it impossible to forecast when that might be.
In January, which is typically an indicator for how the spring market will perform, lease signings jumped by 25% compared with January 2020, Carberry said.
“Renters who were considering moving out of the city can now upgrade their living space without increasing their costs,” he said. “Concessions, which can range from two to four months of free rent, are no doubt contributing to the surge in demand for apartments in the city.”
The uncertainty and shock of COVID-19 could make millennials leery of ever committing to a home purchase, Creamer said. The flexibility of renting and incentives offered by large rental properties also keep it an attractive option.
“About 50% of our clients right now are upsizing their leases with either larger units or longer leases,” Creamer said. “When you add in other perks like free parking, reimbursement of moving expenses or gift card bonuses, renting looks pretty attractive right now.”
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Metro areas in Texas and Florida saw the largest population increases in U.S. over the past decade, as growing economies, a lower cost of living and attractive weather drew an inflex of domestic and international migrants.
Within the Lone Star State, Dallas, Houston and Austin grew by a combined total of 2.8 million from 2010 to 2019, according to a new research report by Freddie Mac. Miami and Orlando, Fla., expanded by more than 1 million people during the same period.
READ ALSO: A Close-Up on America’s Migration Trends
Perhaps counterintuitively, these types of demographic changes do not seem to have a direct impact on housing prices. According to a regression analysis by the report, a 1 percent boost in population drives home prices up by only 0.03 percent. On the other hand, a 1 percent increase in per capita income leads to a 1.5 percent rise in housing prices, while increasing the per capital housing stock leads to a significant reduction in prices.
TOP GROWING CITIES
Other metro areas that made the top 10 list for absolute population growth included Phoenix, Atlanta, Washington, D.C., Seattle, and Denver. In the three-period from 2017 to 2019, Dallas, Phoenix and Houston topped the list.
Breaking down the numbers further, the report by the government-sponsored enterprise found that net migration tended to be the largest driver of population growth in the urban centers that had grown the most. High migration was especially evident in Orlando—where it drove 78 percent of the population growth in the past decade, divided equally between domestic and international arrivals—as well as Miami, Austin and Phoenix.
Robust growth in the South and West was mirrored by far more tepid expansion in the Northeast and the Midwest. From 2017 to 2019, population in the South and West grew at seven times the rate of the Northeast and Midwest. In 2019, the population of the Northeast actually shrank by 0.11 percent year-over-year, while the Midwest grew by just 0.14 percent.
The South and West, by contrast, posted growth of 0.81 percent and 0.66 percent, respectively. Within the South, Texas, Florida and Georgia saw the largest additions of people, while Arizona, Washington and Nevada dominated growth in the West.
Migration accounted for the lion’s share of the population increase in the South. In the West, despite the inclusion of migration-heavy Phoenix, population growth tends to be driven by the fact that births outnumber deaths.
Freddie Mac also highlights a general movement of people from the cities and into the suburbs, which grew by annual rates of 0.3 percent and 0.7 percent, respectively, in 2019. It’s too early to tell whether an urban exodus that picked up during the pandemic will become a permanent trend, the report notes.
One long-term trend to watch has been a steady decline in overall domestic migration rates. The years 2018 to 2019 saw the lowest migration rate on record at 9.8 percent, while the share of movers aged 25 to 34 dropped from roughly 30 percent in 1970 to less than 20 percent in 2019.
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In a new research video from Marcus & Millichap, John Chang gives a positive outlook for both economic and commercial real estate growth this year.
Many economists aren’t just expecting a recovery this year—but one with the potential for significant economic growth. In a new research video, John Chang, SVP and director of research services from Marcus & Millichap, gives a positive outlook for the economy and the commercial real estate sector based on new reports from leading economists.
“Over the last year, we have navigated numerous, very serious challenges, but the outlook for 2021 holds great promise for the economy and for commercial real estate,” Chang says in the video. “Looking at the economy, the outlook is strengthening dramatically. In fact, most economists are now forecasting that 2021 will deliver the strongest growth since 1984.”
Chang outlines three underlies as the catalyst for growth this year. Stimulus is at the top of the list. Following the $2.2 trillion CARES Act package in March 2020, Congress passed an additional stimulus bill in December valued at $900 billion. Now, a third round of stimulus is being discussed. President Biden is pushing a $1.9 trillion round, but Chang expects the ultimate bill to be lower. “There is considerable debate over whether there is enough congressional support for that much of an infusion,” says Chang, saying that a smaller package totaling around $760 billion could be negotiated.
Still an additional round of stimulus will come with major economy-boosting benefits. “The new round of stimulus would likely include stimulus checks. They are suggesting about $1,400 on top of the $600 already in process,” says Chang. “I am just speculating here, but the new stimulus could expand or extend federal unemployment benefits.”
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Although the debate over the stimulus package has focused on stimulus checks, there is more value in expanding unemployment benefits. “Janet Yellen, the former chairman of the Federal Reserve and the expected Treasury Secretary, has already indicated that she believes the federal unemployment benefits will deliver the biggest bang for the buck,” says Chang. “Additional stimulus checks and more unemployment benefits will give the economy another boost, increasing consumption and helping people that were hit the hardest by the pandemic to cover their expenses.”
The vaccine is another reason that growth is on the horizon. “We are making substantive headway toward inoculating the US population. Although there have been setbacks and the process is not going as quickly as hoped, many believe the Biden Administration will more aggressively pursue measures to get the pandemic under control,” says Chang.
Finally, renewed economic confidence will also help give the economy a boost. According to Chang, there is $4.5 trillion in savings and money market accounts that represent the pent-up demand in the market. This funding will help to increase consumer spending once people feel safe again.
“As these three factors align, the potential impact on the commercial real estate market could be enormous. In the second half of 2021, assuming that we achieve a critical mass of vaccine distribution, we could see stores, hotels and entertainment venues reopen,” says Chang. “That would bring back jobs and spending, and in turn unlock household formation, creating demand for apartments.” The economic growth will also help to drive shopping center and travel demand, and as the economy strengthens, companies will launch new office strategies.
All asset classes are set to benefit. “If the economic growth gets even close to the 5%, 6% or 6.5% growth rates that I am seeing from many well-known economists, then the prospects of a major real estate revival in 2021 will be very positive,” says Chang. “That would set the stage for 2022 and beyond.”
By Kelsi Maree Borland
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When it comes to navigating multifamily real estate investments through a global pandemic, life in the suburbs has been pretty good. Of the two dozen development deals that The NRP Group had on the books in January of last year, 23 of them were closed successfully, resulting in a record production year for the Cleveland-based developer of affordable and market-rate housing.
“We started 5,000 units representing roughly $1.4 billion in real estate value, and 60% of that pipeline was in the affordable business, so we do feel blessed and very thankful again that we are a diversified company,” says NRP principal and president of development Ken Outcalt. “And we’re bullish on both sides of the business going forward. Our past experience of not getting aggressive in high-density urban deals has benefited the portfolio, and we don’t have any of those urban deals right now. We are 100% suburban.”
To be sure, 2020 was not without its challenges. The onset of the pandemic and related shelter-in-place orders in March and April resulted in a virtual freeze on apartment investment and development activity as debt providers vanished, equity players sat on cash, and contractors temporarily shuttered jobsites. But despite a hard stop on buying and building in the second quarter, most multifamily firms report a rebound across the second half of the year, and are buoyed by stability in underlying business fundamentals and capital markets that portend a thriving rental sector for 2021.
Like NRP, Charlotte, North Carolina-based Crescent Communities headed into the year with high expectations and the deal flow to match. “Obviously we were at the height of the real estate cycle,” says Crescent senior vice president and chief investment officer Jason LaBonte. ”Everyone was flush with cash, the fundamentals were phenomenal, and our pipeline was strong. We do roughly 10 deals a year, and we were out looking to capitalize the 10th for 2020 when the pandemic hit.”
Although six of those development deals were paused due to pandemic-related capital market pricing issues and two deals had joint-venture partners that ultimately walked, Crescent was expected to close out 2020 with all 10 deals intact.
“A lot of equity partners simply needed some insight into what the future was going to look like, and we all needed to get further into this and realize that people still needed a place to live and that Class A multifamily would be impacted less by the job losses,” LaBonte says. “The JV partners are back in the game, and we’ve replaced the ones who walked, so we’ll get all of our deals done for the year.”
Investors, developers, owners, and operators across virtually all multifamily asset classes report similar positive business fundamentals headed into 2021. At Philadelphia-based student housing company Campus Apartments, executive vice president and chief operating officer Miles Orth says occupancies and performance have remained relatively strong across a portfolio of assets serving 50-plus universities and colleges in 18 states.
“That’s not to say that there was not significant disruption,” Orth says. “Operators had to pivot quickly and address new issues and concerns while remaining laser-focused on supporting their teams. But now that we’re nine months into the pandemic, student housing occupancies and collection rates are among the highest in the real estate industry and are clearly demonstrating that this sector is strong, stable, and vibrant.”
Follow the Money
Indeed, strong multifamily asset performance during the pandemic while other real estate classes have foundered is boosting already high rates of global investment into the apartment sector, catalyzing development and possibly sparking consolidation via the acquisition and disposition of portfolios in 2021.
Montford Park has a wealth of amenities, from a resort-style saltwater pool to a bark and brew dog park.“There is so much capital out there that is ready to invest into multifamily, and a big reason for that is that until the pandemic is resolved, hotel is uninvestable, office is not for the faint of heart, and retail is dead,” Outcalt says. “So there is a lot of dry powder out there looking for apartment deals because most of the other international options for these investors are really risky.”
Equity already allocated to multifamily investments but forced to the sidelines in the second quarter of 2020 also has rushed back into the market, and lending commitments to the apartment sector made by Fannie Mae and Freddie Mac have admirably filled the momentary void from banks, life companies, and CMBS lenders who are now reentering the market. In November, the Federal Housing Finance Agency announced a combined $140 billion commitment to multifamily for 2021, with 50% of that allocation committed to affordable housing.
“Given the pause in activity, the agencies would have to have had just a rocking and rolling fourth quarter to meet the [2020 allocation of $200 billion],” explains PGIM Real Estate head of agency lending Mike McRoberts. “But the amount of capital still chasing the preferred equity and mezzanine parts of deals is still there, and sellers are seeing close to pre-pandemic pricing, which encourages a lot of cross pools that can tie assets together and go to the agencies to structure a credit facility. We did over $1 billion of that in 2020.”
As operators across a majority of markets report only slightly depressed—if not steady—rent fundamentals, buyer appetite in 2021, absent a force majeure event, will remain robust.
“There is a significant amount of pent-up demand for quality multifamily product in quality locations because of the slowdown from the pandemic. A lot of equity players have to get that capital into play or return it,” explains Kevin Keane, executive vice president and chief operating officer for the Wellington, Florida-based Bainbridge Cos. “We are certainly looking at 2021 as a portfolio buyer because we have those funds in play with investors who want to make those kinds of purchases.”
With asset valuations driven by net operating incomes that are heavily weighted toward rent rolls, it’s remarkable that multifamily pricing has remained steady in the face of epic U.S. unemployment and a national eviction moratorium. While rents have remained fairly flat, operators are yet uncertain whether they’ll face exposure to delinquencies across 2021. Anecdotally, the so-called urban exit of renters who no longer need to be close to core office employers and desire lower population density due to the pandemic seems to be bolstering rather than dragging down apartment fundamentals.
“We had some properties that went into lease-up in spring where leasing velocity was down in the 20s versus 30 to 40 units per month, but we did not have to discount rents,” says Keane. “But we are conservative with our underwriting and in some cases even beat our expectations. We think we are benefiting by migration to the suburbs because we are already here. A lot of competitors are still looking for sites, and we have a healthy pipeline of seven developments slated to close in 2021.”
Healthy development pipelines are keeping builders busy, too, and veteran general contractors say the action is hottest in the suburbs, where the pandemic has accelerated millennial household formation and renters escape the dense urban environments that could increase the risk of exposure to the pandemic. “All of these factors are shifting demand for multifamily housing to the suburbs,” says Richard Lara, president and CEO of RAAM Construction. “It’s bringing us more business, and we expect to see huge upswings in demand for affordable communities in suburban markets in the next few years.”
Outbound urban population migration could also offer insurance to student housing operators should universities and colleges struggle with lingering pandemic issues. In particular, off-campus, purpose-built student housing in smaller college towns or suburban submarkets could be repurposed to meet market-rate demand.
“We have some properties where we were able to pivot to market-rate given their location and proximity to desirable locations in addition to the university they serve,” Orth says. “Five of our properties benefited from that pivot and were able to stabilize occupancy by reaching out to market-rate renters, but that won’t work in every instance, which is why we’ve accelerated our leasing program for 2021 to encourage early decisions by students in their housing selection for the fall.”
As president of Walker & Dunlop Investment Partners, Sam Isaacson oversees a $1.2 billion commercial real estate portfolio and one of the largest multifamily lending and brokerage shops in the country. While Isaacson agrees that softness in the multifamily market has thus far been limited to urban core, Class A assets, and could perhaps trigger a larger market shift toward suburban development, he’s unsure if multifamily assets as a whole have yet to prove themselves so bulletproof against the pandemic and its socioeconomic aftershocks.
“Multifamily will not be insulated from millions of people being unemployed and having to change careers,” Isaacson says. “We are taking a risk off position and taking preferred equity instead of joint-venture last dollar exposure, and are avoiding going 100% on the stack given what is going on. If we are taking last dollar risk, it will be on ground-up construction because the risk-adjusted return is better, and we expect a shift there to more suburban product and even single-family build-for-rent given the migration patterns.”
Courtesy Campus ApartmentsCampus Apartments’ TENN is a 603-bed mixed-use property steps from the University of Tennessee campus.
The Long Haul
That’s not to say that luxury urban core is dead as an asset class. On the contrary, veteran multifamily investors and owners feel that market challenges in 2021 and beyond will help winnow an overcrowded playing field of yield chasers and me-too operators and managers, with firms that can adapt without being reactive championing over their peers.
“It’s still too early to predict if there are going to be defaults beyond San Francisco, New York City, and Chicago luxury, and whether or not there has been a true flight to the suburbs,” says LaBonte. “Yes, urban is depressed right now, but time and again those markets have proved to be resilient, and you will see capital come back to core investments. By 2023 and 2024, you will have some suppressed pipeline coming into most of the market, and as long as you are not going in with a merchant build model and build in an eight- to nine-year hold, there will be great opportunities there.”
Like Lara, Outcalt sees increased opportunity in affordable housing across NRP’s markets, particularly given the perfect storm of migration, millennial household creation, and agency allocations to projects meeting affordability thresholds. Playing into the firm’s diversified model (roughly 60% of the portfolio is affordable), NRP is also having success offering third-party construction services to developers anxious to get communities out of the ground.
“In both property management and construction there has been a real flight to quality, and we have 10 deals in our 2021 pipeline that we’ll be building for third parties,” Outcalt says, adding that NRP isn’t hesitant to take on projects in submarkets where it operates its own assets. “Those are the markets where our sub base is the strongest, and one way or another someone is going to build it, so why not us?”
Politics and the economy, too, will continue to shape multifamily real estate across 2021 and beyond. While drastic changes are not expected to agency caps and allocations, leadership at the FHFA is likely to see an overhaul with the rest of the executive branch, and housing policy in general is likely to become more stringent and shift further toward affordability.
“Obviously it’s not just getting at the virus with a viable vaccine and treatment. There is a relief rally in the stock market that can provide higher confidence in your top-line underwriting,” McRoberts says. “Then what is the direction of the recovery, and how quickly can we employ people? The speed of that recovery, the speed of changes to the tax plan, the rent control, and eviction moratorium will all have to settle out.”
Navigating portfolios through those challenges might not be such a bad thing, Isaacson says. “Over the last 10 years, anyone could do well in multi-family, and we expect that 2021 will see a separation of the good from the not so good. A bifurcation in performance is coming that will present new buying and business growth opportunities for top performers.”
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As the U.S. government has poured trillions of dollars of stimulus funding into the economy, some politicians and economists have raised the specter of inflation, warning of spiking consumer prices if the country’s money supply continues to expand at unprecedented rates.
But some economists are unconcerned about the ballooning of the money supply, arguing that rising inflation will likely affect prices not of consumer goods, but of assets, including stocks, bonds, precious metals and commercial real estate.
While it may discourage new investors in CRE, this kind of asset inflation would likely be a boost for large institutional owners of existing real estate assets. And with housing still in short supply nationwide and cheap capital still widely available, multifamily ownership may prove to be investors’ strongest play in a market that is starved for yield.
On the latest Walker & Dunlop Walker Webcast, former Wharton professor Peter Linneman said that the nature of inflation today is fundamentally different from the inflation of the 1970s and 1980s, which caused spikes in the prices of things like gas and groceries.
“Back then, banks were set up to give money to mom-and-pop America,” Linneman told Walker & Dunlop CEO Willy Walker. “Today, those stimulus funds are going to JPMorgan, to Goldman Sachs, and they’re putting that money into massive assets, $100M here, $200M there. That money isn’t going to be chasing bread and cigarettes, it’s going to be chasing assets.”
Former Wharton professor Peter Linneman on the Walker & Dunlop Walker WebcastLinneman predicted that the new money in the economy will drive up pricing on commercial real estate over the course of the next seven years. The result, as with any form of inflation, will be a benefit for those who already own assets and a detriment to those who are looking to buy new ones.
Unlike with inflation of consumer goods prices, the U.S. government’s fiscal authorities are unlikely to take any steps to curb inflation in these sorts of assets, Linneman said.
“Intellectually, they’re aware of what this kind of inflation does to the economy,” Linneman said. “But historically, they’re hesitant to direct monetary policy around asset price inflation.”
Other macroeconomic forces are likely to boost certain sectors of commercial real estate while hampering others. Linneman was especially optimistic about the future of multifamily, noting that it is one of the few sectors of CRE where owners and developers can currently borrow cheap capital. Unlike sectors like office, many banks, government authorities and other capital sources remain very willing to lend for new housing, since the country has run a housing deficit for going on two decades, Linneman said.
One other thing the multifamily market has going for it is the liquidity of its renter base. Because office buildings may only hold a handful of tenants — and an entire warehouse may be rented out by one company — office and industrial assets tend to be “lumpy,” in Linneman’s words, posing a higher risk to their owners in times of economic uncertainty. While many industrial owners are likely doing very well at the moment, a single company going out of business could mean serious pain for their landlord, Linneman said.
Walker & Dunlop CEO Willy WalkerMeanwhile, even conservative estimates on the future of multifamily growth suggest that it is a strong investment. A property’s net operating income could fall 10% in 2021, then 8% again in 2022, but assuming a 2.5% growth rate over the next eight years, a multifamily investor could still see a 9.5% internal rate of return, Linneman’s calculations showed.
“If you have a long hold horizon, I just think you're in a golden age for multifamily,” Linneman said. “The spread is so outlandishly attractive. A lot of money's going to be flowing to the sector that I just think we’re going to look back and say, ‘This is the third golden era of longer-term-hold multifamily.'”
This article was produced in collaboration between Walker & Dunlop and Studio B. Bisnow news staff was not involved in the production of this content.
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L5 Real Estate Investments, LLC is a privately held investment firm focused on stable, income producing multi-family opportunities in emerging U.S. markets.