Jay Lybik—vice president of Research Services for IPA, a division of Marcus & Millichap—advises institutional and major private real estate investors. Recently, Lybik held the following exclusive interview with Multi-Housing News to discuss 2018 multifamily trends. In this candid exchange, Lybik details the driving forces behind the U.S. multifamily sector and the changes that will impact the market in coming months.
Many of the headlines in the multifamily sector focus on coastal and gateway cities. Are there regions or markets with additional growth potential that are under the radar?
Lybik: Nationally, the multifamily sector continues to witness strong demand and steady rent growth. Coastal markets get a lot of attention, but we are seeing other regions and markets that are performing well and starting to grab a little more of the limelight. The Midwest can be said to be under the radar as most of its metros at the end of 2017 had vacancy rates at or below the national average, accelerating rent growth and limited new supply. Columbus, Ohio’s vacancy rate was 4.3 percent in the fourth quarter, and rents expanded by 5.4 percent last year. Meanwhile, at the end of this year, vacancy rates in Detroit and Minneapolis are expected to be at or below 3 percent.
Among 2018 multifamily trends, many of the Midwest markets should see supply and demand remaining well in balance, with rent growth projections besting the national forecast. In addition, secondary markets that have avoided overbuilding also offer substantial growth potential. The Inland Empire and Orlando are notable examples of markets showing signs of robust absorption and rent growth this year.
Last year, the U.S. had more than $150 billion in multifamily trades. To what degree has cross-border investment driven this volume?
Lybik: Attention-grabbing headlines capture interest, especially when a foreign investor buys a large property, but the articles don’t always tell the whole story. Cross-border dollar volume for multifamily (investment) spiked in 2015, with over $17 billion in acquisitions, as compared to an average of $5 billion in the previous five years. However, that 2015 (tally) accounted for just 12 percent of the total volume. Last year, foreign capital purchases totaled $12.5 billion, or about 8 percent of the volume of apartment transactions. Because foreign capital represents a sizable piece of the apartment investment market, it is important to accurately quantify its depth relative to other investor classes that are active in the transaction market.
Looking ahead, the apartment development pipeline appears to drop off substantively, while the absorption of new units has remained steady. What does this mean for apartment performance over the longer term?
Lybik: Once the current wave of construction subsides, the changing demand picture for housing overall offers noteworthy upside potential for the long-term performance of multifamily assets. The growth of single-person households remains a dominant demand driver for apartments. Singles have the highest propensity to rent, and over the past 20 years, they were the only household type witnessing meaningful expansion. Their continued emergence will sustain apartment occupancy, setting the stage for potential future rent growth, especially as the sector moves toward lower construction levels.
As developers face rising construction costs and the finishes of recently completed apartment complexes are on par with those of traditional for-sale condominiums, will more condominium converters enter the space in the next 24 to 36 months?
Lybik: The limited number of condo conversions at this point in the cycle has been interesting, especially given the shortage of starter homes for sale. Historically, condos have acted as a substitute for first-time single-family homebuyers. That said, financing availability for condo conversions has declined significantly as compared to the mid-2000s, when upwards of 90 percent loan-to-value ratios were available. In addition, some states have instituted new laws concerning building defects, which significantly lengthen the liability period for developers, effectively shutting down conversions in those locations. Given these changes, it’s unlikely many converters will enter the multifamily space in the near term.
Value-add continues to be a prevalent multifamily investment strategy for seeking higher yields. Has this trend begun to play out, and if so, what methods are investors relying on for future opportunities?
Lybik: Without a doubt, value-add has been a heavily pursued and effective strategy for increased returns. However, in primary markets, the pool of value-add assets for purchase has declined dramatically as investors quickly identified and purchased the best properties for this type of execution. Many investors are now targeting secondary markets, and there has been a marked rise in the amount of capital flowing into these markets in pursuit of higher yields. In some cases, investors are doing value-add projects in these secondary markets or purchasing newer assets already well positioned in the market for future rent growth.
After homeownership peaked in 2004, we’ve seen this rate tighten dramatically and bottom out in 2016. Should we expect to see a recovery in homeownership, and if so, will it signal an end to the strong demand for multifamily?
Lybik: At this point, the homeownership rate appears to have finally stabilized after declining for 12 years. Existing and new home sales continue to generate modest year-over-year gains, so there are no flashing signals indicating an acceleration of homeownership. Furthermore, rising homeownership does not necessarily mean demand for apartments is falling. The number of young adults living with their parents declined last year by 400,000 after hitting an all-time high in 2016. As this pent-up household demand is released, these individuals will have a high propensity to rent. Thus, even if some current apartment renter households make the jump to homeownership, the newly formed households will offer more than enough demand to backfill vacant apartment units.
With supply highly concentrated at the higher end of the market, how have Class B and Class C assets performed, and how do you expect that will change over the coming year?
Lybik: Supply additions at the top end of the market have caused some separation of operating performance by class, with Class A vacancy rising the most during 2017. Class B and Class C apartments witnessed solid performance in 2017, with their vacancy rates remaining stable or slightly declining. Class C rents witnessed the strongest rent growth of the three classes at 6.1 percent last year. The lack of supply additions below the Class A segment will maintain tight vacancy throughout 2018 for both Class B and Class C properties, with rent growth for both these segments leading the market.
As we head into the ninth year of positive rent growth and absorption, what is one concern investors should keep in mind?
Lybik: The high percentage of young adults living with their parents holds both the best upside potential for future apartment demand and the biggest downside risk if these individuals don’t move out and form their own households. In 2017, the trend appears to have shifted toward the young adults moving out on their own, but watching this (dynamic) could offer good insights into the direction and magnitude of future apartment demand.