Hot Markets Ahead

By Keith Loria, Contributing Editor

The multifamily market in the United States had a big year in 2014, and industry experts expect things to remain positive in the year ahead. Investment opportunities abound but 2015 may be the end of the cycle.

“Apartment fundamentals continue to be positive as demand remains resilient, although the market is approaching a turning point,” Michael B. Cohen, director of advisory services for CoStar Portfolio Strategy, says. “More specifically, the U.S. is awash in a supply wave, and construction will peak in 2015 with almost 250,000 units added across the 54 largest metros.”

In turn, vacancy rates are expected to move up, while rent growth should slow after several years of strong gains. Nevertheless, the apartment market has seen high levels of absorption in the last few years, driven in large part by budget-constrained renters, and that trend should continue into 2015.

“New inventory is mostly concentrated in downtown and transit-oriented neighborhoods, and many of these submarkets will experience some near-term occupancy declines as a result,” Cohen says.

John Sebree, director of Marcus & Millichap’s national multi-housing group, says his outlook on the multifamily market is extremely positive for the foreseeable future.

“The multifamily market has been on a very good run for the last several years and the fundamentals are still very strong and will continue to keep demand at a very high level,” he says. “You have to go back to the recession—we had gone through a lot of overbuilding of single-family homes and retail but not overbuilding of multifamily because construction had pulled back a little because of competition. As we came out of the recession,” Sebree adds, “occupancy rates were already at high levels and as we generated job growth, it increased demand even further.”

Hot development markets

In terms of the hottest development markets, Houston and Dallas are expected to have the most units delivered in the country during 2015. This activity comes as a response to strong demographics and above-average economic growth.

“Tech markets such as Seattle and Denver will also witness significant construction as builders tap into those metros’ strong fundamentals,” Cohen says. “From an investment perspective, sales volume remains quite high, but could level off if investors get ‘sticker shock.’ Indeed, pricing has gotten very expensive in primary markets such as New York and Los Angeles, so capital should continue to fan out to secondary and tertiary markets as investors chase yields and value-add opportunities.”

As a result, investors will also continue to pursue Class B assets, something that was a driver in 2014.

Doug Ressler, senior research officer at Pierce-Eislen, says coastal gateway markets are looking strong and are expected to expand in 2015. His choices for hottest markets include Denver, Seattle, the Bay Area, and the Southeast.

“In Denver, rents have increased faster than incomes, and there’s an increased number of working-aged adults sharing housing,” he says. “Metro-Atlanta has enjoyed an improved job market. According to our evaluation of industry data, metro-wide vacancy in Atlanta has improved nearly 500 basis points since 2009 to hit 4.9 percent. Miami vacancy sits at 3.5 percent, and Orlando sits at 6 percent.”

Best bang for your buck

With the vast majority of new supply coming to market of the Class A variety, in Cohen’s opinion, investors may be better served targeting B assets in A locations.

“Because they are located in the most desirable neighborhoods, these properties have strong demand prospects, but do not have to compete directly with new, luxury assets,” he says. “In fact, they can attract renters who are unable or unwilling to pay top-of-the-market prices, yet desire live-work-play environments in which to live.”

Sebree says there are some great investment opportunities in secondary markets that have a little vacancy and growth in them.

“We are seeing a substantial increase in the amount of money going into secondary markets,” he says. “It’s hard to put a finger on that one market that will turn around, but some of those that have been overlooked include Jacksonville and Las Vegas—both seeing some increased occupancy rates. You’re going to see more people going into these areas.”

Ressler agrees that investors can do well with new apartment construction in urban and high-end properties. He also adds that since many downtown submarkets may already be too expensive at this point for some renter’s pocketbooks, premier suburban locations, which are close to city centers and offer many of the same lifestyle qualities but may be a train ride away, could offer the “best bang for your buck.”

Best returns on investment

A poll of our experts shows that in general, secondary and tertiary locations have not seen the same price appreciation as the major coastal markets. While they carry higher risk than their more established, liquid counterparts, the discount in pricing certainly helps to boost returns.

“For the best returns, I see renovation of aged Class B and C inventory to support growing markets combined with a lack of supply,” Ressler says. “There are no market or governmental mechanisms that encourage developers to create new workforce housing.”

According to Cohen, some of these metros have so far seen scant construction but offer solid absorption prospects, making them prime candidates for greater investor interest.

“Traditional rust belt markets such as Pittsburgh fit the bill, as their regional economies are revitalized and reshaped to stem decades of decline,” he says. “Despite the propensity to overbuild, housing-bust metros like Las Vegas and Phoenix should see better-than-average returns due to their excellent demographics, historically fast-paced growth, and the fact that supply was slower to start in these areas than in markets that recovered much quicker. In these metros with development activity, finding the right neighborhood or submarket is of the upmost importance.”

From a speculative standpoint, Sebree believes the best return generator over the next few years will be in secondary markets such as Cincinnati, Indianapolis, Northern New Jersey and possibly Sacramento.

“All of these second- and third-tier markets are starting to get good job growth,” he says.

The next big thing

Investors and developers continue to search for the next “Williamsburg,” that is, an emerging micromarket/submarket adjacent to a metro’s urban core.

When looking for these “unexpected” locations, neighborhood amenities and access to mass transit are essential ingredients.

“As a result, look for continued interest in ‘under-loved’ sections of Brooklyn and Queens,” Cohen says. “Outside of New York City, another example on the opposite coast might be Koreatown in
Los Angeles.”

Ressler notes some unexpected neighborhoods in popular areas to keep an eye on include Las Vegas, Nev., Washington D.C., and Central Valley California due to its high-speed transportation to Northern or Southern California and low housing costs.

As we look at the year ahead, optimism remains strong. Cohen says that this apartment demand continues to benefit from a “perfect storm.”

“As a preliminary matter, demographics certainly favor sustained absorption. Household formation has picked up considerably since the end of the recession, especially among the prime renting age cohort (20-34 year-olds),” he adds. “This population group is also more likely to live alone and delay marriage than ever before, fueling rental demand. The U.S. homeownership rate also continues to drop and is now about 500 basis points below the historical high reached in 2004.”

Other factors fueling a preference for apartment living include high student debt levels, weak income growth for many Americans, lack of savings, and a continued reticence about the sustainability of home values.

“New job creation and rising consumer confidence are the main reasons for optimism,” Ressler says. “Interest rates are moving up moderately because the economy is starting to strengthen, which is good news for commercial real estate. Investors are tired of the low yields offered by bonds and see a greater return in
real estate.”