Marcus & Millichap 2014 Outlook: Refinance Now, Look to Value-Add

By Mike Ratliff, Senior Associate Editor

From Left to Right: John Sebree, William Hughes and Hessam Nadji.

Long term fundamentals for the apartment industry are looking strong according to Marcus & Millichap’s 2014 Apartment Market Outlook. Continued job growth and already record-high occupancies should keep the multifamily sector strong for several years. The presentation did, however, warm of the possibility for softness in certain core urban markets due to overbuilding.

Overall macro economic trends paint a positive picture for apartments. Retail sales are 15 percent above where they were in the depths of the recession. We have regained 7.4 million out of the 8.7 million jobs lost during the downturn. This job growth is broad based, with meaningful hiring occurring in all the critical sectors. Another positive indicator is coming from a strengthening single-family market, says Hessam Nadji, senior vice president, managing director and chief sustainability officer at Marcus & Millichap.

“The strength we are now seeing in single-family does concern some apartment investors,” Nadji says.  “And that is for good reason. We have lost renters to home buying — we continue to lose some renters to home buying — but that trend is pretty stable. Roughly 30 percent of home sales are going to first time home buyers. But the bigger message of the single-family recovery is again, very positive for the multifamily side for two reasons. First off, a 10 percent price gain on a year-over-year basis in the single-family market bodes well for the economy. Some of those construction jobs are a result of residential construction on the for-sale side coming back.”

Nadji’s second point was that increasing interest rates and prices in single-family have made it harder for would-be homeowners to make a down payment and get approved for a loan. This bodes well for multifamily as well.

One particular concern (in addition to overbuilding) is how long the trend of rent growth can continue. Rents have grown faster than rental household income. This should cause a slowdown in rent growths, but primarily for the Class A sector. Class B and C assets are still showing strong rent growth, which is typical as their fundamentals typically lag those of the higher end product.

On the finance side of the industry, we can expect to see an increase in originations from life insurance companies, banks, pension funds and agency lenders throughout 2014. One of the drivers for this phenomena is the continued improvement of property fundamentals for multifamily (as well as all asset classes), says William Hughes, senior vice president and managing director of Marcus & Millichap Capital Corp.

“Historically low cost of debt and its improving availability have become major positive factors in facilitating more business,” Hughes says.  “In essence, this allows investors to take advantage of some great opportunities. Today we are seeing a wide variety of competitive financing sources along all property sectors in most markets, with credit discipline adjusting to become slightly less restrictive, particularly with multifamily, in order to accommodate in the increase in active capital sources.”

Looking ahead, Hughes is excited for the prospects for 2014. While the fed will reduce its acquisition of bonds and MBS, Hughes believes that the central banking system will remain accommodative until the economy demonstrates significant jobs growth that results in substantial employment gains. Now that the federal budget has been approved and inflation is in check, we should see both improving employment and GDP growth. All these factors make now a great time to finance.

“We recommend that investors take a fresh look at their financing needs, both in terms of refinancing and pursuing new investment opportunities,” Hughes adds. “We continue to believe that at some point in the not too distant future, we will look back on this period and realize how unique it was.”

Investors looking for opportunities in 2014 might be served by examining deals in older properties or in secondary/tertiary urban core markets.

“Class A properties in preferred markets saw cap rates drop substantially in 2010, 2011 and 2012 as institutional investors poured funds into premiere assets,” says John Sebree, senior vice president, director of Marcus & Millichap’s National Multi Housing Group. “Class B and C product likely provides some of the best opportunity in the coming year.”

Value-add plays to drive rent growth are also becoming an increasingly popular strategy. According to Sebree, investors are targeting 1980s construction due to the ability to go in and update in order to compete a bit more with the Class A stock. Investing in next generation or hip urban markets is another possibility.

“The other value-add that is taking place is that we have had a resurgence in the urban core,” Sebree says. “Most metros have had new construction come into the urban cores at a higher rate over the past couple of years compared to what we have seen in the past. This trend is growing the urban cores and is expanding out into neighborhoods that are close to downtown areas. Areas that maybe a few years ago people would not have considered buying. Now I am seeing people say ‘I am going to buy this property — it is a little bit rough right now — but I can see the growth coming my way and I am going to get out in front of it.’”