MHN Interview: Pierce-Eislen’s Ronald Brock, Sr.

Ronald Brock, Sr., president and CEO of Pierce-Eislen, Inc., talks to MHN about the economic factors keeping demand ahead of supply in the apartment industry, such as household formations and cost of materials.

MHN: What do you see happening right now in the multifamily industry?

Brock: As a general statement, it’s increasing at a fantastic rate. The probability is that in nearly all markets there’s going to be an increase in rental rates this year. In some markets the rental rate will be better than what we’ve seen in the past in almost any period.

MHN: We’ve heard this phrase “jobless recovery.” It seems that to a certain extent, a bad economy is still good for the apartment industry. What is your take on that?

Brock: When you speak of apartments, it’s not saying that they’re all alike. When you look at the very top end of the market—discretionary, which is renters by choice—as opposed to the very bottom of the market—which is renters by necessity, and that’s workforce—there’s no comparison between the two. In between those you have high midrange: double-income, no-kids households, where you’ll have a young couple that’s professional, making good money, they don’t have any wealth. In the top end of the market you have wealth and income; they just choose to rent rather than own. Then right underneath the high midrange and just above the workforce you’ve got low midrange, which we call grey-collar, but it’s essentially teachers, firemen, policemen, technical workers, office workers—people who make a decent income but they’re not among the top end.

Those four categories have a world of difference as to how they’re affected. For example, without job recovery, the very bottom end of the market, which is the workforce, it’s going to be a while before it recovers. But low midrange to high midrange is recovering because of household formations. Household formations happen whether the jobs increase or not. As far as the upper end—the very top end of the market, the discretionary—that’s a fairly thin market, but in some markets the discretionary category is pretty strong. You find that mostly in the upper-end cities: L.A., San Francisco, Washington, D.C., the Northeast and along the coastal regions of the country.

MHN: We’ve seen that building for apartments seems to be lagging behind right now with demand going up so quickly. Do you see construction catching up with demand?

Brock: No. Here’s the problem. The reason I mention the rate of recovery in the rental market is because there’s a restriction on supply. It’s simple Keynesian economics; you’ve got supply, you’ve got demand. Demand is driven by two categories. One is job formation, which has been okay in some markets; Texas is very strong in job growth. But household formation is the key. It’s really not job formation so much as household formation.

MHN: How is single-family housing going to be affected by all this?

Brock: Single family as a category has to be dealt with separately entirely. The problem that single family has—and this ranges all over the place across the country—in some areas the inventory is going to take quite a bit of time to absorb, partly because a lot of the inventory was developed in outlying areas, around the path of progress. There’s no question that is was good at that time because the old adage “drive till you qualify” worked. Now those are sort of out there somewhere, and who knows what they’re going to do to attract people to drive there? They can lower their prices, but you’ve got some pretty serious economic questions right now that are going to enter into that, and one of them is the cost of commuting. If you look at pricing on single-family homes, you’ll see those outlying areas have some real problems. And that’s everywhere. That’s not just, say, Phoenix or Las Vegas, where everyone knows that there’s big-time trouble.

MHN: How do you expect developers to adjust their strategies, taking everything you’ve said into consideration?

Brock: There are two things that enter into this. One of them is the cost of financing, whether it’s the cost of capital or the take-out financing. Construction loans primarily are being funded today by HUD 221 (d)(4). That’s a long-term process. You don’t walk in and get a HUD loan in 60 days; it takes quite a while. There’s very little in the pipeline. There are a lot of people who want to develop, but the restriction is, where do you get the funding, both for capital and construction financing? And then of course, with 221 it converts from construction to permanent, which is nice, and it also has no personal guarantees.

On the others, the construction loans are typically funded by either local or regional banks. They’ve had a lot of trouble. There are some that will do it with a very strong developer, but typically if a developer is going to do this to resell, it’s going to be a much more difficult process to get funding for it.

There’s one other canary in this coal mine, and that’s what’s going to happen to the cost of materials. We know that you can get a better deal now on the labor, and it’s been that the materials cost went down, but that’s been coming back up. This business of rebuilding Japan—and we haven’t seen the start of it yet—is almost certainly going to take place fairly soon. It’s going to mean lumber, cement, steel. All kinds of materials are going to be absorbed into Japan. The Chinese have been driving up the cost for quite a while because of their rate of development, and they’re not going to stop doing what they’re doing just because Japan needs work. You’re going to see some serious elevation in costs of materials. That slows the process, too.

So on the one hand you’re slowing the process of development when we need it the most, and on the other hand because we don’t have development and we’ve got demand, it’s going to drive the rental market.