Investors Snap Up Assets in Phoenix

At press time, Arizona’s new immigration law (SB 1070) continued to raise debate throughout the state, with a federal judge blocking some controversial parts of the law. Many are left wondering what the impact of the legislation will be on the state’s population, which could, in turn, greatly impact the multi-housing industry. The state capital of Arizona traditionally has been one of the top metros in the country in terms of population growth, but the law, if it goes into effect, could change these dynamics.

Brad Cooke, vice president, multifamily investments, Colliers International, is optimistic that the effect was already felt after the 2007 Legal Arizona Workers Act (which forces businesses to check the legal status of new hires using E-Verify, or else risk losing their licenses) passed. “We’ve already taken the major loss from that law when it passed,” notes Cooke. “The new law just got more publicity; most of the immigrants that are here are documented and therefore we are not seeing the major fallout” that many had expected.

That’s not to say that everyone believes the worst has already come to pass. Jack Hannum and Bret Zinn, vice presidents-multifamily investment services, Transwestern, Phoenix, for example, have heard from multifamily owners and managers that there’s been some impact from the law—more so in C Class communities than in A or B assets, as well as in smaller building of 50 units or fewer that don’t have professional third-party management.

Still others believe that the law has already caused, and could continue to cause, significant damage to the multifamily industry. “Apartment residents who might not have been here legally didn’t want to stick around for that to kick in …  so thousands of them moved out in the middle of the night,” reports Neil Sherman, senior vice president and partner, Sperry Van Ness LLC, Phoenix. “It’s taken its toll to the point where average vacancy rates might have been single digits; now it’s double digits and some pockets around the Valley are experiencing 25 percent to 40 percent vacancy rates.”

Despite this, Hannum doesn’t believe that the law will impact the amount of product returned to the banks, particularly since “the pain has already been felt, since prices declined from 2005 and 2007,” with troubled communities already returned.

Still, not all has been lost in Phoenix. While the metro area certainly has had its share of problems, it gained about 9,000 jobs during the first half of 2010, according to Ronald G. Brock, Sr., president and CEO of apartment market research service firm Pierce-Eislen Inc. (Unemployment, as of June 2010, was at 9.0 percent, according to the U.S. Bureau of Labor Statistics.) And the diversified economy, which includes technology (Intel and Orbitel have offices in the metro area, for example) and solar power, positions the metro for a strong recovery.

Market fundamentals

From January 2010 to June 2010, average asking rents decreased from $722 to $687, according to Pierce-Eislen. Colliers, meanwhile, reports a small increase in rents in the second quarter of 2010. Six positive quarters of absorption—with over 2,600 units absorbed in the second quarter, the highest level of absorption in the metro’s history, notes Zinn—have caused the previous rent drop (about 20 percent from its peak) to start to stabilize.

At the same time, concessions started to burn off, with both the percentage of the market offering concessions declining (from 69.1 percent to 52.6 percent) and the average amount offered decreasing (from 10.1 percent to 4.4 percent), according to Brock.

“Two years ago, we were seeing as much as two or three months free rent in a 12- or 13-month lease,” recalls Sherman. “Depending on what part of town you talk about, we still see one month free or a $99 move-in special” today.

Vacancy, meanwhile, is on the decline, and is, in actuality, at its lowest since the second quarter of 2009, according to Colliers. (It was at 13.43 percent in the fourth quarter of 2009, 12.15 percent in the first quarter of 2010 and reached 11.39 percent in the second quarter of this year.)

Some pockets of the metro, however, continue to experience 20 percent to 30 percent vacancies, according to Sherman. “My guess is that you’re going to see these … vacancies, at least in pockets, for at least another year or two. I see it maybe starting to turn the corner in late 2011 or 2010,” he predicts.

Meanwhile, the notion that the shadow market has impacted the metro’s fundamentals greatly, similar to the effect it’s had on neighboring Las Vegas, seems to be dissipating. The single-family homes that are being forfeited tend to be on “fringe areas” of the metro, which Brock notes, “are not rental markets under any circumstance, so that particular portion of the properties going back to lenders won’t have any real impact [on the apartment market].” He does add, however, that for-sale condos that have been reverted to rentals are creating something of a shadow market.

Despite this, Cooke reports that he has recorded, through his tracking of MLSs (multiple listing services), a 22 percent burn-off of the shadow market from January to June 2010.

Increasing interest

As far as the for-sale market, “it’s the hottest market in the country” in terms of the number of multifamily sales taking place, according to Brock. In 2009, an average of five properties of 50 units or more traded hands per month, while 2010 is currently averaging nine sales per month, according to Transwestern data.

Hannum believes this number will only continue to increase, as “agency financing is unbelievably good with regard to Freddie Mac; the Phoenix area has been improved in Freddie’s eyes. Today you can achieve 80 percent Loan to Value, with 1.25 service coverage ratio.”

Zinn adds, “In addition to Freddie and Fannie … life companies are now active in the Phoenix area. … It’s a good sign for our market.”

And as the metro waits for the condo market to return, approximately $11 million in bulk condo sales have traded hands. Traditional condo sales have slowed, though Cooke is optimistic that the pace will pick up in the winter, particularly when Canadian buyers, the area’s largest condo investors, move in.

Those looking to make a play in the market are primarily those who already own property in the metro, notes Cooke, and institutions are beginning to “make a presence for Class A assets [though the] private guys are still outbidding [them]. That’s usually what we see: private guys control the market until we’re more stable; then institutions come in.  We are right at that tipping point now.”

Meanwhile, Brock reports that the average price is currently 46 percent off from the period between 2003 and 2007. Class A properties are currently priced at $80,000 per unit, on average, with Class B assets averaging $40,000 per unit. Meanwhile, Class C product is trading in the mid-teens to low-20s, reports Hannum. This is creating increasing buyer interest. In 2008, $604 million worth of multifamily properties were sold, representing 42 transactions at approximately $85,000 per unit, Sherman reports. In 2009, $933 million in sales represented 110 transactions, with the average cost per unit of  $52,974. Year-to-date 2010, 125 transactions have taken place (which, annualized, would be between 180 and 200 transactions for the year), totaling $1.62 billion, with the average cost per unit down to $42,450.

“People buying here are buying by the pound,” Brock adds. “Instead of cash-on-cash returns, they are looking at internal rate of returns, which means they bought it so cheap that no matter what happens they’ll work out fine within three to five years.”

Cooke points out that, while investors are “buying so far below replacement cost, most of these properties had major rehabs done so they aren’t very distressed.” The construction boom in the single-family market kept multifamily in check, he explains, since it drove up construction and land costs, as well as impact fees. Consequently, he adds, during this last cycle, rather than buying new, investors with 1980s product “put $7,000 to $12,000 a door in rehab and brought rents up.” Now investors are buying this once highly leveraged property and holding it until the market recovers and they can push rents up.

Colliers International, for example, recently negotiated the sale of two Class B assets in Mesa, Ariz. Verona Park, a 304-unit property, was built in 1981 and underwent $2 million in exterior and interior renovations in 2007 to 2008. It sold for $15.2 million and currently has a 95 percent occupancy rate. Argenta, a 395-unit community whose occupancy is currently 91 percent, was originally built in 1985 and went through $3.9 million in renovations in 2007 and 2008. It sold for $18.15 million, or $45,949 per unit.

About 80 percent of all multifamily sales in the Phoenix area have been for 1980s and earlier product. “I think you’ll see a lot more of the Class B-minus and lower-quality assets come to market from lenders and special servicers—deals that were pricey back in 2005-2007—and many of those buyers won’t have the ability to recapitalize and structure a workout done with the lender. With the Class B-plus and higher asset, those groups may have the opportunity to modify their existing financing,” says Hannum.

Despite this, Sherman doesn’t believe the metro will see the bottom fall out. “I can’t foresee a situation where prices continue to drop, no one steps in to buy and prices plunge until they get to some rock-bottom number,” he says. “If we’re not at the bottom, we’re close and there’s enough buying activity taking place that supports the level.”

On the mend

So what’s in store for the metro’s recovery? The city’s affordability, including the declining cost of doing business, positions it for a strong recovery—which many believe is on the horizon. As Hannum notes, “the majority of investors that we talk to believe that by 2013, the Phoenix economy will be doing very well.”

The city’s continued population growth also bodes well for the city, with a 2 percent increase in population predicted for this year, according to Scottsdale, Ariz.-based consulting firm Elliott D. Pollack & Company. Supply and demand factors—no new construction and record-high absorption rates—contribute to the notion that the metro is on the mend.

Additionally, the return of the GSEs, pension funds and bridge loans makes multifamily a bright spot, and, since they have returned to Phoenix, “it’s no longer on the bad boy list for lending,” Cooke points out.

“This is one of the most opportunistic markets we’ve seen since the RTC days of the early ‘90s, and I see that continuing for another year or two,” Sherman notes. “If that wasn’t the case, there wouldn’t be so many people raising millions of capital earmarked for opportunistic apartment buys.”

While there is plenty of good news for the metro, there are still some uncertainties left hanging in the balance. Phoenix does not have many barriers to entry, and its plethora of undeveloped land could lead to another round of overbuilding, acknowledges Sherman. “That’s always created a bit of a cap on rent growth; it’s why, around the Valley, rents today are not much higher than they were 20 years ago (adjusted for inflation).”

Meanwhile, the fallout from the immigration law continues to be an unanswered question for now. “Until that’s resolved, that will continue to loom as a bit of a damper on both occupancies and rent growth, especially in C markets,” Sherman predicts. “If a judge lifts it tomorrow and [it] goes into play, at least … people can make decisions going forward.”

To comment, e-mail Erika Schnitzer at [email protected]