Brighter Skies Ahead

Michael B. Cohen is a research strategist with Property & Portfolio Research Inc. (PPR), an independent real estate research and portfolio strategy firm in Boston. Cohen tracks the U.S. multifamily market, is frequently quoted in the national press and is the author of several white papers on the state of the apartment market, including “The End of the Housing Party: Will Commercial Real Estate Investors Wake Up With a Hangover?” He shares his views with MHN Contributing Editor Jeffrey Steele.How is the credit crisis impacting multifamily, regarding both the approval of new renters and getting new projects financed?An obvious casualty of the present dislocation/risk aversion in the real estate capital markets is the apartment supply pipeline. Financing for new apartment construction has become considerably more difficult to secure. Thus, following net completions of about 140,000 units in 2008 and 120,000 units in 2009 across the PPR54 (the 54 largest metros in the U.S.), expected deliveries in 2010-11should be extremely modest. On the resident side of the equation, payroll losses and high levels of home foreclosures mean that landlords are facing a pool of renters who have a more challenging credit background.How will that affect property owners?Apartment absorption is closely correlated to employment growth. Simply put, if you don’t have a job, you can’t pay the rent. During extended periods of job loss, we generally see slower household formation and would-be renters consider alternative living arrangements, such as moving in with family members or doubling/tripling up. U.S. payroll losses are already at 1.2 million through October 2008 and unemployment is sitting at 6.5 percent, with the job market poised to deteriorate even further into 2009. This will represent a major headwind for landlords in terms of maintaining occupancy.What is the impact of the shadow market? First of all, it’s important to understand that the shadow supply market includes both single-family homes as well as condos.According to the 2007 American Housing Survey, 8.9 million single-family homes were rented, as were 2.38 million condos/co-ops. This represents an increase of about 1.6 million homes/condos rented out above the total 9.7 million reported in the 2005 American Housing Survey. In addition, as of the third quarter of 2008, theU.S. for-sale homeowner vacancy rate is sitting near a multi-decade high of 2.8 percent. So, the shadow supply market is real and of sufficient magnitude to compete for the pool of available renters. In terms of the geographic distribution of shadow supply, generally “housing-bust” metros are now contending with higher levels.Does the downturn in single-family construction bode well?Certainly the dramatic decline is promising, as the for-sale housing market seeks to find a bottom in 2009 and work throughchallenging levels of inventory. The same can be said for the condo market. Butthe U.S. labor market will remainweak in 2009, whichdoes not bode well for the possibility of a considerable increase in home sales, unless the decline in prices truly begins to draw more buyers into the market. So the apartment market will still need to contend withthe shadow supply market. As already noted, we are still anticipating net apartment completions in 2009 of about 120,000 units across the PPR54. It’s also worth noting that a full 28 percent of total deliveries in 2009 across the PPR54 will be in three Texas metros: Dallas, Houston and Austin. New apartment supply will not drop off in a considerable fashion until 2010.How will these trends impact vacancies, concessions and selling vs. holding?Apartment vacancies are headed up by about 100 basis pointsin 2009, which will place added pressure on landlords. I anticipate that rents will decline by slightly over 2 percent in 2009, taking a bite out of NOIs. Longer term,I am much more positive about the apartment market, as it will benefit from favorable demographics, modest levels of new supply between 2010-11, and, ultimately, improvement in the economy and labor market.On the investment performance side of the equation, softer near-term fundamentals coupled with a more challenging capital markets environment will translate into higher cap rates as well as falling apartment values in 2009.What effects do you envision based on the election results and the bailout?I do think there will bea continued focus in the Obama administration on stabilizing the credit markets, which has profound implications for an industry like commercial real estate that depends heavily upon ready access to leverage, as well as the U.S. economy as a whole. An outstanding question for apartment investors is the future of the GSEs and their multifamily lending activities. We should have insights next year on their futuredirection. On a related note, there certainly will be greaterattention given to stabilizing the spiralingforeclosure rate, which would translate into a positive for the larger U.S. economy.