The Next Upcycle

Stable occupancy and rent rates, the most powerful of fundamentals, can signal a good multifamily investment. Follow the jobs, strong vertical industries and patterns of migration to find the sound deals of the next upcycle

The multifamily industry, and those who invest in it, is looking with anticipation, and some trepidation, at 2010 and beyond to see which markets will kick off the next upcycle. Everyone knows a rebound will come. For investors seeking future diamonds in the current rough patch, where and when are the big questions.

“There are a number of factors that cause us to be optimistic about the multifamily industry and opportunities over the next 10 to 20 years,” says Chris Lee, president of real estate consulting firm CEL & Associates. Lee cites pent-up demand due to significant numbers of 20-somethings still living at home because of the dearth of jobs, aging baby boomers who increasingly will be downsizing into apartments and the current undersupply of units.

But just where will the uptick begin earliest? Experts cite three prominent factors in identifying those parts of the country that hold promise: areas of strong job growth, markets with growing industries and city centers benefitting from in-migration.

Experts say it may take until 2020 for the U.S. as a whole to recapture all the jobs that have been lost. Thus, seeking those distinct markets that will see jobs come back soonest could be key.

“Clearly, the place to look for multifamily opportunities is where job losses have been the least,” says John McIlwain, senior fellow for housing with the Urban Land Institute. “Washington, D.C. is a very strong bet, although the entire region there has done very well, with actual employment gains.”

Others points to the Sunbelt to resume its job growth, because it tends to be non-union with less regulatory restraints.

Lee sees job growth coming to trade-oriented cities on the East Coast. In particular, he points to Charleston, S.C., and Savannah, Ga., as port cities that will benefit from the anticipated completion of the Panama Canal Expansion project, due in 2014, finally allowing passage for the world’s largest ships from Asia. (A corollary here: West Coast trade ports may lose jobs as the mega-ships bypass them.)

“There continues to be movement toward the South, and somewhat toward the Southwest,” confirms Bernard Markstein, vice president and senior economist, National Association of Home Builders. “Texas has been strong, making Dallas and Houston two of the better markets.”

Neil Gronowetter, chairman of commercial brokerage Multifamily Investor, in New York, observes that the only major cities with positive changes in employment in the last two years were Austin (a little under 3 percent), Fort Worth (about half a percent), and Washington, D.C. (about a quarter of 1 percent). For 2010, he predicts that the strongest job growth will come (in order) in Austin; Raleigh, N.C.; Fort Worth, Texas;  Salt Lake City and Nashville.

Vertical promise

Just as certain locales may benefit from job growth, bringing with it multifamily opportunities, certain industry niches may also have the same effect. Government is a key example, as it was the employer that grew the most in 2009, according to observers.

Marcus & Millichap notes of Washington, D.C. that job growth and stabilizing revenues will keep initial yields in the low 7 percent range for most apartment assets this year.

Almost equaling government as a job-growth engine last year was health care, which is expected to continue to expand. Such markets as Columbus, Ohio; Boston; Philadelphia; Pittsburgh and parts of Cleveland have significant health sectors.

Concentrations of colleges and universities also could see multifamily investment opportunities. According to Marcus & Millichap’s 2010 National Apartment Report, an expanding college-aged population and rising post-secondary enrollment bode well for the need for student housing over the next several years. Student housing outperformed traditional apartments in 2009, with vacancy remaining in the 7 to 7.5 percent range. This trend should continue through 2010 as development in this segment slows by more than 50 percent.

Finally, investors may wish to look closely at those metro areas with large military bases. Because of the federal government’s BRAC (Base Realignment and Closure) program, which reorganizes bases based on evolving military needs, new construction and investment opportunities may arise in these locales.

“Fort Bragg, N.C., is seeing some building,” Markstein observes. “However, it’s very localized, and the usual players—those who deal with the government on a regular basis—have already moved in.”

Mass movement

A longer-term trend that favors rental and multifamily housing is increasing urbanization. The U.S. Environmental Protection Agency has documented a movement back to the urban core in many markets, with specific areas more than doubling their share of permits pulled for their “central cities.”

Consider New York City. Contrary to what many may think, in the early 1990s the New York City metropolitan area (which includes large swaths of suburburn-like Brooklyn, the Bronx and Queens) saw only 15 percent of all residential building permits issued for its central-city cores. By the mid-2000s, that average had skyrocketed to 44 percent, and in 2007 hit 55 percent.

Other metro regions also have seen dramatic infill. Chicago’s central city area, for example, saw its share of residential permits rise from 7 percent to 40 percent over the past 20 years. Portland, Ore., went from 9 percent to 33 percent, and Sacramento, Calif.’s city center permits grew from 9 percent to 25 percent.

“Part of this trend has to do with things like energy and the constraints on the use of carbon-based fuels,” says McIlwain. “People want to live closer to their work.”

Underscoring this, Marcus & Millichap note of Houston that the anticipated completion in 2012 of the METRORail Green Line extensions will connect Texas Southern University and the University of Houston to the downtown core, creating demand for infill apartments near rail stations, as well as generating construction jobs.

By contrast, some cities saw little or no infill change, so the urbanization movement (and thus multifamily opportunities) may not have much of an impact in these locales. They include Dallas; San Jose, Calif.; Pittsburgh; Kansas City, Mo. and Buffalo, N.Y. Hartford, Conn. was alone in seeing its percentage of infill building permits fall over the past two decades.

An obvious caveat of the EPA study, of course, is that its figures stop in 2007, before the worst economic times had their fullest impact. And yet, as a measure of consumer demand, the infill trend carries value and can be expected to resume.

Combining the factors of job growth, strong industries and in-migration, the ULI’s McIlwain notes, “Watch the performance of the traditional 24/7 cities. It will vary in each market, but take a look at Seattle and San Jose, which are both high-tech sectors, and which is continuing to do well. Then there’s San Francisco, San Diego and parts of Los Angeles. Boston, with health care and the mutual fund industry, will remain strong. Many parts of Texas are doing very well because oil prices are continuing to stay high.”

Hidden gems?

What about the hidden opportunities that many investors, focused on strong fundamentals, might overlook?

Consider bruised and battered Florida (see Market Report, page 26). Despite its continued population growth and the prospects for resumed hiring, the state’s severe overbuilding will continue to hurt occupancy and rent rates. But Markstein points out that savvy investors look at more than the soundest, most stable of markets. Here, even Florida can be in play.

“If you set your cost basis low enough, you’ll always get a payoff,” he says. “The smart business people are the ones, presumably, who know how to make money in both down and up markets. Obviously, if you can purchase at a low enough price, you may need only 60 to 70 percent occupancy to make the project pay. And if you get any more than that, then wow, that’s great. That’s the business calculation.”

In addition to Florida, Markstein says those investors “who really know what they’re doing” can sniff out good deals in the severely depressed markets of Phoenix and Las Vegas. Last year, Phoenix saw the median price of an apartment property decrease 27 percent, to $42,100 per unit. Marcus & Millichap predicts that prices there likely will continue to recede well into 2010 as more distressed assets change hands at a discount.

In Las Vegas, meanwhile, maturing debt will compel many owners to put their properties on the market over the next three years. These will have to be discounted to meet buyers’ demands and risk tolerance.

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