Why Apartments Are the Final Frontier

Now is the time for multifamily investors to focus on fundamentals and down-to-earth expectations, says Karlin Conklin of Investors Management Group.
Karlin Conklin

These are the voyages of America’s multifamily investors. Their new mission: to stay down-to-earth in their quest for realistic returns.

The characters on board the famous Starship Enterprise were incredibly courageous and smart. As they explored the galaxy, they seemed to figure out a solution to every problem they encountered.

The ongoing COVID-19 health crisis has certainly been a voyage for the apartment industry. Owners and operators continue to solve complex problems in what feels like the time span of a single Star Trek episode. They’re making disciplined decisions to successfully mitigate investment risk and prioritize safety for millions of renters.

Now the industry is braced for the unknown economic impacts beyond the delta variant and extended eviction moratoriums. Investors can still seize opportunities if they learn to see the landscape ahead through a new lens of moderation. This is no longer about out-of-this-world returns. It’s about focusing on fundamentals and down-to-earth expectations.

The New Space Race

Recent research shows that a large percentage of remote workers with no homeownership or family obligations plan to move within the next year. Their top reasons? To search for more living space and more rental affordability.

Leading recovery cities such as Raleigh, Austin, and Nashville continue to boast impressive office-using job growth. Their median household incomes are already comfortably above the U.S. average and are moving along an upward trajectory. But they also offer fully remote workers more living space at a reduced cost. Residents can live a lower-density lifestyle without sacrificing world-class healthcare, education, outdoor recreation, and entertainment options that coastal superstar cities are known for. Investors are increasingly seeking out these qualities as they review markets in which to place their equity.

It is nearly impossible to land a bargain in real estate these days, but that hasn’t dampened the enthusiasm of those targeting apartments, especially in the Mountain and Sun Belt regions. My firm recently presented an investment offering for an apartment community in Greenville, S.C., and recorded our fastest equity raise and largest investor group size in company history. Investors are boldly going into tertiary markets where strong underlying fundamentals support a realistic return on their investment.

Three-Year Mission: Moderation

My firm has acquired $320 million in apartment acquisitions since the start of the pandemic, all following a “value-add” business plan.

In the past, value-add meant buying older or run-down buildings at a reduced price relative to newer construction, then renovating to improve the property and operations. But rapidly rising prices and skyrocketing construction costs make it increasingly challenging and expensive for existing apartment communities to be fully renovated.

As a result, owners and operators are exploring new definitions of value-add. Over the next three years, this could mean strengthening on-site management strategies or buying a newer apartment property that simply requires lighter upgrades. Today’s tempered renovation budgets can still satisfy tenant demands and yield profitable investment objectives.

As recently as two years ago, we were underwriting deals with average IRR’s at 14 percent to 15 percent and cash flows averaging 7 percent to 8 percent. Properties that we sold achieved IRRs as high as 40 percent.

Our world is not what it once was: The multifamily landscape is more serious, the timing is more pressing, and the demand for real estate is more intense. To participate, smart investors know to expect more moderated returns for the near future. And with so many events creating uncertainty in our world, from a pandemic to climate change to political unrest, predictable and moderate returns are exactly what many investors are seeking.

Just as the Star Trek crew stepped out of their comfort zone, America’s real estate investors are embarking on a unique voyage. With the ability to change the course of our mission in real-time to accommodate market conditions, apartments can still deliver positive cash flow and appreciation. Despite many unknowns ahead, investors like myself will continue choosing apartments as their final frontier.

Karlin Conklin is principal & co-president, Investors Management Group.