While the recession may have been severe for the apartment market, the recovery has been just as extreme, states Hessam Nadji, managing director, Research and Advisory Services, Marcus & Millichap. “There really wasn’t a group of markets that escaped the recession; conversely, there isn’t a group of markets that is being left out of the recovery,” he notes. “Today’s apartment market really offers something for everyone.”
The third quarter of 2011 marked the transition from the recovery phase of multifamily into the expansion phase, adds Gleb Nechayev, senior managing economist at CBRE Econometric Advisors. “It returned to—and actually surpassed—the previous peak in terms of revenues, and by that metric it is well ahead of other property types,” he notes.
According to the most recent analysis from CBRE Econometric Advisors, the U.S. multi-housing vacancy rate will hold steady at 5.5 percent in 2012—down 60 bps year-over-year and 190 bps from its peak in 2009—and actually decline an additional 30 bps in 2013.
And while rent growth varies dramatically from market to market, the average national rent growth is expected to surpass the rate of inflation this year, according to Ryan Severino, senior economist at Reis Inc.
Because of these factors, the multifamily sector is currently the favored asset class of most commercial real estate investors, adds Jubeen Vaghefi, national multifamily practice leader for Jones Lang LaSalle. He points out that “the downside risk in the multifamily sector is relatively limited, and more and more investors are leaning in favor of multifamily.”
Overall, the market has become much tighter, even without any real job growth, says Severino, adding, “any semblance of demand and job creation is going to get people out of their parents’ basement and out of two- and three-bedroom [units] and into their preferred studios and one-bedrooms. Even if we have unspectacular job growth, it will still be a boon for the apartment sector.”
While industry experts don’t agree on every market, they do all note that markets with high concentrations of high-tech employment will likely lead the growth in the multi-housing recovery. Nechayev’s list, for example, includes San Francisco, San Jose, Austin, Denver and Seattle among the top performers.
Severino mostly agrees with this list, adding to it the New York and Washington, D.C. metro areas. In addition to New York City, which typically sees tight vacancies and rental growth, the metro area as a whole—Westchester and Fairfield County, for example—has also been faring well, he points out. And in D.C., Severino notes that “despite the saber-rattling over the government cutting spending, the government is still really resilient … so as long as the nation’s capital doesn’t get relocated from D.C., there will be a lot of strength underpinning the metro markets there,” he adds.
Nadji’s list is comprised of those markets “with the least risk and the highest rent growth.” In addition to San Jose, San Francisco, New York and Washington, D.C., he adds Boston, Orange County, San Diego, Austin, Seattle and Minneapolis to the list of top performers. These markets, says Nadji, have low vacancies, the potential for strong job growth and, in the short term—with the exception of Austin—little to no construction on the horizon.
Meanwhile, Nechayev points to some secondary markets that he considers at the top for the year to come. These include Pittsburgh; Albuquerque, N.M.; and El Paso, Texas, though he does warn that the growth in these areas is “likely to slow down a little bit,” as these markets are fairly affordable, and more people will likely begin to pay attention to where rents are relative to the cost of buying homes.
But, cautions Severino, performance in secondary and tertiary markets tends to be idiosyncratic. “I was looking, on a year-over-year basis, which smaller markets had the largest rent improvements, and it was a random mix of markets,” he explains. “Smaller markets … do tend to exhibit that kind of random performance pattern. Next year, we can see completely different markets having the strongest year-over-year rent growth,” he predicts.
Are there any markets to avoid?
Severino points out that the multifamily arena is the one sector of commercial real estate where most, if not all, metro areas are currently improving. “Even the markets that are kind of at the bottom, that are not performing as spectacularly, as the best-performing markets, are still showing generally positive fundamentals,” he adds.
Nechayev agrees, stating that he doesn’t think that any apartment market should necessarily be avoided. “At this point, it is not so much a question of whether we will have growth next year or not—it’s just how strong the growth will be,” he notes.
When pressed, industry experts did point to markets that still have some catching up to do. Las Vegas, for example, remains 20 percent below its pre-downturn revenues, while Phoenix is still off by about 12 percent, reports Nechayev. Atlanta, meanwhile, is down 8 percent, and Los Angeles remains off by about 6 percent. However, these markets should see stronger job growth and limited new supply in 2012, so, says Nechayev, “this will certainly help these markets to move much closer to where they were before the downturn.”
Meanwhile, Houston, Dallas, Phoenix, Tampa and Orlando continue to suffer from relatively high vacancies, but, Nadji points out, they are expected to recover so rapidly over the next 12 to 18 months that they may post stronger occupancy and revenue growth than his previously listed top 10 markets. He adds that vacancies in these markets are declining 200 to 250 bps per year.
Additionally, Nadji points to a number of “overlooked markets,” such as Detroit, Milwaukee, Indianapolis, Chicago (which, he says, is being punished because of the Midwest stigma) and Portland, Ore. These are markets that don’t typically see much investor interest, “but if you take a hard look at them, they are, in many ways, the diamonds in the rough,” he explains.
While none of the industry experts believe any apartment market should be avoided completely, they acknowledge that some markets do present better investment opportunities than others. Again, they differ in opinion about which markets these might be.
“A lot of investors are focusing their attention now on what we would call ‘primary markets,’” including New York, Los Angeles, Chicago, Washington, D.C., Houston, San Francisco and Boston, notes Nechayev. “That’s where you see a lot of apartment sales taking place right now; sales are shifting to primary markets and a little bit away from secondary and tertiary markets.”
However, because of the resulting pressure on pricing, capital may begin to look at somewhat lower-quality assets—Class B and B- product in the best markets—as well as those assets further from the core, observes Nadji. “As the risk appetite grows and the spread between the top-tier properties and the Class B/B- properties really steer investors toward the higher yield, you’re going to see capital start to move out a little bit,” he says. Still, he doesn’t expect Class C assets or tertiary markets to benefit much in 2012. “It’s a migration of capital down the quality chain—but not too far,” he asserts.
According to Vaghefi, 2011 saw a lot of activity in Boston, New York, D.C., Seattle, San Francisco, Southern California and South Florida, where pricing has increased and cap rates are “about as low as we’ve seen them,” in the 4 percent range, and in some cases, even in the 3 percent range.
Consequently, a lot of investors are starting to look at secondary markets, Vaghefi reports. Even markets that investors had once shied away from—Charlotte, Raleigh, Atlanta, Dallas and Houston, due to an overabundance of new supply—are seeing strong job recovery and are being driven by the healthcare, biomedical, technology and energy sectors. He adds that Phoenix has also seen a strong “return on investor appetite” and Portland, Ore. is back in favor, with an overflow of jobs coming from Northern California.
CBRE’s Nechayev adds that there are potentially sound investment opportunities over the next five years in some secondary and tertiary markets.
“If someone is looking longer-term, then perhaps primary markets can still be good bets,” he notes, “but given where pricing is today, secondary and tertiary markets will likely create more of these opportunities, as their expected performance is not that much different, on average, from the primary markets when you look at components of returns,” for example.
Additionally, Vaghefi predicts that investors will begin to shift their interest from urban to suburban assets, as they may be able to get a little more yield.
As for the more overbuilt markets—Severino calls to mind Las Vegas and Jacksonville, Fla. as examples—even if the supply-demand dynamics improve, “people need to be more discriminating,” he says. “If you’re a real risk-seeker, there can be interesting opportunities. You need to be really prepared to take a big risk in markets like that because they do have elevated vacancies and a supply overhang, and rent growth is not nearly as dynamic in those markets as it is in some of the supply-constrained markets.”
And because of the pressure on pricing, development is expected to ramp up. “In a lot of those metros that are fairly supply-constrained it’s a little bit of a challenge to build, and it’s not cheap to build, but a lot of people are doing the math” and discovering it’s more expensive now to buy, Severino adds.
While Nadji agrees that it’s a great time for development, he cautions that there could be pockets of overbuilding as early as 2013 or 2014.