The Accidental Economist with Jack Kern: 10 Things You Can Count on in 2015 Part 2: Demand and Pricing Expectations

An analysis of sales trends shows several very interesting factors that portend how the balance of 2015 will perform.

Jack_Kern croppedAn analysis of sales trends shows several very interesting factors that portend how the balance of 2015 will perform. With the real estate investment cycle, having started up again around 2010 approaching the end point of sponsor equity terms I’m expecting to see additional properties come to the market starting in late 2015 for some deals. The likelihood is that even more properties will again return to the market throughout the balance of this decade. Many property sponsors acquired portfolios and individual assets in 2010 with the expectation of a five year hold period for some very high quality properties, while others are staying with a slightly longer five to seven year horizon. That means that we are at the very beginning of many sponsors needing to return capital to their partners and the expectation is that with the change in allocation and scope of investor appetite for higher yield alternative investments some but probably not all of the capital gained will still remain in the apartment sector.

An interesting trend is that the disruption caused by the last recession from 2007 to 2009 pushed a great deal of investor interest into 2010, which started the great demand cycle effectively compressing cap rates to their current levels. Previous to this change the demand for mostly investment class assets kept cap rates at a more normal level and for longer periods of time. Now the cycle has accelerated and cap rates remain compressed for all but a very select few assets.

The demand for units remains high and will continue to do so. Not only due to the onerous environment of low wages, high house prices and tough qualification requirements but also because demographics and population migration into employment corridors acts as a stabilizing influence. For the balance of 2015 there will be considerable increases in apartment demand and it unlikely that 2016 will look any different. We are not yet at the point where we can effectively claim we are a ‘renter nation’ (and it’s not a good policy for that either) but we are seeing the continuing emergence that renting is an acceptable and even logical housing choice for most people. And that means there will be no rush to leave apartments to buy overpriced homes.

If you’re holding onto a portfolio acquired about 2010 and underwrote it with the expectation that 2010-2017 would see strong rent growth, you’re doing well. If you’re buying now, in 2015 do not make the mistake of underwriting the same market conditions for 2015-2022. It will be a completely different world. More properties are coming to market, return expectations will be vastly more conservative and cap rates (don’t forget our interest rate forecast) will begin their inevitable decompression, slowly at first but then at a much quicker pace.

My sense of 2015 is business as usual. The game is the same, only the horizon has been adjusted, and that means caution is valid for the future.

Read Part 1 here.

This is the second in the series of observations and forecasts by Jack Kern, publisher and research editor for Multi-Housing News and Commercial Property Executive. As a long time industry participant, Jack will provide future installments which feature market forecasts and other factors you need to know to keep your investments performing.