Why Savvy Owners Are Taking Their Chips Off the Table

It may be surprising, but there are more buyers in today’s market than sellers. Savvy small and midsize private owners are taking chips off the table because multifamily investments are experiencing cash flow at optimal levels. Low vacancy rates and healthy rent growth coupled with low interest rates has created an upward shift in price.

Click on image to enlarge.

Demand Typically Outpaces Supply. Until it Doesn’t.

In a recent survey of active apartment investors, 62 percent said they were selling to take a profit. These owners understand the dynamics of supply and demand. Real estate markets are fluid, as are prices. Short-term price increases in real estate markets in response to positive demand shocks are usually greater than long-run increases.

Click on image to enlarge.

Click on image to enlarge.

In the last eight years, the market has experienced healthy rent growth year over year. Prices have increased consistently for the last seven years along with our economic expansion. On average, expansion lasts five years.

At a recent closing, a client told me he “trade[d] in 10 years of hard work for an afternoon at the title company.” He pointed out that the asset analysis we conducted crystallized for him that if all the planets lined up perfectly for the next decade he might be able to capture the profit he walked away with that afternoon.

Investors are Chasing Yield Deep into Secondary Markets

Competition in core markets with high investor demand is pushing even the cautious investors out of their comfort zones to chase yield deep into “non-preferred markets.”

Click on image to enlarge.

Per-unit pricing has increased consistently for the last seven years creating the best opportunity for midmarket owners to take a profit in over a decade. Of course, some markets are hotter than others. In fact, when you drill down you might find that a submarket may have several distinct micro-markets within it. Exceeding peak pre-recession pricing on average, per unit and per square foot pricing is the highest it ever been nationally and well beyond core markets by 38-62 percent.

Click on image to enlarge.

Shifting dynamics are commonplace in transitioning markets. As market dynamics begin to shift, apartments may be approaching optimal performance levels. Property values flatten and decline in direct proportion to net operating income and increasing interest rates. Unfortunately, we cannot ignore the message that headwinds coming at apartment owners in the form of tax reform, inflationary pressures and rising interest rates send us.

A $100-per-month increase in expenses impacts your property value by $15,000 at an eight-cap. Mid-market owners are selling because they are cognizant of the potential impact of headwinds on price.

Shifting Equity from Wealth Creation to Wealth Preservation

A 1031 exchange buyer recently expressed, “a double net lease is a whole lot easier to run than an apartment building.” Several of my clients are moving outliers. While some are shifting into what they consider better submarkets, others are making lifestyle adjustments by considering different asset classes or simply looking at less management intensive sub-markets.

It is arguably as important to understand the potential ramifications of rising interest rates and your property values as alternate investments and your return on equity. Apartment owners would be wise to consider trading out the outlier assets and consolidating resources for better economies of scale.

This isn’t a bad market to find a replacement property. Usually when the market is up for sellers it’s difficult to find a property to replace cash flow. However, in today’s market leveraged returns are attractive, and up-leg properties abound. Albeit, a good team is needed to assess the competition and know precisely when an owner should cash in those chips.

Anthony Hardy is a senior associate at Marcus & Millichap with 20 years of experience helping clients create and preserve wealth through the timely acquisition and disposition of multifamily properties.

Sales data includes transactions valued at $1 million and greater unless otherwise noted.

Sources: Marcus & Millichap Research Services; BLS; OSU.edu; CoStar Group, Inc.; Federal Reserve; Freddie Mac; MBAA; Moody’s Analytics; MPF Research; NAR; Real Capital Analytics; The Conference Board; and U.S. Census Bureau