Will Renter Demand be Even Stronger in 2012? Industry Says Yes

Encino, Calif.—Despite tepid job growth, net absorption in the apartment market continues, according to Hessam Nadji, managing director of Marcus & Millichap Real Estate Investment Services, who spoke at a webcast today, entitled, “2012 U.S. Economic and Apartment Market Outlook.”

While there are several reasons for this continued absorption despite a real economic recovery, Nadji pointed to the fact that the majority (71 percent) of those who have been hired in 2010-2011 are those in the 20- to 34-year-old range—that is, those who had moved out of their parents’ home, creating positive household formation.

Even with a moderate recovery pace, 57 percent of attendees believe that renter demand will be even stronger over the next year, and 63 percent believe demand will stay about the same, even without additional job growth. And even with a growing supply, Nadji does not believe this will derail a recovery (with the exception, perhaps, of some pockets).

The metros with the lowest vacancy rates are Minneapolis (2.6 percent), New York (2.6 percent), San Jose (3.1 percent), Portland (3.2 percent) and San Diego (3.4 percent). Meanwhile, those with the highest vacancy rates are Jacksonville (9.6 percent), Houston (9.2 percent), Atlanta (8.4 percent), Phoenix (7.9 percent) and Las Vegas (7.9 percent). However, the pace of recovery for these markets is particularly high, with these latter markets improving 200 bps or more year-over-year.

As far as the capital markets, low rates have helped cash flows, driven cash-on-cash returns and supported value creation for the apartment sector, noted William Hughes, managing director, Marcus & Millichap Capital Corp. Lenders have become more confident due to the improving property fundamentals, which, in turn, has made it “fairly easy to finance core assets,” he added, though it’s been somewhat more spotty for those in tertiary markets with smaller assets.

Hughes added that major markets have moved to a 1.25 debt service coverage, which has bolstered LTV past where it would have been otherwise. But the main factor for multifamily, he noted, is the broad assortment of capital sources, including the stalwarts of Fannie Mae and Freddie Mac, as well as life companies that are returning to the market.

While there has typically been a consistent relationship between core inflation and the 10-year Treasury, Hughes added that the former has moved to its 10-year norm, while the latter remains a few hundred basis points off.

“It’s not in unison right now because of the fear factor,” he said. The consumer is tired of good news/ bad news.” However, he added, “if you’re not in the game today, I don’t know what entices you to be in the game. It’s a great time to take down long-term fixed-rate financing.”

And it’s clear the industry agrees. As of the end of the third quarter, dollar volume of transactions measured $44 billion, compared to just over $26 billion during the same period last year (last year saw a total of $45 billion in assets trade). Much of this has been dominated by institutional capital coming back into the market, whereas the buyer composition in 2009 was mostly private capital, Hughes pointed out.

Hughes also added that when the gap between cap rates and 10-year Treasuries is high, these tend to be strong windows of opportunities to invest in apartments. There is currently a 470-bp spread, compared to 425 bps in 2008-2009 and 90 bps in 2006.

And while the markets are mostly favorable, there are some potential challenges in the near term. For Nadji, income levels of renters not keeping up with rent growth is a concern. “We have a ways [to go] before rents exceed peaks, but once we get to that point where they grow 4 percent to 5 percent … unless job numbers pick up and job quality improves, I worry about affordability and renter pushback in terms of rents.”

And then there is what he calls the unexpected, most particularly in terms of what happens in Europe and whether there are problems for European banks–and what that might mean for the U.S.