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Positive Outlook
By Paul Fiorilla on Jan 26, 2016 in News
Orlando—Overdevelopment? Affordability? Rising capitalization rates? An economic downturn? Falling stock market prices?
Bring it on, the multifamily market can handle it this year.
At least that seemed to be the consensus at the National Multifamily Housing Council’s annual meeting, held this week in Orlando. Panelists at the conference’s Apartment Strategies Outlook event were generally bullish on the outlook for the sector in 2016.
“It’s a great time to be in apartments,” is how one panelist summed it up.
The litany of positive fundamental drivers are familiar by now: vacancy rates are near historical lows, with demand driven by strong job growth, the growing number of Millennials and the increasing propensity to rent among young and older renters. Rent growth since the last recession has far outpaced long-term average, while properties values have soared. The market is “Awash in Capital.” That punctuation is not a typo, but the title of a panel at the conference.
Bob White, president of Real Capital Analytics, released full-year 2014 numbers that showed multifamily sales at a record high, up 32 percent over 2014. Cap rates and cross-border investment are at all-time highs, although White said that prices are plateauing and appreciation is starting to slow.
The conditions that produced the influx of capital seem likely to continue into 2016. The U.S. economy, as mediocre as GDP growth might be by historic standards, remains a beacon of stability compared to the struggling economies of Europe and Asia. Not only is that attracting sovereign wealth funds and pension funds from overseas, but there is an influx of high-net-worth investors from China who want to own U.S. real estate, particularly multifamily. That is increasing competition for multifamily assets, not just Class A properties in core markets, but small- and medium-sized properties in secondary markets.
What could slow down the momentum? Certainly an economic dislocation is one possibility. Panelist Jeff Daniels, managing director of AIG Global Real Estate, suggested that debt spreads could widen in the second half of 2015, which would push cap rates wider. If life companies and the government sponsored enterprises (GSEs) fill allocations in the first half, while CMBS spreads widen due to the impact of new regulations, the cost of debt for borrowers could widen 50 basis points or more. Ethan Bing, a vice president at Starwood Capital, also suggested widening corporate bond spreads could impact life companies’ mortgage pricing.
There have been rumblings that lenders are getting more aggressive on terms and leverage, which brings back comparisons to 2007, but those fears were dismissed by Grace Huebscher, president of Capital One Multifamily Finance, during a session called: “What Goes Up…Must Go Down? How Long Can the Apartment Expansion Continue?”
Huebscher noted that regulatory oversight was as conservative as any time during her 30 years in the industry, which makes it harder for banks to get too aggressive. She pointed to the difference between the 95 percent leveraged financing of the peak 2007 acquisition of Peter Cooper Village/Stuyvesant Town in Manhattan—which resulted in a quick default and years of litigation—and Blackstone Group’s recent purchase of the complex with roughly 50 percent financing. Meanwhile, construction lending has been constrained by high capital requirements for high volatility commercial real estate loans (HVCRE).
Panelists were relatively sanguine about many of the potential roadblocks in 2016. Chances of a recession were deemed unlikely. Even Craig Leupold, president of Green Street Advisors, who warned that multifamily values may be at peak levels, said he was “bullish” about fundamentals over the next couple of years. Green Street’s concern about values stems from the malaise in the REIT market, where values have dropped about 5 percent as investors are concerned with rising interest rates and a slowing global economy. Leupold said REIT values are usually a leading indicator of private real estate values.
There was a panel on affordable housing, but affordability was a theme that permeated most of the discussion. Nationally, average rents have risen more than 20 percent over the last five years, well above household incomes. But even here, panelists noted that over a longer term, 25 years, rents and income have largely kept pace. Ken Valach, CEO of Trammell Crow Residential, said that there has been an affordability crisis every few years since he joined the industry in 1989. “People seem to find ways to pay the rents and we build more,” he said.
A panel on the topic of affordable housing of the subsidized kind discussed the difficulties of putting the onus on developers to fix affordability issues. One popular solution, inclusionary zoning, sets aside a portion of a new project for low-income renters. But lowering the rents on some units forces the owner to increase the rents on non-subsidized units, which has the effect of reducing overall affordability.
Developers who build subsidized housing described meeting with municipal officials who tend to be suspicious of real estate firms. Jonathan Holtzman, CEO of Village Green, noted that it is a mistake to go into such meetings talking about money and math. “We have to solve their problem,” he said. “If we approach it as math, they’re not going to believe us.” Instead, he suggested being open to negotiate ways that meet the demands of civic officials and enable developers to meet their revenue targets, including smaller units and a lower number of parking units.
Ultimately, however, the problem of affordability is too big to be solved by building a handful of exclusionary units or through alternate solutions such as rent control, which has started to be raised by officials in a few markets.
The event was kicked off by a research panel, which described the positive fundamental drivers in some detail. Metros such as Houston, Dallas, Charlotte, Raleigh-Durham and Austin have seen spikes in population, which explains how vacancy rates have remained low despite copious development.
