For value investors, Demand, Supply and the Cost of Acquisition are the three factors affecting the apartment building investment decision and all are saying the time to buy is now. There is a tidal wave of new renters coming into the market and there has been little apartment construction to meet this growing demand. Outside of the gateway cities the prices of existing apartment buildings remain below the cost of building new. Fixed rate financing is available for apartment buildings at rates lower than we will see again for years if not decades.
“The multifamily sector is probably the only commercial real estate sector that has very positive fundamentals behind it,” said Jeffrey Baker, managing director at Savills LLC, a real estate investment bank that raises capital for multifamily owners and developers. “You’ve got a demographic that is producing more households that want to rent an apartment. You’ve got virtually no new supply that’s been added over the last several years.”1
Demand = DEMOGRAPHICS
The population of the US has grown 10% since 2000 to 308.7 million. If population growth keeps its current pace and the average household size does not increase further, household growth must pick up to at least 1.1 million per year. Even the slightest decline in household size would allow housing demand to grow by 1.3 million annually. A combination of improving household growth and a steady or falling homeownership rate will produce the strongest growth in rental demand since the 1980s. CBRE Econometric Advisors2
There are typically two sources of demand growth for apartments; Young people (“Echo Boomers” currently) moving out on their own and new immigrants. Those two sources, particularly the Eco Boomers, are making themselves felt but there are two additional sources of apartment demand that are driving down vacancy (and rents up). Those are the renters by choice and renters by necessity both driven by the mortgage meltdown and housing collapse.
Echo Boomers are unbundling
While they stayed home or moved in with friends during the recession, with the upturn in the economy Eco Boomers are moving out on their own again. The best estimate is that about 15 million of the children of baby boomers will enter the prime renter ago of 18 to 34 this decade.3 These renters will grow by 4.5 million by 2015.4
“We see the entry of the Echo Boomers into that apartment market continuing for another 10 years,” says John Orehek, president and CEO of Security Properties. Orehek says his company is already witnessing the effects of this latest demographic wave. “From an age perspective, every year, the average renter age is falling.5
On Average over a million people legally immigrate to the US every year. The majority of immigrants are renters by choice if not necessity.
Home ownership is falling, creating more renters
The homeownership rate may decline to 65 percent by 2015 from [from a high of 69% in ‘06], creating 4.5 million new renter households, according to a March 2 report by Green Street Advisors Inc. “For every 1% decline in the homeownership rate, you get over a million potential new renters,” says Richard Anderson, managing director at BMO Capital Markets.6
Cause number one, foreclosures, according to RealtyTrac (http://www.realtytrac.com/). About 3 million homes have been repossessed since the housing boom ended in 2006. That number could balloon to about 6 million by 2013.7
The real estate collapse and mortgage meltdown has had a big effect on Baby Boomers who are just starting (or at least were planning) to retire. With their equity gone, tighter lending requirements and tax advantages in jeopardy a home is no longer viewed as a cash machine for supporting their lifestyle. Given all that, the prospect of paying for and maintaining a single family home doesn’t seem to be worth the effort and is making more and more Boomers renters by choice as well as by necessity.
Boomers number about 77 million according to the latest data. The Baby Boomers will be re-emerging in significance when they sell their homes, says Orehek. Indeed, between 2009 and 2025, the older, 55- to 74-year-old, age group will increase by a hefty 76 percent Already, MyNewPlace shows an increase in the age of its visitors. In 2008, fewer than 15 percent of visitors were 55 years and older. This year, visitors who were 55 years and older made up 23 percent of all visitors to the site‑a 55 percent increase in two years.
Beyond the demographics, apartment demand will further sharpen if more homeowners become renters in the face of higher down-payment requirements and lower loan limits, among the options for the phasing out of Fannie and Freddie. Chris Macke, senior real estate strategist for CoStar
20% Down Mortgages coming… [B]orrowers will need to come up with a 20 percent down payment if they want to snag the best deal on their mortgage going forward. Per government sources, the Office of the Comptroller of the Currency and the FDIC have agreed on a 20 percent down payment for a so-called “Qualified Residential Mortgage”. – Katherine Swanberg, President, Real Estate Association of Puget Sound8
No New SUPPLY
This growing wave of demand is about to meet little to no new construction, which can only mean one thing, rising rents. From the experts:
There’s nearly no new construction in the multifamily space, and Nadji [of Marcus & Millichap] predicts even less for the rest of this year and in 2012. “We’re still only two years beyond the financial crisis when permitting and financing plummeted,” he said. “The planning, permitting and financing cycle takes a while to recover.” Investors.com 9
We expect the national average vacancy rate to decline through at least 2013 as demand substantially outpaces supply. After falling by 2.9% in 2009, we believe that effective rents will increase from 2011-2014. David J. Lynn, Ph.D., Clarion ING Dec 201010
Industry experts project that approximately 99,000 new apartment units will be delivered in 2010, well below the long-term average of 146,000 units.
Apartment completions will total 53,000 units this year [2011], 46 percent fewer than delivered in 2010. New supply will again fall critically short of demand, which is expected to reach 158,000 units. U.S. apartment vacancy will decrease 110 basis points in 2011 to 5.8 percent as a result, matching the decline recorded in 2010. M&M 2011 National Apartment Report
… Which means vacancies are falling
“The vacancy rate has fallen faster than we expected because renters are not buying homes or condos,” Dupre + Scott wrote in their October apartment report. “Never underestimate the power of bad news to instill fear in consumers. They are afraid prices will fall more after they buy. They are afraid they will lose their jobs. They are afraid they may need to use money they have saved to live on, so they don’t want to put it into a downpayment.” For apartment owners, things will keep getting better, Scott added Friday. “Next year’s low level of production will push vacancies lower and rents higher, particularly in 2012 and beyond.” Seattle PI 11/19/2010
According to New York-based property research firm Reis, U.S. apartment vacancies fell to a two-year low in the fourth quarter as rents rose. The national apartment vacancy rate dropped to 6.6 percent from 8 percent a year earlier and from 7.1 percent in the third quarter. It was the lowest since 2008’s third quarter, when the rate was 6.2 percent, says Reis.
… and rents will rise bringing increasing values
Property market analyzer Green Street Advisors predicts that revenue growth per square foot will rise in every major U.S. metro apartment market this year. The key drivers are young adults who moved in with family or friends between 2005 and 2009.
Cost of Acquisition: FINANCING
Unless you are a cash buyer, the availability and cost of financing factor heavily into the investment decision. While lending standards have tightened and many commercial lenders are out of the game or just starting to return, apartment buildings have an ace up their sleeve when it comes to financing: Freddie and Fannie. The GSEs have and continue to supply liquidity to apartment investors and their multifamily programs are in good shape. They are profitable and are experiencing very low delinquency compared to other lenders.
Government-sponsored enterprises (GSEs) including Freddie Mac, Fannie Mae, and the U.S. Department of Housing and Urban Development (HUD), have dominated the multifamily financing market. They collectively financed over 80% of all multifamily financing in 2008 and 64% in 2009, according to the Federal Housing Finance Agency.
Currently, the GSEs continue to provide attractive fixed-rate financing to the multifamily sector. Loan-to-values typically range from 70% to 80% for a term of seven to 10 years. Debt-service coverage ratios run from 1.25 to 1.35, and the interest rate ranges from 180 to 220 basis points over the 10-year Treasury yield. On average, apartment mortgages are approximately 120 to 150 basis points lower than those of other core property types. ING Clarion
The small loan market is starting to heat up again, as banks regain their appetite for balance sheet loans and wrest some business from the GSEs.
Chase Commercial Term Lending has grown much more active in recent months, mostly on the West Coast. And other national, regional, and community banks, such as Sovereign Bank, are beginning to step off the sidelines again. MFE Magazine 12/13/11
[2011] may be the year of the CMBS comeback, at least if you base it on the number of CMBS shops that are opening. In 2010 CMBS lenders did just over $10 billion, but they expect to do more than 5x that in 2011. MFLoan.com Update
Conclusion: All three legs of the apartment investment stool are in place
Leg one is that there should be a million or more new renters every year for the next decade. Leg two is that there has been hardly any new apartment construction the last eight or nine years and practically none in the last three. In fact between design, approvals and permitting not much new apartment construction can even get started for a year or two. The third leg is that there is fixed rate financing available today at rates that may not be seen for many years. Investing in an apartment building now can provide a conservative investor with steady cash flow that will rise with inflation and provide capital appreciation which is paid for by tenants.
3 http://www.multihousingnews.com/news/national/the-effects-of-demographics-on-the-apartment-industry/
4 http://www.nationalpropertyinvestment.net/custom/index.cfm?id=202703
5 http://www.multihousingnews.com/news/national/the-effects-of-demographics-on-the-apartment-industry/
6 http://www.time.com/time/business/article/0,8599,2013302,00.html
10 http://nreionline.com/property/multifamily/multifamily_sector_improve_1206/
See also “Rents Could Rise 10% in Some Cities” on Yahoo Real Estate http://yhoo.it/gR9nKy
– “there’s been a shift in the American Dream. We’re learning from our surveys that a huge proportion of people are choosing to rent.” They’ve experienced the downsides of homeownership — or seen friends and family suffer — and don’t want to take the risks or pay the higher costs of homeownership.
– Apartment developers many not be able to keep up with this heightened demand, which will force prices upwards, according to Chris Macke, a real estate analyst with CoStar, which tracks multi-family housing trends. “There will be an envelope of two or three years,” said Macke, “when the rise in demand for rentals will exceed the industry’s ability to meet it.”
-Renters beware. But owners will rejoice since the value of an apartment building is essentially a multiple of the income it produces.