Apartment building investment broker ABI Multifamily’s Research Director, Thomas M. Brophy is out with part 1 of a pretty in-depth ‘overview’ of water rights in Arizona this week (Part 1 of 3). This is important not just because most of AZ is a desert (duh) but because Phoenix is expected to grow by the size of Denver over the next twenty-five years (See Phoenix population to add 2.6 million by 2040, housing supply not keeping up). They’re going to need a lot more apartments but the biggest limiting factor will be the ability to provide water for that many new tenants.
The Urban Land Institute/PriceWaterhouseCoopers annual report on Emerging Trends for Real Estate 2014 was released last week and apartment building investors and commercial real estate pros have some good things to look forward to next year. Note that this post refers to the Americas version of the report with separate sections on Canadian and Latin American markets but they also publish Asia-Pacific and European editions as well. This is the 35th edition of the report is it’s based on individual interviews or surveys from more than 1,000 investors, fund managers, developers, property companies, lenders, brokers, advisers, and consultants.
Here are the 5 key trends we should all be aware of with my comments:
Survey participants continue to rank private direct real estate investment as having the best investment prospects. Pretty expected from this group but the National Council of Real Estate Investment Fiduciaries (NCREIF) recently released its property performance index for the third quarter of 2013 and on a trailing 12-month basis, the index’s return was 11.0 percent, split about 50/50 between income and appreciation. A pretty nice return compared to fixed income rates and a much safer looking bet than buying equities at their all time highs.
Dependence on cap rate compression to drive value is being replaced by an emphasis on asset management. Especially in the 24 hour gateway markets apartment building cap rates are about as low as they can get (well until you look at Vancouver BC) so property performance has to come from actually making the property perform. You also have the problem of what to do with your proceeds if you do sell, as you would be reinvesting right back into the same cap rate market that you sold in… unless you changed to a higher cap rate sector, suburban strip centers anyone?
Opportunities to develop property are finally appearing in sectors other than multifamily. CBRE Econometrics had a piece out last week showing that large (> 350k sf) warehouse properties are being snapped up as fast as they’re being built. Maybe developers who moved over to doing apartments the last few years will move back to their home sectors and ease off on the new supply of multifamily units.
Value-added investment ranked highest in terms of investment strategy; distressed properties and distressed debt ranked last. We were licking our chops a few years ago waiting for RTC 2.0 fire sales to begin and while we were able take down some bank owned inventory, the anticipated tsunami of defaults on commercial loans never materialized. At this point most everything has been extended and pretended into performing status or sold off and so it’s back to making money the old fashion way: Finding and/or creating value.
Both equity investors and lenders are widening their search for business to include secondary markets and niche property types. This will be a double edged sword for investors who are focused on those secondary and tertiary markets as debt financing will be more available but there will also be more competition from sophisticated outsiders with deep pockets. The key will be to make them your buyers so dig in, find the right properties and tie them up quickly.
Earlier this week I posted on statistics that generated this chart from CoStar showing that 56% of office buildings that are converted or demolished make way for apartments and/or mixed use. These type of projects do come with their own set of risks and rewards however. Fortunately that same day Globe St. posted an interview with Jim Grauley, COO and president of Columbia Residential on the down and dirty details of repositioning buildings for residential. Columbia does a lot of LIHTC (Low Income Housing Tax Credit) projects but they started up Columbia Ventures LLC to focus specifically on repositioning existing buildings for market rate housing. In a two part interview (part 1 and part 2) he laid out the requirements, risks and opportunities.
One project they currently have underway is the Imperial Hotel in downtown Atlanta. It required a complicated financing transaction for a complete historic and LEED Gold renovation that will create 90 state of the art efficiency apartments. “Columbia also is taking on an adaptive reuse of another historically significant building in Downtown Atlanta converted to market rate apartments” said Grauley.
Their objective is to create “a sustainable urban lifestyle [that] is achievable when transit, occupation, services and entertainment are all in close proximity to home, making car ownership an option rather than a necessity.”
Here are my bullet points from the how-to knowledge he shared:
Target a building that has unique/non-replaceable characteristics.
That is located in a strong, hard to replicate, location.
The acquisition cost of the building structure must be significantly lower than replacement costs.
Market rents are a big driver of what can be done. higher rents drive acquisition, land, and construction costs higher, so in many cases reuse can be more feasible than new construction.
Often reuse projects will have a larger portion of capitalization via equity sources, given the renovation risks or uncertainties and lender tendency to be more conservative with the unknowns in underwriting (= lower LTV or LTC).
The biggest risk is dealing with the unexpected in design, construction, and operations from older buildings. You must plan for this to happen with contingencies and very substantial up front due diligence on the building.
The building must have a layout that will allow the creation of desirable living spaces, with good light, volume, character, and connectivity (Ties in with the 22k floor plate ideal that was mentioned in my first post).
Creativity and knowing the market are key challenges in building out the kind of living spaces that will find market acceptance.
In older cities or districts, there are often more incentives for preservation and reuse and redevelopment.
In historic buildings, projects can utilize historic renovation credits and incentives to allow for feasibility.
It’s optimal when there are incentives and subsidies for renovation—such as state/federal historic tax credits, new markets tax credits.
ROI can be very good, but the often necessary subsidies for renovation or preservation can limit the re-sale timing and in some cases return..
In many top US markets the supply of office space has not just been stagnant, it’s actually been shrinking and apartment building investors have been the beneficiaries.
In a CoStar piece out today entitled Didn’t That Used to Be an Office Building? they list a couple big advantages of converting office space to apartments: Office working residents are close to work, and there’s great access to public transportation. How many people who spend hours a day sitting on the freeway would like the option to park the car all week?
If you combine the residential and mixed use portions of the chart below, 56% of the office conversions/demolitions are going to apartments:
We all know that jobs are a critical driver of the apartment building investment cycle and so we dutifully follow along with the talking heads when the unemployment number is estimated, released and then its potent debated. But Mike Scott over at Dupre+Scott points out in a piece posted Friday that apartment building investors should be following employment, not unemployment. Specifically he recommends measuring how many jobs it takes to create demand for one apartment unit. Currently in King County (where Seattle is the county seat and where Dupre+Scott is located) it takes about 8 jobs to do that:
The formula is simple: Net new jobs / apartment units absorbed. And if you’re an multifamily investor in the tri-county area (King, Pierce and Snohomish in WA State) that Dupre+Scott provides apartment investment research for, they’d be happy to supply you this information http://www.duprescott.com.
Back in February we posted an Axiometrics chart plotting the revenue growth vs. job growth in leading apartment investment markets in the US. They were out last week with an updated chart but not just in the way we might think since the numbers are Axiometrics’ 2013 forecasts for revenue and job growth updated through May this year. To me the real ‘update’ is that they reversed the axises on the chart and I think it makes more sense laid out this way: