Back in the Saddle Again

In the past year, the general economy has tried to cope with the debt crisis in Europe, a polarizing presidential election, the nation falling off the fiscal cliff and, most recently, the imposition of $85 billion in automatic federal spending cuts from the sequester. Also in the past year, the nation’s multifamily housing market has once again posted solid gains in spite of these challenges.

For most metro locations across the country, apartment market fundamentals have either reset or improved from their pre-recession conditions, reports Witten Advisors’ president, Ron Witten. “Basically the national apartment market has fully recovered,” he says. “Apartment values are not quite back to where they were prior to the boom, but have regained much of the decline in value during the deep recession,” he said.

By all accounts, market indicators are overwhelmingly positive for continued strong rental housing demand, which will fuel a healthy hike in new construction projects in core markets across the country this year.

A host of major new multifamily projects were either announced or broke ground in major cities across the US in recent weeks, including the massive Hunter Point’s South project in Long Island City, Queens. The City of New York and the Related Cos. broke ground on the initial 925 units of the development, which will eventually feature 5,000 apartments—making it the largest rental housing development of its type since the 15,000-unit Co-Op City was completed in the Bronx, NY 40 years ago.

While leaders from the National Multi Housing Council and the National Association of Home Builders have noticed a loosening of credit for certain multifamily projects proposed in key urban centers such as Houston, New York City, Dallas, Austin, Los Angeles and Washington, DC, construction activity could be impacted by a promised 10% cut in Federal Housing Finance Agency multifamily finance deals this year, as announced recently by FHFA acting director Edward J. DeMarco.

Developers are feeling optimistic again, leading to increased deliveries next year.

Source: Axiometrics

Steve Edwards, a partner in the real estate & land use practice group of Manatt, Phelps & Phillips, told, “As the capitalization rates for multifamily properties continue to fall, one reason the market has remained viable is the relative availability of low-interest financing from FHA, Fannie Mae and Freddie Mac. It can be expected that any curtailment in the availability of such financing will not have a positive market impact.”

But for now, it’s status quo. As of early 2013, the multifamily sector has been performing well, although the pace of improvement was moderating somewhat from the previous two years. Mark Obrinksky, chief economist and VP of research for the NMHC, says that while some key indices have dropped slightly, the continued expansion of the rental housing market that began in 2009 is still solid. Population growth and other positive demographics suggest that demand will continue to be strong in 2013-14, he says.

David Crowe, chief economist with the National Association of Home Builders, says construction started on 246,000 multifamily units in 2012, up sharply from 178,000 in 2011. He expects a 31% improvement to 321,000 multifamily unit starts for the sector in 2013.

The 10 years leading up to the housing crash saw the market averaging approximately 350,000 new units per year through 2008. Crowe says that rental demand—fueled by a sharp rise in new household formations since the economic recovery took hold—is the primary driver for the projected increase in starts.

So, while there has been a marked increase in new construction, the industry is really just beginning to return to normal levels. “Multifamily has been doing a lot better than single-family because of the rise in demand, but it’s still behind its normal levels,” he notes.

The NAHB noted that permit issuance for future apartment rental projects rose 1.5% to a 341,000-unit pace in January, the highest permitting activity posted since mid-2008. Permitting activity rose 10.1% in the Northeast, 1.4% in the Midwest and 1.1% in the South. The West registered a 0.5% decline in permits issued in January.

NMHC’s Obrinsky points out that during the 1997-2006 period, new construction of five or more multifamily units averaged approximately 300,000 each year. In 2012, there were 233,000 unit starts.

David Crowe, NAHB: “Multifamily has been doing better than single family because of the rise in demand, but it’s still behind normal levels.”

“We’ve already seen a big increase in new construction compared with the trough that we saw back in 2009 and early 2010, but that construction has not yet even taken us back to the level we saw for the 10-year period from 1997 to 2006,” he says. “At this point, we’re looking at a further increase in new multifamily construction and we could reach as much as 300,000 in 2013.”

Household formations in the US are currently averaging about 850,000 a year, as compared to approximately 500,000 during the recession, reports Crowe. “Most of those new households are between the ages of 25 and 34,” he says. “A large majority of them are typically renters anyway, and in this cycle almost all of them are renters because credit standards to get a mortgage are tighter, down payments are higher and a lot of these people will have several jobs before they settle down, so their mobility is greater than their predecessors.”

So at the same time demand is driving new multifamily projects, the industry is also playing catch-up. During the recession there were barely more than 100,000 units in multifamily housing starts each year in 2008 and 2009. “That is barely enough to keep up with what falls out of the stock because of obsolescence,” Crowe notes. The spike in new construction is due to replenishing some of the stock, but “most of it is answering significant demand for rental projects.”

Jay Denton, VP of research for AXIOMetrics Inc., a Dallas-based multifamily research provider, says that from a broad perspective his firm expects urban cores to see peak deliveries in 2013 and 2014, with the suburbs seeing an increase in activity afterwards.

“The real test will be taking place over the next couple of quarters,” Denton says. “If the new properties absorb units quickly at solid rental rates, then I would expect to see construction maintain its current pace. So far, the results have been great.”

With all the new construction, there is a question of its impact on rental rate growth. Current indicators suggest that rent growth will moderate from now through 2016, but will then rise thereafter. The national multifamily occupancy rate was 94.04% in January 2013, down from 94.11% in December 2011, according to AXIOMetrics. Supply remains tight in the class A and B markets, which are both enjoying occupancy rates above 94%. The class C national occupancy rate in January 2013 was 92.4%.

Jay Denton, AXIOMetrics Inc.: “If the new properties absorb units quickly at solid rental rates, then I would expect to see construction maintain its current pace. So far, the results have been great.”

While rents have grown collectively at approximately 13% since the end of the recession, that rate should moderate to a slower, but steady pace over the next few years. Most analysts put effective rent growth in the US in 2012 at anywhere from 3% to nearly 4%.

Still, some segments are seeing more of an impact than others. In class A properties, for instance, effective rent growth has been falling steadily, Denton relates. In 2011, rent for high-end product grew 5.1%, the best of the three asset classes. Today, however, that growth has declined to 3.2%. Class B properties have been increasing at about a 3.7% clip for the past 16 months. The biggest winner of late is the class C apartment sector, which according to Denton is now seeing effective rent growth at about 4.6%.

Due to the availabilities and attractive rents, at least compared to class A and B properties, “Class C properties are now starting to fill up more than they were before, which is giving landlords in that segment some pricing power,” Denton reports.

Performance also varies by location. The top markets for rent growth in 2012 were urban core areas that far outpaced the national rent growth of approximately 4%. According to Witten Advisors, the top 10 cities in multifamily rent growth at the end of the third quarter of 2012 were San Francisco, at 9.8%; San Jose, 8.5%; Charlotte, NC, 7.3%; Denver, 7.0%; and Oakland, CA, 6.8%. Rounding out the top 10 were New York City and Houston, which both saw rents growth at a 5.9% clip; Austin, TX, 5.6%; and Columbus, OH and Salt Lake City, at 5.3% each.

Some cities, meanwhile, saw lease rates decline over the same period. Rents in Baltimore, for instance, fell 2.9%; San Diego saw a 2.5% drop; Sacramento rents fell 1.2%; and Las Vegas lease rates declined by 90 basis points.

One factor curtailing the potential of overbuilding this year and beyond is the cost of construction. “The properties delivering now had lower construction costs than what it would be if the projects were started today,” says Denton. Land, construction material and labor costs have all increased of late.

Peter Torres, Astor Cos.: “Everybody is open to doing business, though they’re still very conservative. But it’s not what it used to be; for a while there were no loans at all.”

Another factor, to an extent, is financing. Although recent surveys by the NMHC continue to report that financing is constrained in top markets, NMHC’s Obrinsky and others say they hear that the lending environment may be improving somewhat.

“We are clearly seeing construction lenders—banks, primarily—interested in making new loans on new apartment developments,” Witten says, “as long as there is enough cash equity in the project. Therefore, equity investors are also interested. They are careful, but they are interested.”

Peter Torres, vice president of the Astor Cos., a rental and condominium development firm in Miami, agrees that financing has improved in recent times. A few housing developments in the greater Miami area have been able to secure conventional financing. “We’re working with a few lenders on some our projects and we’re finding that they also have changed some of their terms,” he says. “Basically everybody is open to doing business, though they’re still very conservative. But it’s not what it used to be; for a while there were no loans at all.” Despite lenders’ requirements of large deposits and other conservative-oriented policies, Torres’ firm has found the transaction parameters workable.

Six months to a year ago, there was a very strong lender bias toward cities on both coasts. “The intense focus on those markets has lessened because pricing has gotten so expensive,” Witten reports. “So we’re starting to see a broadening of capital to markets across the country. Tertiary markets are still finding it difficult to find financing, but major non-coastal metros such as Denver, Dallas and Houston are now active players in the new rental apartment sectors.

In fact, Witten Advisors projects Houston as the number-one market for rental housing starts, currently forecast at 16,200, followed by New York City (14,400 in starts); Dallas (12,300); Austin (9,900), Washington, DC (8,700); and Los Angeles (8,400). Likewise, Axiometrics reports that of the nearly 164,000 units scheduled for delivery in 2013, a third will be concentrated in just six MSAs: Washington, DC; Dallas; New York; Seattle; Austin; and Houston. By all accounts, however, any imbalance this may cause in those markets will be temporary.