In a webinar presented on Jan. 11, 2011, the Marcus & Millichap team gave an upbeat report on the current state of the U.S. apartment industry.
As usual, Hessam Nadji began with an economic state of the union address. After acknowledging nine different problems the economy is now facing, he presented another nine positive indicators. Among them is the fact that retail sales are now higher than they were before the recession. The GDP is back to 2007 levels. The rate of job growth is higher than both of the last two recessions. Worker productivity is at an all-time high.
There are 2 million young adults living at home with their parents. Many of these will move out in the next few years. Their confidence is bolstered by the fact that 65% of all new jobs created in 2010 were filled by those in the 20-34 year old category. Most of these new households formed will be renters, not owners.
On that note, he moved to a slide entitled, “Apartments Entering Rapid Recovery.” Here he mentioned that 2010 was a very good year for the industry. The vacancy rate plunged a full percentage point. He expects another full percentage point drop in 2011, followed by a strong 2012. This is because there is almost no building going on at a time when demand is coming back so strongly. Given the difficult environment for developers, he predicts a good 4 to 5 year run for apartments.
Next up was Bill Hughes, who spoke about the capital markets. Commercial real estate financing got better through 2010 with apartment fundamentals providing the boost. Apartment values went up, lenders started showing more confidence, and Fannie and Freddie continued to provide most of the funding to the industry.
Looking ahead to 2011, Marcus & Millichap believes that in addition to the current sources of capital, insurance companies will once again start to loan on apartments. Several new commercial banks will begin to lend, and the CMBS package will start to reappear.
10-Year Treasuries should stay in the 3.5%-4% range. As the economy starts to rebound, expectations of inflation will push the rates up.
Lastly, he listed sources of debt for three groups of investors. The smaller investor, working in the $1-10 million range, will rely on Fannie and Freddie, commercial banks and some life insurance companies. They will find LTVs in the 70-75% range. Some lenders are taking the DSCR as low as 1.15 to accommodate the smaller investor. Most of the loans will be recourse loans.
Medium investors, looking at deals in the $10-20 million range, will find a wider array of financing options. This is where finance companies come in with mezzanine and bridge financing, and CMBS starts to play a role as well. The debt service coverage ratio will be around 1.20 and the LTVs once again in the 70-75% zone.
Investors needing over $20 million will find the larger banks will work with them on both recourse and non-recourse loans. DSCR and LTV will match the medium group. With more data available in the marketplace now, lenders are growing in confidence.
Finally, Linwood Thompson discussed apartment investment trends and strategies. He started by mentioning that there is a great divergence in the marketplace between the quality and location of assets. “A” and “B+” properties in high barrier-to-entry locations sold very well in 2010, with the trend accelerating in the last 90-120 days of the year. Cap rates are dropping, the cost per door is going up, there is lots of equity raised, and the interest rates and spreads are supportive of this trend continuing.
In stark contrast, class “C” properties, smaller assets and anything in a tertiary market are fairly stagnant right now. These are properties that are typically bought either by a homeowner pulling cash out of a refi on his home, or a business wanting to diversify its profits. Neither one of those “trickle up” paths are active in this market, leading to the dearth of transactions. Agency loans aren’t focused on smaller properties, they still have collection problems that affect cash flow, cap rates are flat to deteriorating, and there is continued pressure from distressed assets.
For the last couple of years Mr. Thompson has brought up the divergence in mindset between those who believe in the long-term investment value of apartments, and those who are still expecting great deals to emerge from the great distressed property sell-off we’ve heard so much about. Well, at this point, more folks are moving into the former camp, as they can see that appreciation is likely, due to the supply and demand factors at work. Apartments are still a preferred investment vehicle, especially since there are so few appealing alternatives.
In his conclusion, he started with the statement, “We’re on the verge of one of the best bull runs we’ve had in a long time.”
He went on to say that the market recovery is starting at the top, with the REITS starting to get back into the game in a big way. Interest rates are still at historically low rates. Lots of equity is being raised, and more of it will be looking for “B” assets in 2011.
Thompson concluded by emphasizing the questions on everyone’s mind: Which markets will have the best employment growth, when will that occur, and how does that compare to supply? When you figure that out, you’re in for a fun ride up.
To view their entire presentation, click here.
- Housing Woes Fuel Apartment Surge (online.wsj.com)
- Investor revamping troubled apartments targets Houston properties (chron.com)