Published: December 03, 2007
By Teresa O'Dea Hein, Managing Editor
The end of a year is a natural time to reflect on the previous 12 months and plan for the upcoming ones. As everyone knows all too well, 2007 has been a tumultuous year with the subprime mortgage meltdown and its fallout, which led to major Wall Street firms reporting more than $20 billion in write-downs for the third quarter. Third-quarter results were also weak for Fannie Mae and, especially, Freddie Mac.
Oil prices topping $90 a barrel and gas prices speeding past $3.20 a gallon in many places have exacerbated economic woes, choking disposable income. Their impact on transportation costs favors the development of urban infill, mixed-use and transit-oriented multifamily developments.
Since it's an ill wind that blows no good for somebody, apartment demand is also expected to be bolstered in the near term as a rising number of foreclosures force some homeowners into rental housing. Tighter mortgage standards are preventing other renters from moving into the single-family sector. The shadow market of rentals of condos and single-family homes in overbuilt markets is also muddying the picture.
On Halloween, the Federal Reserve handed out its own version of a treat by dropping the federal funds rate, a key short-term interest rate, by a quarter-point to 4.5 percent. This signaled continued concerns over the sharp downturn in the housing market and the backlash from the subprime mortgage situation onto the securities markets. It followed a half-point cut in September after nine consecutive Fed meetings of no changes.
However, this down cycle is different from the real estate industry's last big one in the late-1980s and early-1990s, points out Sally Gordon, senior vice president in the Commercial Mortgage-Backed Securities, Structured Finance Group at Moody's Investors Service, New York. Unlike that downturn, characterized by excess capacity, Gordon notes this cycle was marked by an influx of excess capital, which helped drive prices up and ultimately create too much leverage.
While working through excess capacity takes a certain amount of time, Gordon explains, the process tends to be shorter with excess leverage.
"2008 will be a transitional year," believes Gary E. Mozer, managing director at George Smith Partners, located in Los Angeles. While the Federal Reserve lowered short-term rates twice in the last few months of 2007, Mozer points out, "We've had two decreases and 17 increases—the damage has been done. The illiquidity on Wall Street is being measured in billions. Yet, of all property types, I think multifamily has the most resiliency," Mozer concludes.
Multifamily fundamentals remain strong in many metropolitan areas. Population growth continues, households are being formed—particularly as more members of the populous Generation Y enter the job market—job growth and job diversification is evident in many areas, single-family housing is still highly priced in many areas so affordability is impacted, and there are also limits on development in many metro centers. Red flags arise for markets where the local economy is dependent on manufacturing consumer goods.
Vacancy levels have decreased in many markets while both asking and effective rents have gained traction, with concessions burning off in most, aside from Phoenix and a little in Portland, Ore.
Pundits remain bullish on the multifamily market outlook for both coasts—once Florida is out of the picture. (Though it should be noted that the inland city of Orlando remains strong, with continued substantial in-migration.) The big buzzword in Florida used to be hyper-flippism, Baird recalls. With the glut of unsold condos, he says, "now, it's re-apartmentization."
Industry observers differ strongly on potential multifamily conditions in two wildcards: Las Vegas and Phoenix. While many remain pessimistic about the Vegas marketplace, Sperry Van Ness' Baird puts Sin City on his top 2008 list as a "sleeper."
Population growth for Las Vegas in 2008 is projected to be a substantial 3.9 percent, far ahead of second-place Austin's projected 2.8 percent. Additionally, notes Sperry Van Ness researchers, "America's Playground" benefits from lack of personal or corporate income, inheritance, gift, estate, inventory or franchise taxes.
Ferlauto explains, "The knock on Vegas is your expenses tend to be higher because you have more of a transient population, creating higher turnover costs, particularly in Class B and C properties."
Greg Willett, vice president of research and analysis at M|PF YieldStar, Carrollton, Texas, reports that the Vegas multifamily market is cooling off a little. "To me, the numbers say there's a struggle—though it is over-performing our expectations and has not had as big a correction as we thought."
Plus, 40,000 hotel rooms are scheduled to come on line in 2008 in Vegas, and each room brings an average of 3.5 jobs with it, points out David Baird, national director of multifamily for Sperry Van Ness.
All those hotel employees and construction workers have to live somewhere, but it's a gamble as to what kind of properties will be most popular. The question is, Mozer suggests, can casino/hotel workers and construction tradespeople afford Class A apartments?
However, as of press time, Baird says Vegas occupancy levels were still at 94-95 percent. "I'd pick Las Vegas as a sleeper market for 2008," he adds. "Rumors of its demise have been overstated."
While Phoenix has strong job growth, several multifamily experts believe its housing market is oversupplied, partially due to a huge inventory of investor-owned condos, all of which is evidenced by the return of concessions. Plus, there are fewer barriers to entry there. Overall, Willett expects to see a slowdown in the area's economy.
Going forward, based on input from a number of industry experts, the hot multifamily markets for 2008 are expected to include some perennial favorites leavened with a few newcomers. They are:
• Salt Lake City • Seattle
• Inland Empire • San Francisco
• San Jose • Denver
• Minneapolis • Nashville, and
• Portland • Philadelphia
Salt Lake City
Salt Lake City's economy pulled ahead at the end of 2006 and developers haven't yet added new multifamily units, reports Greg Willett, vice president, research & analysis at M|PF YieldStar. After years of struggling through an overhang of housing built for the 2002 Winter Olympics, vacancy hovered at the 2 percent mark in 2007 and annual rent growth moved to near 7 percent. The metro's 4.2 percent employment growth pace was among the strongest in the country, partially driven by tech companies moving in from California. Plus, the premium to buy versus rent is getting huge, with the metro posting home price inflation over 20 percent in 2007.
A caffeine-fueled local economy continues on track to add 44,000 new jobs in 2007. Single-family housing affordability is limited, supporting multifamily revenue growth, which rose 6.7 percent in the past 12 months in the Seattle apartment market, according to Marcus & Millichap Real Estate Investment Services. The firm's research expects asking rents to advance 6.7 percent, while effective rents were expected to gain 6.9 percent to $947 per month. According to YieldStar research, vacancy in the Puget Sound region was cut to about 3 percent. Even though Seattle has a fairly aggressive multifamily construction pace on both the for-sale and for-rent side, adding more than 9,000 units—many of which will be condos, YieldStar says the condo market remains healthier here than in most regions. And many of the apartments on the way won't be complete until 2009.
The pace of the once-rapid apartment completions in Rancho Cucamonga and Temecula as well as other parts of Riverside and San Bernardino counties is slowing down, Willett reports, and new units are leasing quickly. Employers in the Inland Empire were on pace to add 50,700 new jobs in 2007, a 3.9 percent gain, notes Marcus & Millichap. With rebounding occupancy in 2008, rent growth should escalate well above the lackluster pace of 1-2 percent seen recently, according to YieldStar. Foreclosures are returning some homeowners to the apartment market, too. Sperry Van Ness expects 2008 effective monthly rents in the Inland Empire to gain 4 percent on average.
Sperry Van Ness points out there are few other markets where renters make up such a majority—65 percent—as in San Francisco, attracting institutional investors as well as high-net-worth individuals. While the city's 2007 apartment vacancy rate of near 5 percent was a little higher than usual, the market saw sky-high rent growth near the 11 percent mark. Apartment occupancy still is expected to go up a little, however, since it won't take much absorption to surpass scheduled deliveries that total fewer than 1,000 units, notes YieldStar. With home prices so high and still on an upswing, rent growth in 2008 again appears likely to be among the strongest seen nationwide.
After posting vacancy rates of only 3 percent and rent growth near 10 percent in 2007, San Jose remains primed to continue that stellar performance, due to it ongoing apartment construction pace of just 1,200 or so units for 2008, according to YieldStar. Furthermore, the premium to buy versus rent continues to be quite large. Marcus & Millichap adds that the steady job market is fueling household growth that, while near the national average, will outpace its Bay Area neighbors.
In 2007, the Mile High City saw its long-overdue improvements in rent growth, Willett reports, after being one of the country's weaker apartment market performers in the past several years. Vacancy finally has been reduced to less than 5 percent, says YieldStar, and rents were up about 7 percent from 2006. Completions this year proved nearly non-existent but ongoing construction for 2008 has climbed to about 3,500 apartments. YieldStar says that figure looks absorbable as long as the metro produces at least a modest number of new jobs. However, Willett warns, "Denver tends to be one of those boom-and-bust economies."
After a number of years at the bottom of the pack, chilly Minneapolis is emerging as a hot market. Willett expects significant rent growth to come in 2008 since condo completions have slowed and apartment vacancy is down to 3 percent.
Nashville owners are singing a happy tune with vacancy well below the regional norm at about 3 percent. YieldStar reports that Nashville saw effective rents rise at a healthy rate of about 4 percent during the past year. Boosting that outlook for 2008, Nashville will add hardly any new multifamily supply. Permits were issued for only about 1,100 units during the past year, and this figure is down 15 percent from what was already a fairly conservative construction pace.
Portland's apartment vacancy has been held to about the 3 percent mark since the middle of 2006, and the metro has wrapped up 2007 with impressive annual effective rent growth near 8 percent. While employment growth has come down from the peak seen in 2005-2006, the current expansion pace of 1.5 percent is healthy. Given high barriers to entry, total multifamily authorizations for 2007 have dropped 28 percent to only about 4,200 units, many of which are condos. Typical home prices are still heading up, posting about 5 percent increases in 2007.
The City of Brotherly Love is getting cozier with a vacancy rate down to about 4 percent, as of late 2007, and annual rent growth of 5 percent, says YieldStar. Multifamily approvals in 2007 were off more than a third from the year-earlier pace. Developers were forecast to bring 800 units online by the end of 2007.
On the Sidelines Should any of the areas listed above fail to live up to expectations, observers predict that the Texas markets—particularly Austin—may be best positioned to grab leadership spots. And Charlotte, Raleigh-Durham and New York City also remain hot, responding to their own unique demographics and dynamics.