Is Growth in Multifamily Sector Sustainable?

Date: 11/05/2013

The multifamily market, the so-called darling of commercial real estate, isn’t losing that title any time soon. The third quarter demonstrated once again how stable the sector is, as occupancy held steady and rents continued to rise, albeit at a more normal pace.

Those were a few of the points made during the most recent episode of the “Commercial Real Estate Show.” My guests and I discussed the factors affecting the sector, property-level performance expectations and investment strategies for this point in the cycle.

Millennial's Enter the Job Market

The continuously improving economy and job market are sustaining the multifamily market’s success. “The people who are getting jobs are the young professionals that typically rent an apartment instead of buying a house,” said Ernie Eden, vice president of Bull Realty’s Apartment Group.

“Demographics are the key factor driving the multifamily market,” said Jay Parsons, national market analysis manager for Real Page, Inc. “The Gen Y Millennial renters will eventually buy homes, but not until later. They are getting married later and prefer the mobility that living in a rental gives.”

A large pipeline of upcoming college graduates will soon be looking for apartments as well, Parsons added. “Apartment demand should be strong during the next decade due to strong demographics.”

More Normal Occupancy and Rent Growth

The multifamily market is on pace for a similar year to 2012 in terms of absorption and rental rates, Parsons said. In the third quarter, 47,000 units were absorbed nationwide for a year-to-date total of 163,000, he added. Rent grew by 1.1 percent quarter-over-quarter for total rent growth of 3.2 percent year-to-date.

“We are getting back to a more stable multifamily market,” Parsons said. “We are going from a peak market to a more normal growth pattern.” While Class A properties lead the way coming out of the recession, Class B properties are experiencing an uptick in rents as well, he added.

“Class B properties, more specifically our suburban portfolio, seem to have really accelerated rent growth,” said Mike Altman, CIO of Cortland Partners. “Those markets have had less new construction, so demand that’s incrementally coming to the suburbs is pushing rents upward.”

The Class B and C properties are where many investors see upside at this point in the cycle. “Demand at the top end [Class A] is now full and has started shifting toward the B and C properties. That’s led to bigger rent growth in the middle and lower tiers of the market,” Parsons said

Overbuilding? Not a Fear Here

While some fear overbuilding, Parsons said construction has essentially flat-lined, and the overall current level is sustainable. The only overbuilding concerns are relegated to specific markets, even then only slowing absorption in those areas. “The problem is that real estate is a ‘follow-the-leader’ business,” he said. “Everyone is going into hot urban, core submarkets right now and targeting Gen Y renters, so everyone is building the same thing.”

Some companies, like Cortland Partners, prefer to develop in secondary markets to obtain what they believe is a sufficient return for the added risk. “We are going into markets like Lake Charles, La.; Savannah, Ga.; Fort Worth, Texas; and Birmingham, Ala., where we know we can create a yield that is 250 basis points greater than the cap rate in the market, which is a sufficient return,” Altman said.

Time to Buy?

“This is a great time to buy apartments,” Eden said. “We are seeing people all over the country express interest in investing in apartments, even if they haven’t before. Interest rates are historically low. Buyers can purchase properties with cash and still have time to reposition and refinance while interest rates are low.”

Class B properties with a value-add component are at the top of the list for investors, Eden added. In fact, Cortland Partners, which prefers Class B assets with a value-add component, has been very active in 2013, acquiring 22 properties year-to-date, Altman added. “We started the year with 9,600 units and think we could acquire as many as 10,000 new units by the end of 2013, doubling our portfolio in size in one year,” Altman said.

Apartments are still the leading sector in commercial real estate. Based on the discussions on the show about the future of the sector, multifamily is still a safe bet. For more tips, strategies and market projections including cap rate expectations, you’re invited to listen to the apartment show at CREshow.com.