Multifamily housing experts discuss opportunities and challenges for developers and investors, signs of possible oversupply, the potential of properties outside the urban core, consumer preferences for unit types and amenities, the appeal of renting over owning, and other trends.
What lies ahead for developers and investors in the multifamily sector this year?
Charles Hewlett: I would expect that 2014 is going to be a stronger year economically than 2013, which should bode well for the demand for apartments. The challenge is that apartments have been the favored investment and development class for a number of years, so the competition in that sector, even in the face of continually improving market fundamentals, is going to be just as fierce if not more so than it has been over the past couple of years. We keep hearing about institutional capital allocators becoming more cautious about investing in developments and acquisitions, and yet when you talk to people on the ground, you continue to hear about 20 bidders going after the best deal. The supply of capital chasing deals is unlikely to decline, so finding quality deals will be the biggest challenge.
Dee McClure: From an investment perspective, multifamily housing is not as favored as it was previously. Clearly there is continued increased competition on the acquisitions side. We are continuing to see equity sitting on the sidelines, with increasing push for its deployment. However, there is a reduced number of transactions. Competition from foreign investors has also increased, particularly Chinese investors. On the financing side, clearly there is a resurgence of the commercial mortgage–backed securities [CMBS] market, which is highly attractive for the B- and C-class assets. Certainly life companies and foreign debt funds are becoming more active in the multifamily sector. From a development perspective, banks are active in the sector as well, but they are still primarily providing floating-rate loans. There is a niche to be filled there with fixed-rate construction debt.
Does it look like oversupply might pose a significant challenge?
John Echols: I do not see the potential for massive overbuilding that will go on for any length of time. Every deal that gets done, if there’s a construction lender involved, has been thoroughly underwritten. There is so much transparency in these deals for everyone involved, from developers to capital providers. So if the supply becomes too high, it would quickly rebalance. In some previous cycles, overbuilding kept going way too long, and then there would be massive correction. I don’t see that happening anywhere now.
Mark Stern: In certain markets, we have concerns about an oversupply of housing—for example, Washington, D.C.; San Francisco; and San Jose. Chicago gives us a little bit of concern. Then there are the Texas markets, because they typically have pretty large supplies when the markets heat up. A lot of multifamily housing is being built in Houston and Austin. Of course, oversupply almost breeds opportunity in the future. Our company is very opportunistic, and in 2010 we bought a lot of construction loans. But we don’t see supply being troublesome right now, on the whole. This is still a good time to invest in multifamily housing. You just have to pick your opportunities. We don’t buy core assets, and we don’t develop. Instead, we focus on value-add and opportunistic investments. We’re looking for rehab opportunities where we can transform the property and try to raise rents.
Hewlett: In the Washington, D.C., area, a couple of submarkets have been experiencing negative net rent growth in the last several quarters, and that is entirely supply driven. The long-term fundamentals of this and other supply-constrained coastal markets are very strong. There just will be a period of some weakness in terms of rental rate growth as the inventory gets absorbed. But if you look at the data, I don’t think you could make a strong argument that the rental apartment market at a metropolitan or national level is severely out of balance—just the opposite. There has been and continues to be pent-up demand for rental apartments. It just takes job growth and rising consumer confidence, particularly so that young folks can get out of their parents’ basements, join the ranks of the employed, and form households.
Are more opportunities developing for investment or development in multifamily housing outside the urban cores?
McClure: Investors continue to chase yields because we are in a compressed-capital-rate environment. So more institutional investors are becoming willing to consider secondary and even some tertiary markets, primarily for the ability to successfully purchase properties with attractive yields. That also reflects a growing understanding that those locations will prove salable down the road and that those assets can provide a very stable return. It’s an approach that smaller regional players have been deploying for years. I’m also seeing some interest in other subclasses of multifamily. There is more interest in student housing, for example, due to the higher yields.
Stern: Young people want to live close to where they work, and that’s been driving the focus on urban settings. I think you’ll start seeing more development in the first ring of suburbs. In the Chicago area, Evanston and Oak Park are examples: they’re just outside the city. The key for suburban development is going to be proximity to public transportation.
Echols: In urban areas, there have been a lot of new high-density, high-cost high-rises and mid-rises that are highly amenitized, but there has not been much activity in the suburbs. Some developers are moving toward becoming active in the suburbs again. We are; we’ve always been active and very successful in the suburbs. But the institutional capital is focused on urban-core, high-density projects for now. The suburban areas are wide open, but developers can’t get financing for projects there, so it doesn’t get built.
What kinds of units and amenities are proving popular?
Echols: For high-density projects—mid-rise or high-rise buildings with multilevel parking structures—rooftop decks or other public areas at the upper levels that offer views of the city are becoming popular. These are accessible to all residents and placed either on the residential building itself or on the parking structure, whichever is more doable. The units themselves are Class A, condominium-grade, institutional quality, with every amenity that you can think of, including granite countertops, ten- to 12-foot [3 to 3.6 m] ceilings, enlarged windows, and all the latest technology. None of those amenities is necessarily new, but you have to offer a full Class A amenity package to compete.
McClure: Clearly, affordability has become more central to developers, especially if you look at the demographics of the next wave of renters. In urban settings, smaller units are becoming more desirable, and, in certain locations, micro-units that are under 400 square feet [37 sq m]; I’ve even seen one with only 250 square feet [23 sq m]. The oddity is that renters want larger communal spaces so they can sit and text in lieu of talking to each other. There’s increased competition in urban settings to provide the most affordable unit possible in a new A-plus multifamily project with smaller living spaces and all the bells and whistles. This “amenity war” means that additional opportunities for revenue arise, such as renting bicycle parking and larger storage spaces. We are also seeing more of a human touch with amenities; for example, the management will walk dogs while residents are gone. It’s about figuring out how many services you can provide residents so they have everything they want at your property and not someone else’s.
Do you see signs of a shift in consumer preferences for renting versus owning?
Hewlett: I don’t think that the dream of homeownership is changing fundamentally in the United States, but there may be a delay of a couple of years due to the hangover from the Great Recession. The lesson is still very fresh in the minds of generation Y that you might lose if you invest in for-sale housing. But if you look at all the consumer research, people in their 20s will tell you that they expect to own a home at some point in the future; they are just waiting a few years longer than the previous generation did.
Stern: At its peak in the United States, the homeownership rate was close to 69, 70 percent, and now it’s down closer to the mid-60s. There’s still a propensity to rent, and I think it has to do with people wanting to stay mobile. However, I also believe that we’re at the point in some of these markets where, as rents keep getting higher and the costs of renting come close to the costs of owning, people will go back to buying condos again. In oversupplied markets, some of these new rental properties will likely be converted to condos. I’m not sure if homeownership is the ultimate dream that it used to be, but I do see the homeownership rate going higher than where it is now.
Echols: The multifamily rental sector was probably the only beneficiary of the housing bust, because a lot of people realized there were risks associated with being a homeowner or a condo owner. There is a strong and growing preponderance of young people in the country who want the mobility that renting provides and who don’t want to be encumbered by the responsibility and costs of ownership. People enjoy the lifestyle they can have in some of the new, highly amenitized apartments. They enjoy the fact they can live exactly where they want to live for as long as they want to live there, and then if they get a job offer in another city or locale, they can quickly make a move. Homeownership rates are now drifting back to more normal levels, but if you look at the demographics, there is a huge wave of young people adding to the ranks of renters for the foreseeable future.
What other trends are you noticing?
Stern: In Chicago, as the recession came, a lot of suburbanites started moving downtown because the rents dropped and now they could afford to live in a downtown high-rise. So what happens now that downtown rents are going back up? In downtown Chicago, they’re hitting all-time highs again. Will people migrate back to the suburbs, or will they stay urban because they love it? The young people at least want to live in the city. They want to be close to work, entertainment, and restaurants, and they want to be close to each other.
Hewlett: College enrollments are about to peak and start declining. But even as enrollments decline, a lot of first-tier institutions are trying to ensure that they are competitive from a housing standpoint, so there are lots of interesting niche opportunities over the next ten or 20 years. The student housing market won’t be as robust as it has been for the past ten years, but schools will have to compete to attract the cream-of-the-crop students, and housing is one of the key ways to do that.
McClure: I don’t know if this is a trend, but in the over-40 age group, some are owning a home in one area and working in a different city and renting an apartment there. Their work and lifestyle require two residences, with a part-time presence in the apartment. They may currently represent a small percentage of overall residents, but with today’s technology, you don’t have to be at company headquarters five days a week. I’m interested to see how developers will look to capitalize on that market segment.
Ron Nyren is a freelance architecture and urban planning writer based in the San Francisco Bay area.