Since the housing bubble burst and other sectors followed it into the recession—numerous observers have predicted that multifamily markets would lead the real estate recovery. As early as March 2009, Forbes magazine forecast that rental projects would lead the rebound, and signs showed it could happen before the end of that year. But the real estate rebound did not happen that quickly and still has not fully materialized, though experts agree that market fundamentals still point toward recovery.
“Multifamily continues to be one of the brighter spots in housing,” says David Crowe, chief economist at the National Association of Home Builders. “Not only is the overall index on the rise, the market-rate rental component has improved dramatically. In the first quarter, the market-rate rental component was 60.5 [percent], the highest level in more than five years,” says Crowe.
“You don’t often see occupancy and rents increasing at the same time,” confirms Rich Anderson, a real estate investment trust (REIT) analyst covering the multifamily sector for BMO Capital Markets, based in New York City. “It’s a great fundamental picture today.”
Although the increase is cause for optimism, the multifamily market still faces significant challenges, Crowe says. “There is considerable pent-up demand, but the ongoing crisis in funding for new construction means that developers are limited in their ability to meet that demand.”
According to a recent market report by real estate analysis firm CoStar, construction of new multifamily housing is expected to outpace that of new single-family homes this year because of falling homeownership rates and market shifts. Costar predicts 22,536 units will be added to the nation’s apartment supply in the next year, with most of those being built in fast-growing urban areas like Dallas, Atlanta, Baltimore, Denver, and Oakland. In response, REITs and private companies are positioning themselves to capitalize on the emerging demand for apartments, creating new alternative funding sources.
Among the most significant players in the southern California multifamily market are Kennedy Wilson, UDR Inc., Sares-Regis Group (SRG), and KB Home. Many of these firms are focusing on the younger demographic, which in more propitious times would look at homeownership. But with the economy in a glacially paced recovery, a larger share of young Americans, even those who have careers, are watching home prices fall while they still need tens of thousands of dollars for a downpayment. The tumultuous real estate market has left many people either unable or unwilling to make the financial commitment to purchase a home, so they are turning to rental housing. As a result, apartment vacancy rates are falling precipitously and rental rates are climbing.
This increased demand could be good news for companies such as UDR, a multifamily REIT based in Highlands Ranch, Colorado, that focuses on apartment communities in select markets throughout the United States.
“As a result of the down economy, there has been a secular shift in the housing dynamics across the United States. A number of powerful forces—including foreclosures, tight credit markets, and the rise of gen-Yers—have contributed to the rise of people choosing to rent rather than purchase a home,” says UDR president and CEO Tom Toomey. “As more Americans have begun to favor renting over homeownership, it has created greater demand and, hence, pricing power for apartment owners and operators. At the same time, I foresee a divergence in multifamily returns based on portfolio location. We continue to favor the densely populated urban markets over suburban locations.”
| 21 Chelsea, New York City |
Toomey believes that the urban markets will continue to outperform suburban ones for two key reasons: the barriers to entry in densely populated urban markets make it difficult for future development; and college-educated 20- and 30-year-olds prefer urban communities over suburban ones. Stronger job growth in urban markets has been a major reason for their preference for urban living.
“We will continue to focus our efforts in expanding into urban markets that are characterized by above-average job growth, low home affordability, and limited new supply—three of the key drivers to strong rental growth,” Toomey says.
UDR believes now is the right time to expand: this year it has announced nearly $1.2 billion in acquisitions and $375 million in new developments. “I am confident that the multifamily industry will continue to lead the real estate recovery, especially due to the positive macroeconomic factors influencing the sector,” Toomey says. “We are uniquely positioned to outperform, given our portfolio concentration in high-barrier-to-entry urban markets.”
In the past 12 months, UDR has entered or increased its presence in Boston, Manhattan, San Francisco, southern California, and Washington, D.C. In July, it announced the off-market acquisition of the Rivergate and 21 Chelsea apartment communities in New York City.
“There is an opportunity to substantially increase rents, both through the implementation of UDR’s operating platform and through the redevelopment of these Manhattan communities,” Toomey says. “In Washington, D.C., the acquisition of View 14 was an opportunity to own a recently developed community with luxury-style finishes and amenities located directly across the street from our 255-home development project, 2400 14th Street.”
“There’s no place in real estate brighter than multifamily today,” he concludes.
In California, Beverly Hills–based Kennedy Wilson (KW) has also invested heavily in the multifamily sector. The company pursues multifamily acquisitions where its team members believe they unlock value through several strategies, including asset rehabilitation, repositioning, and creative recapitalization. A nationwide leader in the auctioning of units in previously distressed properties, the company seizes on the market’s current favorable terms for acquisitions.
| Hanover Square, formerly office space for Goldman Sachs Group Inc. and Kidder Peabody & Co., was converted in 2005 to a residential tower. |
“Geographically, we focus primarily on apartments in supply-constrained, infill West Coast markets,” says Robert Hart, president of the firm’s KW Multifamily Management Group. Kennedy Wilson recently announced that its joint venture with the LeFrak Organization has refinanced two of its multifamily properties with new debt totaling $56.4 million at an average interest rate of 4.6 percent: the Grove, a 331-unit community in San Jose, at a seven-year fixed rate of 4.34 percent on $32.3 million of new debt; and Indigo Springs, a 278-unit community in Kent, Washington, at a ten-year fixed rate of 4.96 percent on $24.1 million of new debt.
“These assets are located in our target markets, where we are seeing improved operating fundamentals and solid rent growth,” says Hart. “We were very pleased to be in a position to take advantage of the low-interest-rate environment and obtain very attractive Fannie Mae fixed-rate financing, which will provide Kennedy Wilson and its investors with double-digit cash-on-cash returns for these assets.”
Kennedy Wilson announced in May that it and its partners had acquired Bella Vista at Hilltop, a 1,008-unit multifamily community in San Pablo, California, for $140.5 million. According to Real Capital Analytics, the purchase represents the largest single multifamily asset transaction by unit count in the United States so far this year. The addition of Bella Vista is also the largest single multifamily asset acquisition in Kennedy Wilson’s history, increasing the company’s multifamily portfolio to 12,906 units in the western United States and Japan and assets under management to $7.4 billion.
The current state of the multifamily market in southern California and Los Angeles allows prices to rapidly rise because the fundamentals have greatly improved. Rental growth has been tremendous in the past six to 12 months and occupancy has increased tremendously.
Sares-Regis, which is among the leading developers and managers of commercial and residential real estate in the western United States, has 1,900 residential units in preconstruction and development and more than 3 million square feet (279,000 sq m) of commercial industrial space in the entitlement process. Since its inception in 1993, the company has acquired or developed about 20,000 multifamily and residential housing units and 44 million square feet (4.1 million sq m) of commercial properties. It also counts itself as the largest privately held developer of sustainably built and managed apartment units in southern California and has completed construction of the first green speculative industrial project in Orange County.
In Huntington Beach, California, construction is set to start on the firm’s Boardwalk Apartments—487 luxury, sustainable, transit-oriented apartments. A bus transit center is just one block northwest of the project, and the development is within walking distance of shops and restaurants. City planners say focusing on development that is near transit and walkable is a key for continuing revitalization efforts in the heavily trafficked area. Construction should begin soon at the project, which will have an estimated value at stabilization of $164 million, says Mike Winter, senior vice president of SRG’s multifamily development division.
Boardwalk Apartments is an important residential component at a gateway to the coastal community of 202,000 residents that bills itself as Surf City, U.S.A., say city planners. “Members of the city’s Department of Planning have noted that Boardwalk Apartments will bring needed housing balance to the area, offsetting an abundance of retail,” says Winter. Irvine architectural firm TCA planned and designed the project. Using on-grade, wood-frame podium design, TCA incorporates four levels of construction, with parking below three levels of units and units on the first floor in front of the parking.
| In July, UDR announced the off-market |
Boardwalk Apartments will have 429 one- and two-bedroom apartments, 54 studio apartments averaging 647 square feet (60 sq m), and four townhouses at 1,339 square feet (124 sq m). Amenities include club rooms and lounge areas, a swimming pool, resort-style fitness and spa areas, a private indoor theater, and a combined internet café/postal facility. Consistent with SRG’s sustainable-development policy, Boardwalk Apartments will be GreenPoint Rated under the Build It Green program for new multifamily construction—an alternative to the U.S. Green Building Council’s Leadership in Energy and Environmental Design (LEED) program.
The for-sale condominium housing market—where KB Home has long been dominant—is also contributing to the real estate recovery.
“Housing is a very local business, and the recovery will be local as well,” says KB Home CEO Jeffrey T. Mezger, based in Los Angeles. “There are markets in many cities located in desirable areas close to employment centers and good schools that are demonstrating stability. These are the areas in which KB Home is focusing its investment and new community openings, particularly in land-constrained areas of coastal California and Texas. KB Home has been operating successfully in this space for many years.”
A recent offering is Primera Terra at Playa Vista, a community in southern California that is one of the largest communities of LEED Platinum–certified homes in California and currently the only Platinum-certified community open for sales in the state. The 52 luxury condominiums are equipped with energy- and water-saving features and built with sustainable materials to make them more comfortable and efficient than a typical new or existing home. They are rated at least 40 percent more energy efficient than homes meeting California’s Title 24 standards for new residences.
KB Home’s dedication to LEED values in this community extends to many aspects not usually seen in this market. The subterranean parking garage is equipped with electric vehicle charging stations, and every home comes with an energy-monitoring system that can be accessed via a personal digital assistant device or the internet, allowing homeowners to track their energy use and costs in real time. The homes are priced in the $500,000s and $600,000s, considered an achievable price point by West Los Angeles standards.
According to the PricewaterhouseCoopers Real Estate Barometer, the best-performing sector in the U.S. real estate industry is the multifamily market, which is seen to be entering an expansion phase through 2014. The multifamily sector seems to be anticipating the new norm in housing for the upcoming decade: for the first time in history, more people in the world live in urban areas than in rural communities. In the United States, this means metropolitan areas are the true centers for population and economic growth.
As the recovery gains momentum and development accelerates, multifamily projects and investments are poised to lead the way toward overall improvement of the real estate industry and will be a major factor in the renaissance of urban living and city development.