A Building Balancing Act

Experts discuss concerns about multifamily housing supply and demand, whether the sector has peaked, and markets to watch.

SEVERINO ON WHETHER MULTIFAMILY HAS HIT A PEAK.

PrivcapRE

Multifamily housing is considered the gold standard of commercial real estate investing. We’ve seen significant capital flows into the sector in the wake of the crisis, yet many are questioning whether it’s hit its peak. How do you assess the market?

Ryan Severino, Reis

Fundamentals, based on data and our outlook, have hit a bit of a peak. We expect vacancy to trend upward for the next four to five years, even though rents will continue to grow. On the capital side, there’s still demand for apartments, both in existing inventory and developing new product. We expect to see cap rate compression and a pricing increase in the next four to five years. Capital markets haven’t quite peaked yet. There is still pent-up demand for multifamily that will be unleashed in the next few years.

PrivcapRE

The fundamentals are suggesting something different in terms of the value we can get out of multifamily. What are your expectations for net operating income growth, and what’s driving that?

Severino

That will be an interesting change for the property type versus what we’ve seen in the last three, four, five years. Coming out of the recession, landlords were willing to play the occupancy game to generate revenue growth. They weren’t as concerned with pushing asking rent so much as generating occupancy increases for revenue and NOI growth. That story played out, and we’re starting to see construction ramp up, so vacancy compression won’t contribute as much to revenue growth. The onus will be on landlords to push rents in order to drive that revenue growth.

PrivcapRE

Are we set for a demand implosion for multifamily?

Severino

I don’t think so, because if you look at the underlying drivers, they’re all pretty strong. We’re talking about Generation Y being a relatively young, large generation. Most market prognosticators define the prime rental cohort for apartments as 20-to-34-year-olds. Most of Gen Y doesn’t have a spouse; they don’t have children; they’re transient. All of those things dissuade them from being owners as opposed to renters.

PrivcapRE

What are your expectations for rent growth in the next three years?

Severino

A little higher—in the 3 to 3½ percent range. It’s partly a function of vacancy being tight at about 4 percent. Even if it does drift upward during the next four to five years, sub–5 percent vacancy is still tight enough for landlords to extract rent increases from their tenants. Supply will increase, and some landlords will lose tenants. That’s counterbalanced with new properties tending to come online at higher-than-average market rents. Because those two things are in a tug-of-war, somewhere in the 3 to 3½ percent range annually is a reasonable outcome in the next three to five years.

PrivcapRE

Are we expecting a glut of supply in 2014 and 2015?

Severino

Most construction will probably come online in 2014. It’s not as if we’ll downshift into the levels of the last few years, when people were concerned about fundamentals and the economy. There was less capital available for new construction. I do expect a decrease over time, but not anything like the last few years. There will be more construction and competition in the marketplace than in 2009, 2010, or 2011.

PrivcapRE

In terms of multifamily, is there anything in the next few years that worries you?

Severino

The big concern is supply. Everybody knows real estate is a local phenomenon. Investors and developers are going to have to be cautious about the submarkets and neighborhoods they’re in—making sure that if they’re going forward with a deal, they really understand the local factors. Three to five years ago, it wasn’t as much of a concern, but given where we are in the cycle now, this is an important juncture. We’re going to see vacancy rates flat to upward in the next five years.

CARROLL ON HAVING FAITH IN FLORIDA, AND BALANCING SUPPLY AND DEMAND.

PrivcapRE

There’s been a lot of capital going into the multifamily sector, which has many asking: Can performance in 2014 be as robust as in the past couple of years?

Patrick Carroll, Carroll Organization

It’s submarket specific. We’re looking at which markets have been slower to recover, and that’s where we want to invest our dollars. Markets that have been strong will continue to perform well, but you won’t see outsized returns. We’re firm believers in markets like Florida that have been slow to come back. We’re seeing that market rebound, and that’s where we’ll be investing heavily.

PrivcapRE

What are you seeing in terms of occupancy? How is the housing market’s recovery impacting your strategy and occupancy gains?

Carroll

Occupancy has been strong, and we’re cautious of overbuilding. If there’s demand and need, it will more than likely be oversupply. We’re focusing on submarkets that haven’t seen a lot of supply—suburban markets where it’s been hard to get capital to develop—and that’s where we’re looking to buy. I hope demand keeps up with the new supply.

PrivcapRE

There are concerns about coming supply when you look more widely at multifamily, not only at Florida and Texas. Are there any concerns from your side?

Carroll

Houston, Texas, has been a great market. A market that shows early signs of recovery is the easiest in which to raise capital to develop new properties. They see new supply first, and the story has yet to be told on how those markets digest it. Houston is taking it in stride.

PrivcapRE

What are the expectations for your own portfolio but also general growth in the next couple of years?

Carroll

Again, it’s submarket specific. As a whole, in the markets we’re most active in—Texas, Florida, Georgia—we project 3 to 4 percent rent growth. That’s coming off 7 to 8 percent rent growth in some of these markets. To get those outsized returns, we’ll have to improve the property, reduce expenses—do something to create additional NOI for our investors.

PrivcapRE

You see quite a rebound for multifamily in Florida. What are you expecting?

Carroll

I’m looking forward to a continued rebound in Florida, which was devastated by the downturn in housing markets. It was almost a domino effect. The housing market got crushed, it affected the overall employment picture, and that caused everybody to pull back. Now tourism is back, the housing market is coming back, and Florida is going to start firing on all cylinders again.

APPEL ON GROWTH RETURNING TO MORE SUSTAINABLE LEVELS.

PrivcapRE

When you look at capital inflows for the U.S. multifamily market, one question is whether we’ll continue to see the same performance as in the last couple of years. What’s your perspective on today’s market, and what are you expecting in 2014 and 2015?

Russ Appel, Praedium Group

The last couple of years were the first in my 30-year career where investing in real estate could earn almost four times the risk-free rate in current cash flow, with leverage of 60 to 65 percent. We can earn six times the five-year risk-free rate, again, using 60 to 65 percent leverage. It’s certainly not maximizing leverage, and earlier in my career I could never have said that. Looking forward, we can get great yields from the sector and continue to see growth.

PrivcapRE

When you look at your portfolio and rising interest rates, is there enough growth ahead in 2014 and 2015?

Appel

Everybody’s concerned because we had two years of high growth in the sector. This property type is forecasted to have the highest growth in the next several years, but because it’s less than in the prior two, people are concerned. There should be concern about supply in certain markets, but demand is strong. It’s the only property type with a hedge against interest rates. Not a complete hedge, but if interest rates go up, home mortgage rates will likely increase, meaning the cost of home ownership goes up and pushes people back to the rental market.

PrivcapRE

Is there anything that’s concerning you in multifamily as you look at the next couple of years and compare it to growth in 2012 and 2013?

Appel

If we get less growth than in 2012 and 2013 but it’s still solid, no one’s going to complain, because of the cash flow you can get from multifamily. We’ll see growth in the sector, albeit not as robust as in 2012 and 2013. We can’t keep up that kind of growth—it’s not sustainable in an environment where wage growth has been relatively slow. As we see wage growth, maybe we can go back to that robust growth. That will depend on household formations and the trade-off between ownership and renting. The question investors are asking is how much supply there is. We have a big hole, because there was such limited construction in the past three years. Now we’re going back to average levels of supply and not enough supply for the demand.

PrivcapRE

We talk about Gen Y and Gen X renters. Will we see a peak in demand, and will it decline in the near future?

Appel

You have the echo boomers coming to an age where they’re creating households. More broadly, about two-thirds of the population owns and one-third rents. For people in their early 20s to mid-30s, it’s the opposite, so two-thirds rent, one-third own. If you look at the number of people approaching that age, we’re going to see more demand. Then it depends on whether they buy or rent over time. No one knows the answer to that, but getting mortgages is harder today.

PrivcapRE

Is multifamily about to hit a peak, or has the sector already hit one?

Appel

I don’t think we’ve hit a peak, and we’re not about to hit one, because there’s still growth and good yield. There aren’t many investments offering that across the investable universe./