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2014 Resolution: Where are Multifamily Assets Headed?

Ankit Duggal
3 min read

Investors you are only 68 days away from 1/1/2014. 2014 is upon us!

Have you made you investment resolution?

As an investor it is important to understand your asset class market and make investment plans before you start buying or selling based on where you market sits.  Markets are in a constant state of flux and investors need to know where the market for their respective asset classes are trending so that they can make the best decision on how to participate based on their risk-reward investment criteria.

Today we will discuss the multifamily asset class and put it into the context of what is happening in the asset class from a strengths, weakness, and recent market trend perspective and recommend a  couple of ways to play the asset class for the upcoming fiscal year based on my analysis.

Strengths

The multifamily asset class growth has been driven since 2009 by positive demographics- young adult renters, shadow households, foreclosed homeowners, and downsizing baby boomers- that has created significant demand drivers. While on the supply side, the developments had been constrained given lack of risk-on capital markets since 2009 to 2011.

The supply side equation is starting to change given the Niagara of capital flowing into the apartment sector since 2012 which has, in turn, driven cap rates on existing assets nationwide below 6 and is providing more risk-on capital for apartment developers to bring up new supply into markets. The supply side on a nationwide basis is still going to be under control given that nearly 300,000 new units are needed per year to compensate for population growth and units being functionally obsolete. According to Fannie Mae, the multifamily sector is projected to experience nearly 204,000 new apartment units to come online in 2013 which is below the 300,000 needed to maintain equilibrium in markets nationwide.

Weakness

Large capital flow into the multifamily sector raises concerns as the waterfall of capital is chasing fewer and fewer deals which has made exit cap rate projections of below 4% very frothy, in my personal opinion.

The growth in demand for rental units especially associated with non-traditional sources of demand i.e.  foreclosed homeowners and downsizing baby boomers  have driven up rental prices while inflation adjusted household income has gone up as much. This mix creates a dangerous combination of unaffordable rental prices that may slow down or decline over the coming years especially in markets where new projects are easy to get off the ground such as Sunbelt markets as well suburban areas which can create a supply-demand imbalance.

Market Trend

Where is market sitting today? Great question and I use REIS Quarterly Trends report to keep me on top of the emerging trends and issues in each asset class that I monitor. Dr. Victor Calanog, REIS VP of Research,  provides very astute insights into the key issues surrounding the asset class and below you will find his Q3 update for the apartment sector :

Key Stats

  • Vacancy rate dropped 10 basis points to 4.2%
  • Current vacancy rate 100 basis points below national long term average vacancy rate
  • Asking and effective rents grew by 0.9% and 1.0% respectively

Dr. Calanog Analysis Key Takeaways:

The national apartment vacancy rate is more than 100 basis points below the long term average and  landlords are losing pricing power because rent levels have exceeded historic norms.  Interestinglyasking and effective rents quarterly year-to-date average for 2013’s three quarters is actually lower than that of 2012. So what’s happening next to the multifamily sector:

  1. Higher supply growth, and
  2. Constrained ability of landlords to raise rents

Watch his thoughts, take a review on the video below:

Q3 2013 Apartment Trends from Reis Reports

My Thoughts based on REIS Research:

Based on the above factors, it seems that the multifamily sector rental prices may decline in markets with low supply constraints and on a nationwide basis the vacancies of multifamily assets will bounce back up to its historic long term average. The mean reversion to the long term vacancy rate will create lower than projected return profile for assets bought with the low vacancy rate built into the model.

Making a Bet for 2014:

I would still be an investor in the multifamily asset given that the trends are favorable, provided the growth in population, shadow households and low overall supply. I would play the multifamily asset class as an equity and mezzanine investor.  As an equity investor or operator, I would recommend focusing on multifamily assets in high-barrier-to-entry urban infill markets that have the potential for Gamma strategies, fancy way of saying improving cash flow through better management and making strategic capital improvements to reduce building expense and improve rental efficiency thereby increasing asset value.

Any assets surrounding transit locations that have a bring renters to major employment hubs will be great markets however you will face a lot of competition from other investors and buyers. As a mezzanine investor, I would recommend investing capital into operators who are pursing Alpha and Gamma investment strategies within the Opportunistic investment style or invest into assets that are in redeveloping urban markets producing a high capitalization rate with catalyst of municipal redevelopment.
Photo Credit: Mondo Tiki Man

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.