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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   February 2015

Has the Multifamily Market Peaked?

With the sector reaching a potential top, investors are looking for new opportunities

The 2008 real estate meltdown rewrote the rulebook on the American Dream, making renting the go-to option for many Americans. Even today, the effects of the recession remain, and it looks like 2015 is on track to be a fine year for landlords. Vacancy rates are at historic lows, hovering around 4 percent, while rent prices increased 4 percent this past year, according to the National Association of Realtors.

Despite economic progress, traditional real estate capital for first-time homebuyers remains sluggish. The scarcity of capital for homebuyers resulted in the growth of rental units to the tune of 220,000 this past year, with an expectation for an additional 250,000 units in 2015, according to data from CoStar Group.

This is promising for landlords and apartment  investors, but the trouble with reaching this type of historic height is that a cap is hit sooner or later, and once this ceiling has been reached, there’s nowhere to go but down. With vacancy rates remaining stagnant in many parts of the country, some investors are already concerned that all of these new units might suppress future gains in rental income.

It’s not surprising, then, that an increasing number of investors are looking elsewhere for opportunities, particularly in the rebounding industrial and retail real estate markets. Wary of being left holding the bag if another bubble bursts, skittish investors may be looking to exit the multifamily market.

Excessive pessimism can be just as hazardous to an investment portfolio as robust exuberance, however. The new units constructed in 2014 and 2015 may represent the low-hanging investment fruit of this real estate cycle, but apartments remain at the top of the lending hierarchy. Plenty of investment opportunities still exist in the multifamily real estate sector.

Consider that this past December both Fannie Mae and Freddie Mac announced their plans to assist credit worthy homebuyers by lowering downpayment  requirements to just 3 percent. Fearing that this leniency might result in a spike in the number of defaulted loans, some banks may initially hold off on participating in the programs even though they contain proper  safeguards and are not viewed by experts as risky lending. This move will likely enable some current renters to qualify for mortgages, but on the whole, these programs are expected to offer only a moderate amount of stimulation to the lower end of the residential purchase market, leaving plenty of room for the rental market to expand.

Digging deeper

Lenders are still offering better pricing on apartment loans than on other categories, and this has an obvious impact on cap rates. If there is an upcoming correction in the multifamily housing market, it’s unlikely to happen all at once. The economy is showing steady improvement, which typically translates to consumer confidence and a modest increase in wages. And as history shows, tough economic times are often followed by an influx of money into the economy because consumers spend excess cash on a backlog of goods and services.

This influx of cash is unlikely to immediately convert renters into buyers. For starters, consumers will not instantly have enough extra income to purchase a home, and the availability for traditional credit will still be limited. In addition, many starter homes that would otherwise have been on the market have either been bought already or are tied up in foreclosure proceedings.

In other words, commercial originators can rest assured that landlords will continue to find people who need apartments to rent. In fact, an improving economy might mean that more members of the millennial generation will opt to move out of their parents’ homes, which in turn will add to rental demand.

Lowering construction and renovation costs is another
sure-fire way to increase profits.

As with all investments, finding success in today’s — and tomorrow’s — multifamily sector is largely a matter of taking advantage of market inefficiencies. For example, once the demand for apartment units is met, attention will likely shift to the quality of housing. Apartment complexes that offer enhanced amenities such as strong Wi-Fi or ready access to public transportation will gain an edge in the marketplace.

Let’s take a look at a few other aspects of the multifamily market that may play an increasingly significant role in the origination industry.

Affordability

Investors looking to get the most out of the multi- family market may want to focus on affordability. Much of the recent growth in apartments has been at the high end of the market, leaving the number of affordable units sparse.

Affordable housing advocates have long warned that there is still a shortage of affordable housing units. If  investors — and the originators who work with them — find ways to make quality apartment complexes more  affordable, these parties can gain an  advantage over their competitors.

Location

Some areas of the country are still lagging in terms of economic recovery, while others are outperforming the national average. These higher- performing areas might have an  urgent need for new apartment units.

North Dakota, for example, is experiencing robust economic growth because of the oil and natural gas boom occurring in the U.S. heartland. The state is seeing unprecedented population growth, and because of this there’s a desperate need for workforce housing. In addition, North Dakota has plenty of open space for building and relatively few zoning hurdles to impede eager investors.

Whatever the specific market may be, investors and originators may find a great deal of success in focusing on underserved markets. The challenge with these markets lies in determining not only where they’ve been but also where they’re going. For example, the challenge for North Dakota is in seeing how its economy is affected by the recent downturn in energy prices.

Subsidizing costs

Lowering construction and renovation costs is another surefire way to increase profits. The government now aids landlords by funneling money into repurposing existing structures in urban areas to stop sprawl, weatherproofing older housing stock and investing in small-scale green energy generation. These federal incentives will likely exist as long as President Barack Obama is in office, and originators can meanwhile help their clients reap the benefits.

Many states offer similar rebate and incentive programs to encourage energy efficiency and repurposing of older housing stock, especially in blighted areas. Some urban municipal governments are also adopting a decentralized approach to the perceived threat of climate change by offering incentives for renovating apartment housing stock and embracing green building.

All of these programs allow landlords to share the burden of increased green-building costs, whether that burden is shared by federal, state or  local governments. Once these improvements are made, investors can find financial reward in having an edge over competitors by offering lower energy prices and higher-quality units.

•  •  •

These are just a few possible strategies that originators can help their investors pursue if the rental market has in fact peaked. Many investment analysts agree that the multifamily real estate market remains a strong outlet for investment this year, but it’s never too early for commercial originators to help their clients enhance their business plans for apartment construction and renovation to safeguard future profits. 


 


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