While we’re closing out another record-breaking year, we’re looking ahead to one that will be a little bit slower, but by all means healthy and stable.
To get an idea of how the industry is preparing to handle the maturing cycle, we asked five executives across the country to share their thoughts on current market conditions. Here, they reveal what surprised them this past year, what indicators they’re watching now, and what has them excited about the year ahead.
Joe McKendry
MIKE SCHALL
The apartment industry has treated everyone well so far, but recent job-growth reports and dampened rent growth could be signs of things to come, says the CEO of Essex Property Trust.
Where do you see the most opportunity in 2017?
We’ve been very active in two areas. First, we’ve originated preferred-equity investments in existing shovel-ready development deals. Rapid changes in apartment development dynamics, including double-digit construction cost increases and very conservative bank construction lending parameters, have created this opportunity. Second, we continue to grow our institutional co-investment platform, taking advantage of the extraordinary positive leverage—the spread between cap rates and the seven- to 10-year mortgage rates—in the apartment markets.
What markets still have the potential for more rent growth?
Generally, Southern California has the best growth potential in the short term. More specifically, the areas of Southern California that have muted levels of supply, such as the San Fernando Valley and Woodland Hills. Seattle led our portfolio in rent growth in 2016 and carries significant Âmomentum into 2017.
Do you think cap rates will continue to compress or start to expand?
Many investors expect upward pressure on cap rates given [the] deceleration in rental growth. We don’t agree with this assessment, for two reasons: First, stock-market Âinvestors often focus on short-term trends, while the real estate markets are more focused on long-term growth rates. Second, the extraordinary amount of positive leverage in the system creates exceptional cash flow in a yield-starved market. We recently completed a 10-year fixed-rate mortgage below 3%. If similar financing is applied to an average-quality apartment acquisition, the cash on return can exceed 6%.
Do you see any changes in the equity markets?
With decent U.S. economic growth expectations in 2017, we don’t see major changes in the equity markets. However, we could see greater volatility given the expectations of Fed rate increases, the forming of asset bubbles given extraordinary low interest rates, and the continuation of muted growth rates.
What surprised you in 2016?
2016 has been another industry-leading year for Essex. However, certainly the rate of deceleration of job growth, leading to muted rent growth, in Northern California was unanticipated. A year ago, reported job-growth numbers in San Francisco and San Jose were in excess of 4%, compared to 2% to 3% by the end of 2016. Interestingly, job growth in Seattle hasn’t experienced this deceleration, even though it has a similar job base as the Bay Area.
How are you changing your strategy to tackle slowing rent growth?
We’re funding more of our activities through dispositions and have focused on building occupancy, especially as we approach year end and its normal seasonal slowdown.
