“You have to be prepared to make a substantial ground commitment,” says Mary Ann King, president of Moran & Co., a Chicago-based multifamily brokerage firm that has sold more than $8 billion in assets nationally. “And you’ve got to identify partners with a long-term time horizon so that you are not forced to sell the minute you complete a project.”
As BRE’s Moore puts it, “If you’re building in these markets, you’ve got to be willing to hold your assets for 20 years or more.”
Political acumen, municipal relationship-building and exhaustive local market knowledge also come in handy when grinding a deal through the wheels of approval. That’s because in urban centers, you’re guaranteed to run into opposition from community groups. “The nature of the interest groups at work in these markets is often a bit different than in commodity markets,” says John Kriz, a managing director focused on real estate at Moody’s Investors Service in New York. “You need a certain degree of political savvy, for sure.”
Take Drew Colquitt. The managing partner at Phoenix-based Alliance Residential attended 44 meetings over a two-year period with 21 separate municipal, community, and neighborhood groups to get approvals for a project in Kirkland, Wash. The 500-unit, mixed-use development was to be built on a brownfield site just across Lake Washington from downtown Seattle. To get the project entitled, Colquitt had to go over its plans countless times. “We talked about different ideas, different designs, and worked on environmental issues to assure everyone involved that this was going to make their community a better place,” Colquitt says. “We even worked with one individual who wanted to make sure that we would increase the amount of neighborhood art in the area.”
California is notorious for its lengthy entitlement and approval hurdles. BRE’s Lange says one of the reasons is the state’s unique tax structure: “In California, all property taxes go to the state’s General Fund. But sales tax revenue stays with the local municipality,” Lange says. “So, if you’re on the planning commission or city council, you would probably rather see retail use on a piece of land than housing.” As a result, developers in California need to pick their sites carefully, and know which ones are worth fighting for. Moore, BRE’s CEO, says the firm chose to walk from a site in Orange, Calif., for that reason. “The site had an auto dealership on it, and in the end, we knew that taking away those retail sales was going to be extremely problematic, so we passed,” Moore says. “Going after it would have been like pushing water uphill.”
With less and less land available in these markets, though, developers say they need to be increasingly imaginative to identify potential plots, most of which are rarely zoned for multifamily. Guericke at Essex says his firm is currently building a high-rise in Oakland, Calif., on a former parking lot, and is getting ready to tear down office suites in Studio City, Calif., to build apartments. “The process is just so competitive that you have to be a lot more creative in going out and finding the infill sites that will fit your parameters,” Guericke says.
Other markets impose different limitations. On the island of Manhattan, for instance, the waters of the Hudson and East Rivers dictate how far developers can go, whereas in Washington, D.C., a congressional mandate creates a height barrier. “Talk about long-term constraints,” Equity’s George says.
Once you enter a high-barrier market, you may have to put more effort into operating your property, too. After all, someone living on Fifth Avenue is likely to have different expectations than a renter in downtown Nashville, Tenn. For instance, when Equity Residential acquired the Trump Place properties on Manhattan’s Upper West Side in 2005, it immediately discovered residents there had unique demands. “They wanted their dogs walked,” George says. “One of the first things we did was to bring a doggie daycare boutique into the retail area. It’s been unbelievably successful.”
IT’S A COIN TOSS Yet, for all the attention major apartment companies give high-barrier markets, not everyone is convinced that the returns are worth the increased cost and time commitments required. At Mission Residential, a Vienna, Va.-based real estate investment firm that targets the Sunbelt, managing partner Chris Finlay is somewhat baffled by the current exodus to the coasts.
“These companies are abandoning the middle-America markets to go to the large, highly competitive—and very expensive—coastal markets,” Finlay says. “We have a different approach; we really think that five to 10 years out, the Nashvilles of the world [will] blow away the New Yorks from an investment standpoint.” He bases his view on the fact that employment in Nashville, Charlotte, N.C., and Austin, Texas, is growing at a rate of about 2 percent with a projected 3 percent population jump in the near term, versus such growth predictions of 1 percent or lower in most high-barrier cities. “We see those factors as big drivers for apartments in our markets,” he says.
Finlay isn’t alone. In May, New York-based research firm Reis expanded its coverage in 52 smaller markets, citing concerns among its clients about rising prices in large, high-barrier markets. “As transaction prices in the largest apartment markets have reached historic highs, some investors have diversified their portfolios through acquisitions in smaller metropolitan areas,” said Sam Chandan, Reis’s chief economist, in a press release.
Still, proponents of high-barrier markets point to equally convincing data. “In Orange County, rent growth has averaged 6.6 percent over the last 10 years,” says King of Moran & Co. “That’s one of the strongest long-term average rent growths anywhere, and we’re almost never in a situation here where rents go down. The fact is, there’s a reason people are willing to settle for a lower initial return in development-constrained markets: Over the long term, the returns are usually greater, and you have stronger, more consistent rent growth.”
Joe Bousquin is a freelance writer in Auburn, Calif.
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