Development Cycle
TIC APPEAL: A tenant-in-common group bought this Indianapolis property for $20 million in July 2005.Courtesy Sperry Van Ness According to Real Capital Analytics, condo conversions accounted for more than 33 percent of all 2005 multifamily deals through September, and conversions are likely to continue to lead the market through 2006. As a result, new multifamily construction has been kept in check, and the value of many Class B and C apartment projects has risen based on the demand for conversion units or because they are next in line to receive rental demand once Class A units are depleted by consumers.
Barriers to entry for new multifamily developments remain high as well. Dirt is expensive, vacancies are just now showing signs of improvement, and rents in all but the hottest markets are still only in the early stages of recovery. The continued rise in the cost of materials also is impacting the development market’s bottom line.
“It’s hard to pencil out a financially feasible apartment development with today’s numbers,” says White. “Some major players have been able to finance and construct traditional rental projects, with plans to hold until market conditions improve. But developers and investors that don’t have the ability to hold a newly constructed apartment building are taking a risk. For most, value-added deals still make the most sense.”
A piece of good news on the development front is that multifamily inventory has remained steady, and as condo conversions take more rental units out of the market, a further reduction in supply will continue to improve the fundamentals of the apartment sector. This is particularly true in super-hot condo conversion markets such as San Diego, Washington, D.C., Las Vegas, Manhattan, and Florida’s Miami, Orlando, and Tampa metro areas.
Based on new development announcements and murmurs among multifamily owners, the turning point toward a healthy rental market may already be on the horizon. Some opportunity for new multifamily units is riding in on the coattails of the mixed-use and lifestyle center development craze.
In most major cities, there is also now a waiting list of people trying to rent condominiums, signaling either an oversupply of condos or a dwindling supply of apartment units. The main concern among speculators is what will happen if rates rise rapidly and the homeownership trend goes away.
“What will investors in conversion-crazy markets do if the condo market disappears?” asks White. “Will there be a mass of sellers trying to unload properties at prices drastically lower than they ever expected to?” He adds that condo conversion is a cyclical event and that the opportunistic buyer who can purchase in a major market for a good price and then hold for the long term could earn a windfall from the next and eventual positive market swing.
Good Times
David Baird is national multifamily director for Sperry Van Ness in Las Vegas. Regardless of the application, 2006 is going to be a strong year for multifamily. Higher interest and cap rates may usher in the beginning of change–slight adjustments in price, improvements in occupancy, and the emergence of new types of capital–but they won’t stop things in their tracks on any front. There is enough capital out there to keep projects progressing and deals rolling for the year to come, and probably well beyond.
Lone Star Living
Texas apartments fill with hurricane survivors.
One quarter out from Hurricane Katrina’s devastation, Texas apartment owners and operators are seeing their vacancy rates reconfigured by a stream of displaced residents.
Apartment demand following the storm was particularly robust in Dallas and Houston, says Joe Clements, managing editor at M/PF YieldStar.
John Fleck/FEMA A closer examination of Dallas/Fort Worth shows that Katrina’s impact on plummeting vacancy rates was felt most keenly in neighborhoods with many older units. According to M/PF YieldStar, stronger-than-usual demand was felt in Dallas/Fort Worth submarkets such as the Highlands and Mesquite, among others.
Not surprisingly, vacancy rates for Dallas/Fort Worth dipped 2.1 percentage points year-over-year for the third quarter of 2005, down to 7.8 percent. (Vacancy rates for Houston registered 6.2 percent in the third quarter of this year, versus 11 percent for the same period in 2004.)
Clements observed that owners in Houston, Dallas, and other markets took concrete steps to help those so abruptly displaced. “Though these two [metropolitan areas had already] received a notable bump in demand between June and September, causing occupancy rates to climb meaningfully, apartment operators chose to lower rents,” he explains. “They didn’t want to appear as if they were price-gouging evacuees.”
–Amy Rogers Nazarov
Slow Or Steady?
Experts offer their starts predictions for 2006.
2006 may be the year rising interest rates begin to slow multifamily construction. Or maybe not. Although housing industry economists all predict 2006 housing starts that stay close to the volume seen each of the last five years, there are some modest differences. Economists at Fannie Mae and Freddie Mac forecast a slight decline thanks to rising interest rates and high vacancies–but the National Association of Home Builders and the National Multi Housing Council do not.
Sources: U.S. Department of Commerce, U.S. Census Bureau, “My guess is we will see starts that are not that different from the last few years,” says Mark Obrinsky, NMHC chief economist. “There’s no reason to think anything different.”
In fact, the NAHB forecast calls for multifamily housing starts to remain at 349,000 through 2007.
Freddie Mac, on the other hand, predicts interest rate increases will slow starts to 340,000. Fannie Mae economists say high vacancy rates will bring a drop in starts to about 324,000 next year.
What housing economists don’t expect is a big impact from energy prices. “I don’t think we’re going to see a further run-up in oil prices above where we’ve seen them,” says Frank Nothaft, Freddie Mac chief economist.
“I think they will hover in the $55- to $65-a-barrel range for the next few months, then come down.”
–Nichola Zaklan