Private-local buyers powered the national market in 2002 – assisted by low interest rates, Internal Revenue Service (IRS) Section 1031 exchange requirements, and a lack of alternative investments that accounted for approximately 50 percent of the dollar value of all purchases. Almost every category of multifamily buyer was a net purchaser of multifamily properties, except for private-national investors who were the net sellers to the rest of market (see the chart below). Clearly, sellers recognized the strong pricing environment, fueled by low interest rates and an increased demand for stable, cash-flow yielding investments, and sold into this demand.
During this period, multifamily real estate investment trust (REIT) earnings declined almost across the board. Several multifamily REITs cut dividends in the fourth quarter, and the average REIT dividend yield for the multifamily sector was 7.7 percent at year-end. Public REITs’ fourth quarter earnings announcements highlighted owners’ limited ability to increase same-store revenue–which when coupled with an increasing expense burden led by property taxes, insurance, and marketing expenses, hampered net operating income and funds from operation growth. Still, multifamily REITs continued to trade at or near their net asset value and ended the year with total returns better than most other stock market indices – negative 5.8 percent versus the S&P 500’s negative 22.2 percent.
The West led the nation for multifamily sales in 2002, with $6.6 billion or 33 percent of the total, up nearly 50 percent from 2001. The average price-per-unit in the West exceeded $91,700, an increase of 4 percent from 2001, with a median cap rate of 7.6 percent according to Real Capital Analytics. The strongest markets in the West were located in Southern California, where multifamily real estate fundamentals remained almost uniformly positive and entitlement processes are notoriously slow. Sales in San Francisco and the Silicon Valley continue to be challenged by that region’s economic hardships.
The Southwest accounted for 24 percent of the nation’s dollar sales volume in 2002, totaling $4.8 billion for the year – rising 9 percent from 2001. The number of transactions increased 25 percent to 332. Cap rates were relatively flat year-to-year with a median rate of 8.7 percent in 2002. At nearly half the price-per-unit of the Northeast, this region’s average price-per-unit of $56,500 was down 13 percent from the previous year. Transactions continue unabated, despite the difficult operating environment for multifamily owners in most of their markets, due to strong IRS Section 1031 exchange transactions and the belief that strong demographic characteristics will return when the recession runs its course.
The Northeast and Mid-Atlantic regions also fared well. Combined, the dollar volume of sales jumped 18 percent to approximately $3.6 billion, while the number of transactions stumbled 28 percent to 122. The average price-per-unit was in excess of $107,000, up nearly 32 percent from 2001, and median cap rates declined to 8.4 percent. REITs were the largest category of buyer in these regions accounting for 40 percent of the dollar volume of all purchases in the Northeast and Mid-Atlantic (versus their 20 percent share of the nation’s total dollar sales volume). REITs were rebalancing their portfolios by increasing exposure in these high barrier-to-entry markets. The Washington and Baltimore markets were buoyed by relatively strong operating fundamentals, while increasing concessions and vacancies hampered the rest of the region. Moving forward, strong acquisition demand continues for multifamily properties located in New York, Boston, Washington, and Baltimore.
In the Southeast, multifamily sales by dollar volume dipped 18 percent to nearly $4 billion, while the number of transactions plunged 29 percent from 2001 to 230. The average price-per-unit was in excess of $61,000 in the Southeast, and the median cap rate dropped to 8.7 percent by year-end. Operating fundamentals were under pressure in most markets with the exception of South Florida. The majority of the remaining Southeastern markets have few barriers to new development, which further dampens demand for communities in the Southeast.
The Midwest also experienced dollar sales volume declines in 2002, plummeting approximately 50 percent to just below $1 billion. The Midwest’s average price-per-unit fell 17 percent to approximately $48,600 in 2002, while cap rates also fell to 8.5 percent. The Midwest markets also were hit by declining operating fundamentals. Most Midwestern markets have few barriers to new development, and the average home price is low enough to place a cap on rental rate growth. Analysts also have noted that the demographics of the Midwest show out-migration further inhibiting the value of Midwestern multifamily properties.
Multifamily sales values have performed well in 2002, driven by near-record investor demand created by a dearth of alternative investments and the availability of high loan-to-value, low interest rate loans. As the economy recovers, the multifamily sector should improve faster than other sectors due to the short-term nature of its leases. Longer term, echo boomers and immigrants will increase demand for the multifamily sector.
The sector’s operating fundamentals will muddle along through the coming year, and values should remain robust provided the interest rate environment remains benign. This situation is not at all bad when one considers how the rest of the economy has performed over the last several years.
–Edward E. Midgley is a director at Insignia/ESG Capital Advisors Group in New York.