This is no fake-out: Multifamily leaders expect 2006 to be a year of recovery for the industry. Are you thinking, I’ve taken that bet before and lost big? Weren’t ’04 and ’05 supposed to be years of recovery? Well, huddle up: With the national vacancy rate falling, rents rising, and concessions hovering at a minimum, there’s a whole new game plan for the multifamily industry.
These market improvements are due to a variety of factors. Just to name a few: An improving job market is driving rental demand, condo conversions are helping the rental market by shrinking the supply of apartments, and the thousands of Hurricane Katrina victims who are filling vacancies in many sluggish markets, especially Houston.
“We are anticipating a robust recovery,” says George Quay, president and COO of Farmington Hills, Mich.-based Village Green Cos. “We have already seen some fairly dramatic improvements in the fundamentals in many of our markets over the past four to five months, and we believe we can continue to build on that in ’06.”
A recovering market brings a year of renewed opportunities for the multifamily industry. Executives expect to invest more money in acquisitions and new developments than they have in the past few years. Apartment firms are already revamping their sales techniques, teaching leasing agents how to capture much-anticipated higher rents in improving markets. Companies also are taking the time to assess their technology offerings–whether that means fully unleashing the powers of a newly implemented Web-based property management system or expanding online leasing capabilities.
To prepare you and your team for the coming year, here is a look at a handful of multifamily leaders’ expectations and predictions in a few key areas.
–Rachel Z. Azoff
Finance
Watch for falling–and rising–cap rates. Just because the defense is sneaking linebackers and safeties up to the line doesn’t mean there’s always going to be a blitz. And, just because it looks like cap rates will go up doesn’t mean they will. If you would have asked Tom Osterman last year what cap rates would do in 2005, he would have told you they would go up. He would have been wrong. So this year, Osterman, a partner in New York-based Sterling Equities, is staying out of the prediction business.
“I’m confused by the fact that cap rates haven’t gone up,” admits Osterman, whose firm owns and operates 15,000 multifamily units around the country. “I’m surprised cap rates have stayed this low for this long. That’s why it’s been so difficult to buy and why we’ve been a net seller.”
Eventually, Osterman thinks interest rates and rising national debt will pull cap rates up. “The interest rates keep going up,” he says. “If you look at the macro situation, it’s the whole guns and butter stuff, like during Vietnam. You can’t keep borrowing, especially with any tax increases and money not getting more expensive. When money starts to get more expensive, that has to impact the cap rates.”
While short-term interest rates have gone up, long-term rates have remained stable. “The key factor will be what happens to long-term rates,” says Al Campbell, senior vice president for Mid-America Communities, an apartment REIT in Memphis, Tenn. “We expect it will be well into 2006 before long-term rates significantly move. Cap rates will continue to be low, and it will continue to be a competitive real estate market.”
Other factors do influence cap rates. If fundamentals improve, apartment values will stay high, Campbell says. People who can’t find other investments could also keep cap rates low. “If it’s a 6.25 percent cap rate compared to 4.25 percent Treasury, that’s still an attractive investment for real estate,” he says.
There’s only a certain level of value that apartments can reach, says Steve Heimler, president and CEO Stratus Real Estate, a third-party manager based in Woodland Hills, Calif. If people are just buying for appreciation, they may find it very difficult to find buyers (unless they’re selling to condo converters). Because of this, Heimler doesn’t think cap rates will creep lower. “My crystal ball does not see continued cap rate compression but, instead, a return to cash-flow based acquisition analysis,” he says. “The days of appreciation-based purchases will come to an end, and economic fundamentals will once again be important.”
Rising interest rates could be painful for some. “When the rates go up, the assumption is that people with floating rates will be in trouble,” Osterman says.
While variable-interest loans could burn some people, other financing trends of this past boom, such as more flexibility from Freddie Mac and Fannie Mae and more competitive structures on commercial mortgage-backed securities (CMBS) notes, may be here to stay into 2006 and beyond. “There’s a lot of money in the system,” says Mid-America’s Campbell. “It’s been very competitive, and financing has been attractive for borrowers. It has created new products and new structures in the market.
I believe that the market has become so efficient because of those changes that some of those new products are going to stay.”
–Les Shaver
Property Management
Maximize on-site opportunities for capturing residents and rebuilding revenues. Sometimes it takes a season or two to adjust to new field conditions. While a recovering marketplace brings opportunities for the multifamily industry, it also brings a whole new set of property management challenges–from revamping current leasing strategies to rethinking marketing techniques.
“One of the biggest challenges in property management that I see in 2006 is reprogramming our staff to deal with improving markets,” says Bill Donges, president and CEO of Atlanta-based Lane Co. “You have to work really hard to make sure your leasing people and your service people are dealing properly with the improvements in the marketplace.”
To prepare for the year ahead, multifamily firms are retraining employees on how to lease apartments in an environment where residents are willing and financially able to pay more in rent each month for added amenities and services. “There will be opportunities [in 2006] to capture enhancements to your revenue, but if you aren’t marketing your property properly, you are not going to be able to take full advantage,” says Mark Fogelman, president of Memphis, Tenn.-based Fogelman Management Group.
So Fogelman is teaching his staff how to capture a higher rent level by selling based on location and amenities, instead of on price alone. But simply retraining your staff will not be enough, Fogelman adds. His company plans to implement a commission structure to encourage employees to sell higher rents.
Companies also are teaching leasing agents how to be more proactive in initiating sales, which is especially important as apartments continue to compete with condos and low interest rates in 2006. So next year, expect to see more leasing agents approach potential prospects, instead of the other way around. To drive traffic to its doors, Village Green Cos., a Farmington Hills, Mich.-based company, encourages its sales team to meet with local employers and retailers on a weekly basis. The company is taking more of a hotel salesperson approach, says George Quay, the company’s president and COO. “If you are a salesperson in a hotel, your primary responsibility is finding accounts that need hotel rooms,” he says. “We have taken that to the apartment industry.”
But the biggest marketing push in 2006 will be Internet advertising. After all, the Internet is now the No. one source of traffic for the majority of multifamily firms. And a strong 2006 will allow companies to invest more in their Internet capabilities, such as offering online leasing. “Customer interaction over the Internet will be the big focus going into ’06,” says Tom Toomey, president and CEO of United Dominion Realty Trust, an apartment REIT based in Richmond, Va. “You have to be able to complete all phases of your business cycle [online], from attracting them, to leasing to them, servicing them through work orders, collecting their monthly rent, to ultimately the move-out.”
Expect to see more companies add manpower to help run their Internet advertising efforts, as companies are quickly realizing that Internet marketing isn’t as easy as it may seem. One of the biggest challenges: responding to prospects’ email in a timely fashion. Lane Co. recently hired two employees whose sole responsibility is to answer inquires sent by email. “Our goal is to be almost instantaneous in responding to an inquiry,” says Donges.
–R.Z.A.
Insurance
Brace for even bigger insurance hits. The financial impact of Hurricane Katrina, one of the deadliest storms to strike the United States, will be hit hard well into 2006. The storm, which hit the Gulf Coast in August, caused more than $100 billion worth of damage, with an estimated $14 billion to $35 billion of insured property affected. For many multifamily owners, these devastating losses translate into higher insurance premiums for 2006.
Apartment owners with properties located in areas with exposure to hurricanes, flood, and earthquakes, such as the Gulf Coast, can expect to see insurance premiums skyrocket by as much as 30 percent, says Eric Schake, executive vice president at insurance broker Willis Group, based in New York. “It will be even more significant or severe if they actually have a loss,” Schake says. “We have seen some substantial increases already.” There is some good news: Insurance rates are only expected to increase minimally for properties that are not located in storm-prone areas, Schake adds.
As the insurance industry faces strong pressures to pay back the astronomic losses in the Gulf Coast, insurance providers will likely become more selective in terms of which companies they are willing to underwrite. “It’s the double whammy,” says Dirk Wakeham, president of LeasingDesk Insurance Services, an insurance provider based in Irvine, Calif. “The losses take capacity out of the system. … You couple that with the fact that companies now don’t want to be there anymore, [and] it could get a little dicey.”
But property owners shouldn’t feel helpless. There are steps they can take to mitigate high prices. An important step: Be prepared. Insurance companies want to deal with owners who have clear systems and procedures in place in the event of a natural catastrophe, advises Schake.
Mid-America Apartment Communities, a Memphis, Tenn.-based REIT, takes this advice to heart. The company retains a proactive approach to risk management and loss control throughout its entire portfolio. “All that we can do to continue to minimize the event of losses for whatever reason, the better off we will be when it comes time to renew our insurance,” says Eric Bolton, chairman and CEO of Mid-America. The company stresses the importance of educating residents on safety issues, such as banning grills on balconies and demonstrating the proper use of fireplaces. Plus, whenever damage does occur, the company is quick to address the problem and minimize any further loss.
Mid-America is also taking a second look at its acquisition strategy in light of Hurricane Katrina’s devastating effects. “We are spending a lot more time being very thoughtful about where we buy properties,” says Bolton. “We fortunately don’t have anything on the waterfront or on the coast, and I would probably be somewhat reluctant to buy something directly on the water at this point.” With insurance premiums rising, there’s no need to tempt fate.
–R.Z.A.
Technology
Now that you’ve drawn up the plays, it’s time for the execution. Some thought this game day would never come, but the tech-wary multifamily industry is finally on board with the latest software and programs designed to help businesses run more smoothly and effectively. A shotgun formation, a field goal, a Hail Mary pass–whatever your play of choice, a wide range of available technologies is helping companies score big in the industry.
In 2004 and 2005, a majority of multifamily firms implemented a host of new high-tech capabilities, from Web-based operating platforms and call centers to online leasing tools. Now these companies are facing their next challenge: really putting these systems to work and creating maximum efficiency with minimum hassle as these new operating platforms affect everything from on-site management processes to back office practices.
“Making the decision to adopt these technologies is one thing,” says Mark Fogelman, president of Memphis, Tenn.-based Fogelman Management Group. “But actually using the information to help you is a whole different game.”
One of the biggest challenges is learning how to best apply the endless data available from a Web-based management system, says Fogelman. “A lot of people are left with way too much data, and I think a big part of our goal is going to be figuring out how we sort through all the information we have and really key in on the two or three areas where we can use the information,” he says.
In 2006, companies also plan to focus on the integration of existing systems. Lane Co., an early technology adopter who has been using Web-based software for several years, is in the process of integrating all its different software suites, such as accounting and maintenance programs. Lane Co. plans to add a revenue management and procurement system to the mix next year.
Multifamily firms expect to see big results from newly adapted technologies. Steve Heimler, president and CEO of Woodland Hills, Calif.-based Stratus Real Estate, is most excited about the automation benefits of his company’s newly unveiled Web-based management system. The system will automate the time-consuming manual data entry for a variety of weekly reports. In fact, the company expects to save approximately $2 million a year in staff time just by automating its weekly occupancy and collections reports. 2006 is a year where “a lot of people are going to try to automate information so they can make better decisions,” says Heimler.
Mid-America Apartment Communities rolled out a Web-based system in 2005 and is strategically taking advantage of the system’s ability to track everything from resident data to product inventory. “As the economy goes through its ups and downs, you just have to manage your business in a more aggressive fashion. This system and the tools it brings is going to give us that capability,” says Eric Bolton, the company’s chairman and CEO.
–R.Z.A.
Human Resources
Redouble your efforts to draft and keep free agents. An improving job market in 2006 is good news for the economy. But for the multifamily industry, more available jobs could spell trouble. As more job opportunities open up in a variety of industries, the already daunting task of employee retention will only become a greater challenge for multifamily firms. And of course, any team is only as good as the talent it can attract–and keep. Just ask United Dominion Realty Trust.
Over the past couple of years, the REIT has skillfully lowered its turnover rate from 70 percent to 40 percent. “That is a big improvement, but still not where I want to be,” says Tom Toomey, the company’s president and CEO. So this year, the company decided to take its retention and recruitment efforts to the next level by adding an executive-level position to head its human capital initiatives.
“As a public company, the board of directors ask what are the succession and talent growth plans for your company, and you can’t just dismiss it as, ‘Oh well, we are going into the marketplace and hiring people,'” says Toomey. “You need more focus, and we brought it in at an executive level, and I think it will pay off over time.”
Stratus Real Estate, a private real estate company, has similar goals. The Woodland Hills, Calif.-based company is hiring a director of human resources to help train new employees and keep site-level associates well-connected to the corporate office. “We have identified our weakness associated with HR as being a lack of follow-through and tracking of [training] classes and growth of our field employees,” says Steve Heimler, the company’s president and CEO.
Employee retention, of course, is only half the battle. First, you have to find the talent, which is no easy task. “We need to make it more desirable for up and coming associates to want to be in our industry,” says Mark Fogelman, president of Memphis, Tenn.-based Fogelman Management Group. “Unfortunately, not many people grow up and say, ‘I want to be in apartment management.'”
So companies have learned to become more creative in their recruitment and training initiatives. For instance, Village Green Cos. has a manager-in-training program for recent college grads across the country with finance and hospitality degrees. “It is a robust crash course over six months,” says George Quay, president and COO of the Farmington Hills, Mich.-based company. The graduates work in every facet of on-site operations and get to know the on-site managers as well as the executive management team. Approximately 22 members of this program are now running Village Green’s apartment communities.
Companies are also tapping into talent at multifamily-related industries. Steve Heimler of Stratus Real Estate has his eye on the hospitality industry. “It is an industry that has much better training programs, yet the employees have lower pay, worse hours, and they move people in every day instead of every month.”
Regardless of where you find your next leaders, it is essential to be selective and hire the right people from the start, advises Eric Bolton, chairman and CEO of Mid-America Apartment Communities. Bolton places the most emphasize on hiring the right people to serve as property managers. “The property management position in my opinion is the absolute key position in the company,” he says. “If you get that particular hire right, odds are the property is going to do pretty well.”
–R.Z.A.
Strategies ’06
On supply and demand:
“Spiraling construction and land costs seem to be our two biggest challenges looking forward. Both are well outpacing rent growth. For-sale product would seem to be the solution, but obviously the market can only handle so much supply, and it’s unknown how long interest rates will keep for-sale product within affordable reach. Market oversupply in certain for-sale markets will also present a challenge.” –Steve Patterson, president and CEO, ZOM Development
On capital concerns:
“Investing capital via development and acquisitions with a projected internal rate of return greater than the weighted average cost of capital. Both the development and acquisition arenas remain very competitive, and the cost of capital will rise as interest rates rise.” –Keith Oden, president and COO, Camden Property Trust
On national challenges:
“Clearly, the rebuilding of New Orleans and surrounding areas devastated by Katrina and Rita and the production of affordable housing strike me as the biggest immediate domestic moral, if not fiscal, challenges for our industry and our country. The evacuation of New Orleans vividly demonstrated the underbelly of the beast of poverty in this country. With appropriate governmental leadership, ranging from regulatory reform to environmental and insurance assistance, and the redirection of resources, the power and energy of the private housing market can be successfully harnessed and mobilized (as it was following World War II), to create the housing and jobs this country so desperately needs.” –Tom Osterman, partner, Sterling Equities
On top goals:
- “Mitigating risks associated with rising production costs and land entitlements. We will accomplish this with an even higher level of due diligence and research.
- Growing revenues via select multifamily for-sale opportunities. We will accomplish this primarily with significant presales or rental as a viable alternative.
- Enhancing the lifestyle afforded our residents and buyers with creative locations, design solutions, services, and amenities. Identifying development sites with special lifestyle adjacencies, guiding talented designers with well-founded market understanding, and staying in step with our evolving customer profile will all play a role here.” –Steve Patterson, president and CEO, ZOM Development
On maximizing potential:
- “Achieving same property net operating income growth in excess of the inflation rate (projected at 3 percent in 2006).
- Realizing the potential of YieldStar (our new revenue management system), which we are currently implementing.
- Delivering new development communities, which are currently under construction at or above projected yields.” –Keith Oden, president and COO, Camden Property Trust
On technology:
“At Stratus, we are in the early stages of a software transition that is the single largest focus of energy for the coming year. We hope to roll out consistent software (we currently have five different accounts-receivable software programs) to 75 percent of our sites during the 2006 calendar year. Our second largest goal is to address ‘process’ issues with a vision toward automation and a reduction of manual and redundant procedures. Finally, we hope to better integrate our satellite offices with corporate headquarters.” –Steve Heimler, president and CEO, Stratus Real Estate
On growing the portfolio:
“Sterling American’s philosophy of investing has always been on the management of risk to preserve capital, create long-term wealth. and generate superior returns. For the first time in many years, this philosophy has led to a reversal in the balance of our most recent $1 billion of acquisitions from two-thirds multifamily to two-thirds commercial. We believe, however, that there will be opportunities to increase our multifamily holdings in 2006 and beyond through:
- Ground-up development
- The acquisition of highly leveraged and distressed assets subject to the pressures of rising interest rates and increased operating costs that cannot be entirely off-set by rent increases
- Joint-ventures and acquisitions of multifamily assets, often with local partners, that can benefit from the infusion of new capital, and the advantages offered by Sterling American’s extensive resources and operating experience in 43 states” –Tom Osterman, partner, Sterling Equities
On leading:
“[We want] to maintain and extend our franchise position in our high-barrier coastal markets. For many years, AvalonBay has enjoyed a unique competitive position in high barrier-to-entry markets as a leading operator and value-added investor. Over the last couple of years, others have adopted various elements of our strategy. As a result, we need to work hard to continue to maintain a leadership position. …On the investments side, we will focus on targeting opportunities that play to our strengths, where financial capacity, reputation, an integrated operating platform, and creative deal structuring can set us apart from our competitors.” –Tim Naughton, president, AvalonBay Communities
On operational issues:
“It is my opinion that clients in our markets will not feel the cap rate compression that was experienced for the last few years and will therefore refocus on traditional operations in an effort to grow net operating income and their values. Property managers will be challenged to decrease concessions where possible and continue to push ‘other income,’ such as RUBS programs to bolster net collections. The industry will continue to be challenged in the areas of technological integration and education of on-site staff. As the tech wave continues to add value to the industry, the high annual attrition rates of employees will become a larger issue to control.” –Steve Heimler, president and CEO, Stratus Real Estate
On big challenges:
- “Rising interest rates. To address these, we will continue to stagger our debt maturities when issuing/refinancing activities occur, and we will maintain a level of floating rate debt approximating 20 percent.
- Construction cost increases. We will continue to closely monitor costs and update projections as necessary. We may “value-engineer” existing design plans and scale back some luxury items if needed, and we will use general contractors that are 100 percent bonded or subcontractors with sub-guard insurance.
- Raising rents. We need to capitalize on rental revenue growth in improving markets, in light of the last three years of weakness. Our new revenue management system will objectively evaluate opportunities to raise rents and maximize income.” –Keith Oden, president and COO, Camden Property Trust
On real estate:
“Perhaps the greatest industry challenge for next year will be whether real estate in general can continue to deliver strong returns for investors after having outperformed the broader market for the last few years. Real estate has fundamentally been re-priced in the capital markets during this time, and many believe the capital markets may have overshot on real estate valuations and that other asset classes might offer a more compelling opportunity over the next couple of years. If this proves to be the case, real estate will be hard-pressed to extend its winning streak that it has enjoyed for the last few years, despite improving fundamentals working in our favor during this part of the economic cycle.” –Tim Naughton, president, AvalonBay Communities
On finding deals:
“Sterling American Properties’ largest challenge for 2006 will be, as it was in 2005, to acquire multifamily and commercial properties at prices that can be justified by the underlying real estate fundamentals. It has taken increasingly more time and resources for Sterling to ‘ferret out’ value-added opportunities where we can apply our 35-plus years of knowledge and hands-on operating experience to create superior returns.” –Tom Osterman, partner, Sterling Equities
On new processes:
“The commitment to transition software systems represents a huge exposure in increased workload and frustration–managing the process will be our largest challenge in the coming year. That project is coupled with a revised education department that will be tasked with educating our field staff across four states and many cities with a goal of consistent processes throughout [our portfolio]. Finally, we feel challenged to continue to offer the highest possible level of service to our expanding base of clients and markets. This is a challenge that never goes away.” –Steve Heimler, president and CEO, Stratus Real Estate
On building and purchasing:
“We’re taking less risk on commodity cost increases in our construction purchasing. For example, in the past we may have floated with the lumber market, but will now often lock-in earlier and take delivery early in the job and store materials on site or in a subcontractor’s yard. We’re also increasing the level of national purchasing programs/contracts to increase our purchasing power with vendors and better leverage the scale of the organization. And, we’re being very sensitive in the programming of the communities, making certain not to over-program or over-spec a particular community relative to the targeted customer segment. In the past, there has been a tendency to be guilty of feature creep, where every successive community was being built to a higher spec than the previous community.” –Tim Naughton, president, AvalonBay Communities
On rents:
“In 2006, we anticipate a modest rise in rents, and a burning off of concessions as the disparity between the costs of ownership and renting continues to expand. Renting is currently a relative bargain in most areas of the country, compared to the cost of ownership. Rising interest rates and utility costs is likely to magnify the disparity in 2006.”–Tom Osterman, partner, Sterling Equities
On affordability:
“With a Fed that is fairly determined to slow growth with higher interest rates, combined with escalating construction and land costs, affordability will become an issue. Users and investors without alternatives and inadequate market understanding will continue to buy, but absorption is likely to fall, and prices will follow in many markets.” –Steve Patterson, president and CEO, ZOM Development
On adjustments:
“Condos have become a mainstream of the housing market and are not about to disappear. In 2006, however, we are anticipating a small downward price adjustment in most markets tied to a decline in investor confidence and rising interest rates. In some markets that we believe to be overheated due to investor activity (rather than purchases by owner-occupant), such as Miami and Las Vegas, we see the possibility of a more significant price adjustment.” –Tom Osterman, partner, Sterling Equities
On winners and losers:
“Some markets will be on top of the world, while others will likely find that broken deals will create a confused market that will ultimately benefit apartments.” –Steve Heimler, president and CEO, Stratus Real Estate On rents:
“They will increase by varying amounts, based upon geographical location. They will increase because higher interest rates mean higher mortgage rates for new home purchases, which are our biggest competition in our markets.” –Mark Fogelman, president and COO, Fogelman Properties
On rent growth:
“In our California markets we are anticipating 3 [percent] to 6 percent actual rent growth on the coast and 6 [percent] to 10 percent reduction of concessions in the Arizona and Central Valley markets. In Hawaii, we will expect 15 percent rental growth due to restricted supply and increasing demand.” –Steve Heimler, president and CEO, Stratus Real Estate On demand:
“We expect that apartment rents in general will climb at rates exceeding historic averages in most regions as home sales decline and apartment inventory continues to contract from conversion activity. Luxury rentals in overbuilt condo markets may not realize such aggressive rent growth due to competition from investor-owned condos.” –Steve Patterson, president and CEO, ZOM Development