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Good Vibrations the Continuing Theme for the Multifamily Business

Apartment REITs Developing While the Market is Hot; Still Buying Harder-to-Find Deals; Selling Assets to Finance New Deals
Multifamily development is taking off again

Overlooking the fact that the 20- to 34-year-old renters driving the robust apartment market are probably too young to remember the Beach Boys, apartment REIT Camden Property Trust played the surfer anthem on its pre-earnings conference call music to set the theme for the ongoing apartment industry rebound.

“Our pre-conference music was chosen today to commemorate the 50th anniversary of the Beach Boys,” explained Richard J. Campo, chairman and CEO of Camden. “I know we’ve received a number of emails about the Beach Boys being maybe a little too old for this crowd on the call, but for some of us, the ‘Good Vibrations’ is definitely a continuing theme in the multifamily business. We are looking forward to catching the wave of continued strong operating performance in 2012.”

Major publicly traded owners and operators of apartments reported that market conditions continued to improve across all areas in 2011, with occupancy, sales volume, equity and debt financing all showing continued signs of improvement.

“Investors continue to view apartments as a preferred asset class in today’s environment and long-term demographic changes favor rental housing,” said Mark Obrinsky, chief economist of the National Multi Housing Council in Washington, DC. “In the face of an unprecedented virtual shutdown of development, the apartment market continues its strong recovery as developers play catch-up to the growing demand for rental housing.”

Apartment REIT executives addressed the development topic as well as what they see in the acquisition and disposition pipeline and which markets in the country offer the most and least opportunities.

Basement Lurkers Driving Apartment Development

“The recession forced many young folks to double up with roommates, or worse, move back in with their parents. Of course, this is starting to change, which is good for prospective apartment demand,” said Suzanne Mulvee, senior real estate strategist for CoStar Group. “Since 2004, when the homeownership rate peaked, the number of 20- to 34-year-olds has swelled by 2.8 million. In a normal economic climate, this would be fantastic news for landlords. However, the recession drove unemployment among younger workers over 12%, more than double housing boom lows, and killed new household formation.”

That is now changing “as employment for members of this cohort rose faster than employment for middle-aged workers. Over the last year, 62% of all jobs added were awarded to this younger cohort,” Mulvee said. That has helped spark new demand and the apartment industry is now benefitting.

Editor’s Note: CoStar subscribers can enjoy more indepth analysis of the multifamily market by participating in the State of the U.S. Multifamily Market Review and Forecast webinar on Thursday, February 16 at 12:00 Noon EST.

The combination of strong absorption and reduced deliveries worked in the apartment industry’s favor in 2011 and helped fuel solid earnings growth in spite of the weak economy.

UDR Inc. has 18 development and redevelopment projects currently underway that, when completed, will deliver 6,163 units. The company said its development and redevelopment pipelines will require approximately $400 million and $100 million of spending respectively in 2012.

Thomas W. Toomey, president and CEO of UDR, made note of the factors supporting the firm’s 2012 outlook. “First, multifamily supply remains in check. Second, there remains an aversion to home ownership as evidenced by still downward-trending home ownership rates. This phenomenon continues to stimulate demand by depressing turnover and thereby limiting fresh new supply. Lastly, job growth is expected to continue to gain traction in 2012. More importantly, is that the 20- to 34-year-old-age cohort, who has a high propensity rent, should continue to garner a majority of the jobs,” said Toomey.

But there has been some concern that the number of new projects now in the pipeline could outstrip the potential demand along the way.

“Based upon the current level of starts, which has averaged an annual pace of under 170,000 for the last three months, new completions shouldn’t pose a threat in most markets for at least a couple of years,” Timothy J. Naughton, CEO and president of AvalonBay Communities Inc. “In our markets, [Washington] DC will be the exception in 2012 as new deliveries are expected to pick up in the second half of the year.”

D. Keith Oden, president and trust manager of Camden, said one of the things it looks at to determine whether their development pipeline is too big is the ratio of the jobs being created to what the completions are or deliveries are likely to be.

“If you look in our portfolio for 2012 and you take the jobs number divided by the completions number, so anything above 5-to-1 ratio means that things are getting tighter and better around margin, anything less than 5-to-1 would indicate that there things are – that supply is getting edge,” Oden explained. “Out of the 17 markets that we operate in, there is not a single market that currency has less than a 5 to 1 ratio. If you take the aggregate ratio for all Camden’s markets, the ratio right now is 10 to 1. So, we’re projecting across Camden’s markets about 440,000 college jobs and about 44,000 completions. That’s an extraordinary number and (as we like to say) we’ve been tracking this for 20 years and I’ve never seen a scenario like that.”

Property Acquisitions More Challenging, But Still Work in this Market

As part of their ‘capital recycling’ efforts, apartment REITs continue to be active in the marketplace as buyers, too, but are finding deals a bit more challenging as some landlords pull their properties from the market as fundamentals have improved.

Equity Residential has had challenges of its own in unsuccessfully trying to acquire a huge stake in Archstone Properties, losing out to rival Lehman Bros. Aside from that, though, other challenges have arisen David J. Neithercut, president and CEO of Equity Residential said.

“I’d say [acquisition opportunities] are becoming more challenging,” Neithercut said. “It wasn’t long ago when institutional money was no longer pursuing value-add (properties), but we’re seeing a lot of demand for value-added transactions.

“We begin 2012 looking at the transaction market as very similar to last year, and that means an awful lot of capital chasing relatively little supply in our core markets, as well as continued demand for assets in non-core markets with a cap rate spread between the two that remains as wide as we’ve seen for quite some time,” he said.

“Now, brokers are telling us that they’re being asked by owners to value more core assets, which lead these brokers to believe that more product might be coming to market, but I’ll tell you we haven’t seen it yet,” Neithercut added.

During 2011, we also acquired six land parcels, and entered into a one long-term ground lease, all for future development totaling $725 million of new product. Four of these properties or these parcels were acquired in the fourth quarter.

Campo of Camden Property Trust said, “We continue to be active in the transactions market and will be active this year. From what we hear from the broker community, there are a fair number of broker opinions of value that are coming out and there are a fair number of owners that are being pushed by their banks and other lenders where we have debt maturing this year, so we think it’s going to be a pretty good acquisition environment.”

UDR grabbed the headlines last year when it acquired more than $1 billion in New York City. And it started out 2012 forming a new real estate joint venture with MetLife, in a $1.3 billion portfolio of 12 multifamily communities totaling 2,528 apartment units across the country.

“I think when we looked at the beginning of 2011 and we’re formulating that game plan about what to do, we thought it was a great window of opportunity to buy that most people were not in the market trying to buy the caliber of assets we were, and that we think we’ve been rewarded by finding unique opportunities in that window,” said UDR’s Toomey.

“On the acquisition, we’re continuing to look at the marketplace. It’s hard for us to forecast and really see a significant number of opportunities at this point,” Toomey said. “As we start out in ’12, well, our attention has turned more to what do we think the pricing of assets are for the sales side of the equation, and we’re going to move more towards that initially at the year, and I think we’ll have success on the sales front,”

Capital Raising Through Selling

UDR’s new capital needs for its developments and MetLife JV will be met through disposition of non-core communities in 2012, the company said.

“In 2012, we are marketing some of our non-core communities and expect to sell to $400 million to $600 million of these communities at an average cap rate between 6% and 6.5%,” said David L. Messenger, UDR’s senior vice president and CFO. “These dispositions are expected to be dilutive by nature given the timing differences between the realization of sales proceeds and the reinvestment in the development and redevelopment activity in 2012.

Overall, the company estimates its non-core assets between $1.2 billion and $1.5 billion.

“If you look at where I and we as the management team size it, that’s equivalent to about where we are in the development pipeline,” Toomey said. “And so our strategy over time is to sell assets and redevelopment, the new development and the development pipeline of (one two) is over the next three years, that’s kind of our horizon to dispose of that.”

AvalonBay Communities also is continuing to shape and reposition its portfolio. Last quarter, it sold five assets, three that were wholly owned and two that were owned by an investment management fund.

“Given the growing permitting activity and the uncertain impact of potential fiscal reform on the [Washington] DC area over the next two to three years, we thought it was a good time to harvest value,” said Timothy J. Naughton, CEO and president of AvalonBay. “Despite our recent actions, DC remains an important target market for us, and over the long-term, we expect to increase our exposure in this market.”

Equity Residential also continued to sell non-core assets, and reduce its overall exposure to non-core markets. It sold 47 assets during the year for a little less than $1.5 billion at a weighted average cap rate of 6.5%

“We were seeing what we thought were very reasonable prices per door, prices per square foot on that product, and we went ahead and hit that bid,” Neithercut of Equity Residential said. “I think that we’ll continue to sell those assets or those non-core assets, non-core markets, today, provided we find opportunities to reinvest that capital.”

Finding non-core assets starts with the returns that are substandard because rents aren’t growing fast enough or capex is too high, said Camden’s Campo.

“Within that then we look at things like the direction of the submarket, asset quality, is it gotten to a point where we can’t operate it to a Camden standard anymore and that’s how we fine tune the list of the bottom quarter of performers,” Campo said. “And so for 2012, we’re ramping up dispose this year in the $250 million range. So depending on the average asset size, you’re talking about six to eight Camden communities out of 200.”

Hard To Find a Market That REITs Don’t Want To Be In

“Our 2012 guidance contemplates 7.4% market rent growth which is consistent with a 5-year outlook,” said Michael J. Schall, president and CEO of Essex Property Trust. “The following factors were important in arriving at our market rent estimates.”

“First we’ve seen a slow but steady improvement in the states of California and Washington economies since 2010 and we do not see this progress abating,” Schall said. “Clearly we expect the coastal areas of California and Washington to outperform as the inland areas have greater unemployment overhang from foreclosures and related issues.”

Slow but steady improvement is the story across much of the rest of the country.

“I’d put Northern California in 7% to 8% range,” said Leo S. Horey, executive vice president of operations for AvalonBay.

However, “on the other end of the spectrum while still healthy and positive, I’d put [Washington] DC around 4% and then the remainder of our regions are around our average call it, 5.5% to 6%,” Horey said.

Camden Property Trust’s Oden graded other markets across the country. As “A” markets he listed: Austin, Dallas and Charlotte. He gave an “A-” to Houston and Raleigh. Denver and South Florida received a “B+.” Orlando, Washington DC, Atlanta and Tampa were in “B” category. Southern California and Phoenix were both rated “B-” but improving. Coming in last this year was Las Vegas, which Oden rated a “C-.”

In comparing 2012 outlook to last year, Oden said all of its markets have a better rating this year except Washington DC, which it lowered from “A” to “B.”

“Overall, our portfolio this year would rank as a “B+” compared to an overall ranking of “B” in 2011 and every markets is rated either stable or improving,” Oden said.

Reprint from Costar.com           By Mark Heschmeyer

Categories: multifamily, Uncategorized
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