Jobs, Uncertainty Holding Back Multifamily Bull Run (from GlobeSt.com)
ENCINO, CA-The multifamily industry is heading for its next bull run, but hesitancy on the part of the business world is a major obstacle. Still, investors should begin to prepare themselves for the next cycle. That was the message from a trio of executives at Marcus & Millichap Real Estate Investment Services Inc., who delivered a special presentation, “US Economic, Capital Markets and Apartment Market Overview and Outlook,” yesterday.
Beginning with a broad look at the economy, SVP and managing director of research services Hessam Nadji pointed out that the crawling pace of job growth is the primary reason behind the fears of a double-dip recession. In the 2001-2003 recession, the US lost 2.7 million jobs, but gained 8.1 million between 2003 and 2007. This latest downturn saw 8.4 million positions terminated between 2007 and 2009, but has only seen a net gain of 723,000 since year-end 2009.
But that figure isn’t going down anymore, and that’s good news, said Nadji. When it comes to job losses, “it looks like the worst is over,” he said. “We’re not moving forward quickly, but at least we established a base” when it comes to employment growth. What’s needed, he noted, is a confidence boost for corporate America, which has been hesitant about its growth.
“Until confidence shifts, we will not see growth,” said Nadji. “And the growth has to be led by corporate America, because it’s not going to be led by consumers.” Programs to spur job creation, such as the SBA, are helpful in starting momentum, he added, but are not a panacea.
Nadji also cited an increase in economic activity on the part of the consumer, namely, a recovery in retail sales excluding automobile and gas purchases, as a bright spot. Another positive is that there are no fears of inflation, though “the Fed is still not convinced the recovery is sustainable, and is ready to do something about it,” he relates. But with interest rates already at record lows, the government may be “out of ammunition.” The yield curve continues to fall, but it’s still far above the recessionary level, and it’s expected that job growth will pick up in 2011 and 2012. So the comeback, Nadji concluded, is going to be gradual, and not the massive snap-back that was experienced in prior upturns, due to the heavy debt loads.
After going through a stabilization period this year and into 2011, apartments will enter into a period of rapid recovery, as new deliveries remain low and the vacancy rate declines from the 7.8% overall level it hit at midyear. Yet “while the crisis was on a national level,” said Nadji, “the recovery will be on a local level.”
Regionally, the coastal cities are doing well, but surprisingly, so are a few Midwestern markets, including St. Louis (1.5% year-to-date job growth), Indianapolis and Minneapolis (both 1.2%), which Nadji attributed to a gain in the US manufacturing business. Yet job growth is not driving apartment demand everywhere, with places such as Sacramento (-1% YTD job growth), San Francisco (-1%), Las Vegas and Oakland, CA (both with -1.2%), still boasting strong multifamily fundamentals.
In fact, first-half overall absorption was clearly ahead of job growth, on a national level. And at midyear, the unemployment rate among 20- to 34-year-olds—the prime renter cohort—is about 200 basis points higher than the overall unemployment rate, which is nearly 10%. And though the residential market is beginning to recover, the drop in single-family home sales has worked to apartments’ benefit. The 2% dip in the homeownership rate, said Nadji, has put 3.4 million households back into the renter pool. While that’s been helpful, “we eventually have to get back to job growth as being the primary driver.”
Despite the concern over jobs, the capital markets have remained friendly to multifamily, according to William E. Hughes, SVP and managing director of Marcus & Millichap Capital Corp. The overall commercial real estate financing market has improved, with lender confidence rising, improving property fundamentals and property values stabilizing. The capital markets are also seeing a recovery, he observed, as spreads have narrowed, along with Treasuries and other indices, and interest rates remaining at low levels.
As of midyear, there was $843 billion on multifamily debt outstanding, held mostly by the agencies ($310.5 billion), commercial banks ($207.4 billion) and structured products ($105.6 billion). The debt from life companies has remained relatively steady over the past few years, at $47.3 billion, or a 6% share of the market, at midyear. But, Hughes pointed out, they’re becoming more active. In fact, so are commercial banks, and agency lenders are still in the market. All this bodes well for multifamily borrowers since debt will be available for all types of product.
And failed loans aren’t a major concern, with delinquencies at less than 1% for the GSEs and life companies. Banks and thrifts are also seeing an improvement in delinquency rates, currently flatlining at around 4%, while CMBS delinquencies continue to rise, hitting around 8% at midyear.
There’s also been a significant shift in who is lending, and how much, for commercial product, since 2007. The most significant change has been among CMBS lenders, who accounted for 34% of all acquisition financing in 2007 but only held a 5% share at the end of the first half of 2010. National, international and investment banks also decreased their presence, from 29% to 13%. Meanwhile, regional and local banks and government agencies increased their lending activity between 2007 and 2010, rising from 6% to 12%, and 1% to 12%, respectively. Debt assumption, which was used in 16% of acquisition financing in 2007, is now present in nearly half of all deals today.
While its presence has diminished a bit, Hughes doesn’t write off the CMBS market just yet. In fact, he sees the market reemerging, expecting it to hit a total of around $10 billion by year’s end. He indicated that he’s seen existing players, such as Bank of America, City JP Morgan, RBS Greenwich Capital and Wells Fargo, as well as new entrants, like Cantor Fitzgerald and Starwood Capital, express an interest in the market. And with their investment goals varying between $400 million and $2 billion, Hughes expects overall CMBS to eventually grow to a $20-billion to $25-billion market by the time 2011 is over.
For borrowers, now is the time to act. The government’s need to finance the deficit, combined with increasing investor confidence in the economy and a search for higher returns, will force interest rates up. “At some point in time, the interest rate window will close on us, and we’re going to have to deal with that,” said Hughs. The question investors need to ask themselves today is, ‘Do you wait for property fundamentals to improve and risk the interest rate window closing?’ ”
Zeroing in on the investment market for multifamily was Linwood Thompson, senior vice president of Marcus & Millichap and director of its National Multi Housing Group. He says the market is divided into two camps: those who believe in the inherent long-term investment value of apartments, and those who believe in the short-term transactional value. He noted that he ranks of the former are rising while the other group is decreasing.
“The market is clearly improving,” said Thompson. “Two years ago, when asked who was going to blink first, I said buyers would—and that’s happened. Sellers have stood their ground and deal velocity has decreased, but prices have increased.” This trend has been further supported by the debt environment, he added.
And buyers’ strategies have shifted, too. More buyers believe the market is at the bottom and are now seeking solid investments, while fewer are looking for deep discounts. Anecdotally, Thompson said he knows of a few groups who have shifted their investment tactics from distressed plays to other avenues.
Of course, the higher-quality product in prime markets is doing better, as investors bid those prices up. Yet class C product and smaller assets are having a harder time trading, and that’s where one can find deep discounts, he noted, adding that this trend will continue as special servicers deal will lower-quality product.
The overall dollar volume of distressed transactions more than doubled since midyear 2009, coming in at over $2 billion at midyear 2010, while overall apartment sales volume went from $9.7 billion to $14 billion during the same period. The overall increase in distressed volume is not an indicator that the overall market is weakening,” said Thompson. “Distressed product still accounts for a small percentage of the market, and this is evidenced in cap rates.” After rising substantially from 2007, average cap rates have started trending down over the past 12 months.
With the spread between caps and 10-year treasuries at 470 basis points—compared with 90 basis points in 2007—some investors have decided that now is the time to buy. Public REITs, institutional investors and equity funds, which accounted for 13% of all apartment buyers last year, have tripled their activity since then to 36% of buyers. Meanwhile, private buyers went from having an 81% share to 60% at midyear.
“People are getting ready for the next bull run in multifamily, and that’s a good indication of what’s ahead,” said Thompson. The timing of that run, however, is up for debate as the lack of job growth continues to hamper a recovery. Pragmatic conservatism, or uncertainty, is holding companies back. “US businesses have the capacity to expand, but they just don’t have the will to do it.” Yet with the November elections around the corner, a change in the direction of policy, he said, could do a lot to impact demand and growth.