With all the uncertainty surrounding the multifamily domain throughout 2008, consistent predictions among experts have become understandably difficult to find, and many expectations from even a few months ago now seem much less valid as the full effect of the credit crunch begins to settle in. Here are five widely held – though often still arguable – beliefs that merit closer inspection by all market participants:
Multifamily Rumor No. 1: The single-family housing market's loss is the multifamily market's gain.
Validity: Unknown.
In discussions of the gray skies that continue to cover the single-family housing market, mentions of resulting greater demand for multifamily housing have persistently emerged as the silver-lining sidebars.
On one hand, the logic does appear to work on multiple levels: First, former homeowners who have been forced out through foreclosure will need places to live, explains Joe Mullen, president of Philadelphia-headquartered Madison Apartment Group. In addition, consumers with dubious credit standing who would have able to take advantage of the prior era of easy borrowing and obtain a mortgage can no longer do so and must thus continue to rent.
‘A lot of the renters that we'd lost over the years to homeownership are almost a whole other segment that you're going to pick up on,’ he says, adding that this trend can be expected to continue as long as unsettled conditions retain their hold on the single-family residential market.
Michael B. Cohen, research strategist at Property & Portfolio Research Inc., disagrees, denouncing the notion that families in foreclosure and would-be homebuyers are giving apartment demand the noteworthy boost some in both the multifamily community and the investor community have claimed.
‘If that is the case, then why are we seeing [multifamily] fundamentals deteriorate considerably in the formerly hot housing markets?’ he asks. ‘If it's such a good demand story, then why are vacancy rates moving up so precipitously?’
Although he agrees that the sheer drop in homebuying and condo-buying is undeniable, Cohen points to a number of external factors – including the national economy and job growth, as well as product supply trends – that limit any consequential boon for apartment housing.
Multifamily Rumor No. 2: Echo Boomers and immigrants can be counted on to fuel rental demand in the months and years to come.
Validity: Reliable, with a few caveats.
‘Over the course of this decade, and as we go into the next decade, we certainly do have the wind at our backs in terms of demographics,’ says Cohen, though he notes that every developer has already taken into account these favorable patterns when formulating project plans.
Many developers are aware, for example, that the peak birth year of the Echo Boom generation was 1990 – thus suggesting the maximum rental demand from this segment is likely to be realized in the next few years. Additionally, immigrants' steady contribution to the rental pool is a continued demand plus, especially in gateway cities.
Accordingly, some areas have recently seen spikes in rent, while others have remained steady and are generally expected to hold on for the remainder of the year. However, Mullen cautions, beyond 2008, ‘There are too many factors that could come into play that no one's even thinking about today.’
Even now, overall vacancies have begun to trend upward from their low of 5.8% in 2007, adds Cohen, and are predicted to cross the 6% threshold sometime this year.
Multifamily Rumor No. 3: The declining values and upward movement of cap rates in the sector of late should be regarded as worrisome.
Validity: Slight-to-moderate.
In general, ‘The upward pressure on cap rates – coupled with slower NOI [net operating income] growth – will lead to some downward pressure on values in 2008,’ Cohen forecasts. NOI and rent growth are widely considered to have peaked, especially in more challenging economic markets such as Detroit. Such shifts will undoubtedly factor into deal underwriting.
But despite the predicted softness, ‘It's not the end of the world for apartment investors, given the dramatic cap rate compression and value appreciation that we have seen in the apartment sector between 2003 and 2006,’ he continues.
Furthermore, a certain degree of value loss – while temporarily painful – can produce higher yields for investors down the road, he points out, citing real estate markets' cyclical nature.
Multifamily Rumor No. 4: The shadow market and its effects on standard apartment supply require close attention and may wreak havoc on supply-demand balance in 2008 or 2009.
Validity: Reliable.
If there is one term multifamily players should expect to hear frequently later this year and next year, it is ‘shadow market.’
Particularly ominous in such condo-heavy markets as southern Florida, but a nationwide concern, this market presents itself as both broken condo conversion projects reappearing as rental supply and individual condos that were bought by investors who can no longer sell them in an environment of declining values and are now turning to rental efforts.
‘In markets that have been saturated with condos, they're going to try to get their arms around the shadow market and what's out there,’ Mullen predicts, adding that the depth of that additional supply market remains unknown even to participants close to its influence.
The proportion of those shadow-market condos that will ultimately be absorbed by renters is equally difficult to forecast. In addition, notes Cohen, single-family homes emptied by foreclosure are also being rented out to some degree and competing with the traditional multifamily supply for the rental pool.
Even without all of these extra sources of supply, multifamily development may be heading into dangerous oversupply territory on its own.
‘We're expecting the highest level of net completion in 2008 that we've seen since 2003,’ Cohen remarks. A total of 139,000 units is predicted to come online this year across the 54 largest markets in the U.S.
Mullen, however, maintains as long as overbuilding remains somewhat in check, employment trends will keep supply and demand curves favorable. ‘That's how we rent apartments: through job growth,’ he points out.
Multifamily Rumor No. 5: Difficulties associated with financing projects now – whether due to conduit lenders' withdrawal or remaining lenders' increased scrutiny – will influence product supply trends next year.
Validity: Unknown, but increasingly convincing.
Historically, among major commercial property types, lenders have favored multifamily's reassuring profile, with its low volatility of returns. But the exit of conduit lenders and drop in transaction velocity across the sectors of commercial real estate affects acquisition and pricing in particular for multifamily, according to Cohen.
Mullen notes that his own firm has recently seen an increase in transaction volume due to its high availability of discretionary equity and longstanding practice of putting in 25% to 30% of equity even before such numbers became mandatory. Solid relationships with the government-sponsored enterprises, another necessity for multifamily players these days, have likewise enabled the company's deal flow to continue – albeit with a very close watch on unpredictable interest rates.
‘The one thing that has really helped the multifamily sector – as compared to, say, the office or industrial sector – is that Fannie and Freddie are still in business,’ Mullen stresses. ‘They're still lending money, and they're still being aggressive.’
In general, however, ‘The commercial mortgage industry needs to realize that deal volume is going to be below the levels we saw in the past two years,’ Cohen states. ‘Be realistic about deal volume.’
Lenders' adjustments to transaction leverage and minimally acceptable borrower qualifications, by now, have been well-documented and accepted both inside and outside the multifamily sector. By driving out the high-leverage buyers and making deals a bit more challenging for some others, financiers could very well have a beneficial influence on fundamentals next year, according to Cohen.
‘If we do continue to see lenders be more risk-averse, then we might get a little bit of an upward surprise in better fundamentals in 2009 as we see more modest supply deliveries,’ he suggests.
