September  2009 VOL. 2

Multifamily Outlook
Challenging conditions today, better times ahead

Today’s multifamily market continues to struggle, creating a difficult situation for owners and managers. Although the next 12 months will continue to be tough, the market should begin to improve in mid-2010, and multifamily owners and managers can look forward to a prosperous future.

With a wave of “Echo Boomers” or “Generation Y” entering prime apartment rental years once jobs return, apartment demand should be almost immediate. As a result, occupancy and rental rates should improve sooner than in other property sectors.
 
“The demand side equation begins to look really positive in 2011,” says Charles R. Brindell Jr., CEO of Trammell Crow Residential. “And, if you have a long-term view, there is reason to be optimistic for the next 10 years because supply has been more severely constrained than any other time.”

Weak demand

For now, though, demand is minimal mostly because of the weak job market. Most apartment owners believe national unemployment rates will exceed 10 percent; in July 2009, it was 9.7 percent—the highest in 26 years.

“At that level, it’s difficult for us in almost all markets,” says Jeff Friedman, chairman, president and CEO of Associated Estates Realty Corp., a Richmond Estates, Ohio-based apartment REIT that owns, manages and is a joint venture partner in 50 apartment communities that contain a total of 12,451 units. “It’s more difficult to push the rents for existing residents and for new leases.”

During the second quarter of 2009, multifamily net absorptions of investment-grade apartments were up 40,786 from the previous quarter, but down by 9,959 from a year ago, according REIS. Since the bulk of new leasing activity occurs during the second and third quarters, such weak net absorption is a sign of real weakness in apartment demand, according to the National Multi-Housing Council.

“The seasonality that we see in the spring and summer hasn’t been there,” says Mike Mauseth, vice president of TransUnion’s Rental Screening Services. “Owners are feeling that the volume we normally see just hasn’t been there.”

A recent TransUnion survey of more than 870 property managers across the United States reveals that half of the respondents are experiencing more difficulty locating qualified renters as compared to last year. Another 81 percent of respondents are concerned that they will not find reliable residents for the remainder of the year.
 
While 32 percent of respondents stated that vacancy rates are higher than the same period last year, 48 percent viewed it about the same and 20 percent have experienced lower vacancy. The survey found that 57 percent of respondents had property vacancies of 5 percent or less, 22 percent of respondents had property vacancies of 6 to 10 percent, 13 percent of respondents had property vacancies of 11 to 20 percent, and 6 percent of respondents had property vacancies of 21 percent or higher.

On a national basis, apartment vacancy rates were at record levels in the second quarter. The U.S. Census Bureau vacancy rate for all rental apartments (in buildings with five or more units) rose to 12.2 percent, the highest on record (going back to 1968).

The M/PF Research national vacancy rate for investment-grade apartments was 8.1 percent, the same as the revised first quarter figure and also an all-time high (though this series only goes back to 1993). The vacancy rate rose slightly in the South to 9.2 percent, remained steady in the West at 7.7 percent, and declined slightly in the Northeast to 6 percent and in the Midwest to 7.8 percent. The figure for the South was a record; it also was the 10th straight quarter in which the highest regional vacancy rate was in the South.

All major markets have slipped, according to RREEF, but several are outperforming national conditions: Washington, D.C. and Baltimore (due to government stimulus) and San Francisco and San Diego (due to supply constraints and desirability).

Sacrificing rent for occupancy

Apartment owners and managers are focused on obtaining new tenants, and many of them are willing to take on residents with a riskier credit profile, specifically as it relates to foreclosures, according to Mauseth. That’s one reason why TransUnion has created a new online tool called SmartMove, which landlords can use to verify credit and set their risk levels to accept residents with foreclosures on their credit.

“This is an indication of how owners are looking at recent credit quality,” Mauseth says. “They’re willing to disregard certain events that have become a pandemic.”

In addition to evolving standards on credit quality, most institutional owners have sacrificed rental rates to maintain occupancies. For example, Brindell says TCR’s portfolio has held up “rather well” across most markets, with stabilized assets reflecting occupancies in the low- to mid-90 percent range. “But, like everyone, we’ve seen a big decline in rental rates,” he points out, adding that the company’s net effective rents have decreased 8 to 15 percent.

Atlanta-based Post Properties Inc., which owns nearly 20,000 apartments, is in the same boat, according to Tom Wilkes, president of Post Apartment Management. “We’re all reducing our rents to maintain the desired occupancies,” he admits, adding that residents’ average household incomes are 10 percent less than they were last year.

Within the Post Properties’ portfolio, Charlotte and New York are the weakest markets, primarily because of job losses in the financial sector. Wilkes says Post Properties is renewing leases at existing rental rates, but is lowering rents as much as 8 to 10 percent for new leases. “Our rent roll is going to be at least 5 percent lower,” he explains.

Associated Estates’ portfolio has maintained strong occupancies, but it has had to resort to concessions. “We are buying occupancy by giving concessions,” Friedman says.

For the most part, the concessions are working: overall, occupancies have decreased a little less than 1 percent and NOI is down 2.7 percent. Occupancies are up in Indiana and Ohio (suburban Cleveland assets are 99 percent occupied) and are remaining steady in Maryland and Virginia. Georgia is the REIT’s weakest region, with an occupancy level of 88 percent and a decrease in NOI of more than 20 percent.

For the sector as a whole, apartment rents measured by public and private data sources continued to diverge widely. Same store rents for professionally managed apartments tracked by M/PF Research declined by 3.4 percent, the biggest decline on record. In contrast, the CPI rent index, which covers all rental housing, not just apartments, rose by 2.9 percent in the second quarter.

This was the lowest such increase in more than four years. Coupled with the negative inflation of the quarter, however, “real” rent actually rose by a startling 4.1 percent, the highest in 55 years.

M/PF Research found that rents continued to decline in all four regions for a second straight quarter. The West had by far the largest decline at -6.5 percent, while smaller declines were posted in the Northeast (-2.1 percent), the Midwest (-1.8 percent) and the South (-2.0 percent).

Lack of new product

Despite these grim statistics, the apartment sector will likely lead the recovery in institutional real estate—in large part because of a lack of new product.

The frozen credit markets have severely curtailed new development projects, both urban and suburban. In fact, Brindell says single-family and multifamily starts have been reduced to levels he hasn’t seen in his 33 years in the business. According to his own projections, only 80,000 units will break ground in 2009 and 2010—an amount not seen since the 1970s.

The U.S. Census Bureau says multifamily permits and starts continued their steep decline during the second quarter, while completions increased. Permits decreased sharply to a seasonally adjusted annual rate of 101,700, down by 32.1 percent from last quarter and 72.1 percent from a year earlier. Having dropped for nine consecutive quarters, this is the lowest level of permitting on record (since 1959).

Starts declined nearly as dramatically to 108,000, down by 28.2 percent from last quarter and 67.1 percent from a year ago. This was the second lowest figure on record. In contrast, completions increased to 293,000, up by 16 percent from the previous quarter and 24 percent from a year ago. Multifamily completions in the investment-grade market also declined slightly to 22,696, down 1,973 from last quarter and 5,858 from a year ago.

While supply is constrained, demand will boom from the “Echo Boomer” generation. These children of baby boomers are expected to revolutionize the apartment industry, according to a recent report by the Harvard Joint Center for Housing Studies. In the next 10 years, Echo Boomers will cause a roughly 2 million household increase among the cohort of 25- to 34-year-olds, traditionally a vital renter cohort.

“The demographics related to household formation have never been stronger, and we expect 400,000 to 500,000 new renters to enter the market every year for the next decade,” Friedman says.

By 2013, REEFF projects the U.S. vacancy rate will drop 230 basis points to 6.3 percent, and rental rates will begin to grow again.