Owners are showing their confidence in the apartment industry by beefing up their portfolios. Among the 25 largest apartment owners in the U.S. ranked by the National Multi Housing Council (NMHC), 18 reported a gain in total apartment units in the past year. Boston Capital took one of the biggest jumps with the addition of more than 17,000 units, bringing its total portfolio size to 147,000 units and rising in the rankings from No. 6 to the fourth largest apartment owner in the country.
“We are very bullish on the apartment market for a variety of reasons,” says Mark Dunne, senior vice president and director of market rate housing at Boston Capital. Improving rents and occupancies are the chief factors. “We have had a couple of years of robust rent growth and improvements in net operating income,” Dunne says. In 2004 and 2005, the firm's rent growth averaged 8% per year — about double the industry average.
Improving vacancies are giving rents a much-needed boost. Nationally, the vacancy rate for investment-grade apartments declined to 4.4% during the first quarter of 2006, down from 5.6% a year ago, according to Dallas-based M/PF Yieldstar, an apartment-consulting firm. At the same time, first-quarter effective rents averaged $952, up 4.3% over the same period last year.
“That is the best number the industry has seen in about five years,” says Mark Obrinsky, vice president of research and chief economist at the NMHC. “But we also don't want to exaggerate what has happened here,” Obrinsky cautions. Rental rates, adjusted for inflation, are still 7% to 10% below where the industry was when the recession started in 2001. So, even though the industry is on the right path to higher rents, there is still a ways to go to make up for those past losses.
Paying top dollar
Stronger occupancies and rents may help to sustain the high prices apartment properties have been trading for in recent years. Cap rates on apartment properties sold during the first quarter averaged 5.9%, a further decline from the 6.1% averaged in 2005 and a big drop compared with the 8.7% averaged in 2001, according to New York-based Real Capital Analytics.
While the majority of apartment owners are still on a buying spree, that hasn't stopped them from selling off some assets to take advantage of premium pricing. In fact, seven owners on the top 25 list actually experienced a decline in their apartment portfolios in 2005. No. 19 ranked Lincoln Property Co., for example, dropped from 46,367 units to 43,470 units.
“We are still very active — buying on our own account or in joint ventures with others,” says Jeff Franzen, a senior vice president in the Washington, D.C. office of Lincoln Property Co. Yet at the same time the Dallas-based firm is taking advantage of buyers willing to pay incredibly high prices. For example, Lincoln Property recently sold The Ridge Apartments in Waltham, Mass. to Cornerstone Real Estate Advisers at a cap rate below 6%.
Weakening condo market
Apartment owners also are hoping that an anticipated slowdown in the condo market will open up new opportunities for both acquisitions and development. “The condo boom really put apartment development in the back seat for the last several years,” Franzen says. “As a result, a lot of markets seem to be somewhat underserved in the rental market.”
Condo completions totaled 98,000 units nationally in 2005, and are likely to peak this year with an anticipated 110,000 to 115,000 already in the pipeline, according to the NMHC. Preliminary estimates for the first quarter indicate that the number of condo conversions has fallen to its lowest since early 2004. The fourth quarter of 2005 recorded conversions of just over 30,000 units, down from more than 50,000 in the third quarter, according to New York-based researcher Reis Inc.
Condo converters and builders have bid up the price of both land and buildings during the past two years. In Northern Virginia, for example, condo developers have been bidding about 150% higher than apartment builders for land, making it impossible for apartment builders to compete with those prices, Franzen notes. However, in recent months condo developers have become less aggressive with bids on par with what apartment developers are willing to pay, he adds.
As a result, Franzen expects apartment construction activity to heat up again. In the Northeast/Mid-Atlantic region alone, Lincoln Property has approximately 1,500 to 2,000 new units in the pipeline compared with the 1,000 units that were built in the region during the past two years.
Ultimately, improving occupancies and rents coupled with healthy job creation and rising interest rates is expected to feed a continued appetite for apartment properties. “We expect continued good growth in fundamentals,” says Dunne of Boston Capital. “Maybe not as off the charts as in the last couple of years, but very good growth.”