A slew of factors, including steady job growth, condo conversions and exorbitant single-family home prices, are bolstering the national apartment market. Over the past two years, low interest rates have lured many renters into becoming homeowners, which cut into occupancy and left owners with sluggish rents. That so-called “Perfect Storm” has apparently blown out to sea—and apartment investors welcome the lull.
The fundamentals tide has apparently turned although it’s taken a good two years for the comeback to take hold.from Manhattan-based real estate research firm Reis, Inc. confirms that national apartment vacancy fell 20 basis points to 6.4% during the second quarter, which it hasn't done since year-end 2002. And market observers project that vacancy will trail lower in coming years. Reis expects vacancy to recede to 6% by the end of 2008. By comparison, two years ago, vacancy was hovering as high as 10%.
Wachovia Securities analyst Stephen Swett wrote in an Aug. 8 research note that second-quarter apartment REIT performance was "generally ahead of expectations" due to stronger core trends. Those trends include job growth across manyand the prospect of higher interest rates.
Yesterday, the Federal Reserve lifted interest rates by a quarter point to 3.5%—the tenth straight increase in four years. The Fed has said that more quarter point increases are likely, too. Adds Swett: "We're seeing true acceleration in apartment NOI [net operating income] growth and, at the margin, market survey data indicates even stronger improvements."
One bellwether REIT that posted strong second-quarter results on the strength of property and condo sales was Equity Residential (EQR). Total revenues for the second quarter registered $499.5 million compared to $460.2 million in the second quarter of 2004. The sale of 772 condo units and two land parcels generated $234.6 million for EQR during the second quarter.
While demand may stall,of new condo units isn’t expected to slow down over the next few years. Reis reports that condominiums accounted for just 10% of all new multifamily projects started in 2003. By 2004, the percentage hit 18% and Reis expects it to reach 31% by the end of this year. Reis also projects that a full 43% of all new multifamily projects begun in 2006 will ultimately become condo properties.
Reis CEO Lloyd Lynford isn't so certain that this bodes well for multifamily investors, however. In his view, a steady supply of new, amenity-laden condo units could force apartment landlords to spiff up their older, less competitive units. "Apartment investors may be faced with the need to commit additional resources to their properties as well as to develop innovative asset management andstrategies in order to maintain their competitive position," says Lynford.
Despite the challenge, Lynford is sanguine about prospects for the apartment market. He expects that 63,000 apartment units will be absorbed in 2005, up from only 39,300 units last year. The combination of lower vacancy rates, robust absorption and the steady removal of competitive units by condo converters should drive rental increases of 3% and 3.5% in 2006 and 2007.
Lynford cautions: "Scrutiny and vigilance will be required by investors as they strive to determine the long-term impact of the condominium onslaught on their apartment portfolios."