While we're closing out another record-breaking year, we're looking ahead to one that will be a little bit slower, but by all means healthy and stable.
To get an idea of how the industry is preparing to handle the maturing cycle, we asked five executives across the country to share their thoughts on current market conditions. Here, they reveal what surprised them this past year, what indicators they're watching now, and what has them excited about the year ahead.
ELLA SHAW NEYLAND
The president of Steadfast Apartment REIT says 2017 is looking strong for continued growth.
On a scale of 1 to 10, how positive do you feel about the market for 2017 (10 being filled to the brim with positivity)?
When you look at the real estate market in totality, I would rank it an 8.5 for 2017. First, debt capital—except for new construction—will still be available and at interest rates that will continue to be low by historical standards. I don’t anticipate any significant increase by the Fed until the economy is on a more sustainable path of recovery.
Second, [both domestic and foreign] investors are still finding value in a real, tangible asset such as real estate.
Finally, real estate fundamentals are strong based on the amount of real equity in the capital stack, as well as the fact that it’s increasingly more expensive to build. That’s very different from the last cycle. Therefore, existing real estate is even more desirable.
What markets still have potential for more rent growth?
In the apartment world, demand is driven by job growth and population growth; people are moving to cities where businesses are also moving. The one big difference I’ve seen is that the baby boomer generation only moved when they had a job. Millennials are picking a city they want to live in, such as Denver, Austin [Texas], or Dallas. They move there; then, they look for a job. They place a lot of emphasis on experiences and quality of life. They work to live. Baby boomers were viewed as living to work.
Do you think cap rates will continue to compress or start to expand?
There’s really been very little movement in cap rates across the board for a while. Any future movements will be principally because of a change in investors’ return expectations more so than interest rates.
Do you see any changes in the equity markets?
There’s every reason to believe that equity markets will remain strong. There’s so much dry powder sitting on the sidelines that will finally find a home.
Also, many large institutional investors saw their overall returns drop this year, but in most cases their real estate allocations were the shining light in their portfolio.
FIRPTA should drive more foreign equity, as well as the fact that real estate now has its own index.
The third quarter showed rent growth is starting to slow down and level out. Are you changing your business strategy to tackle that?
Rent growth for luxury apartments clearly is slowing and declining in many markets as the market tries to absorb a large number of new deliveries.
Roughly 82% of all new construction recently has been luxury. Plus, there are fewer and fewer renters who can afford the high monthly rents, much less increases. But the demand for moderate-income rent communities is actually exceeding supply.
Most new household formation annually has been choosing rental housing, which explains the ever-decreasing homeownership rate, which now sits at 62.9%, the lowest since the Census Bureau started tracking it. But although wages ticked up slightly recently, most people make less than they did before the Great Recession.
What demographic trends are you keeping an eye on?
Every generation is embracing apartment living. The millennials are getting married later and having children later, or not buying homes.
And the On-Demand Economy is allowing older Americans to age in place in rental housing. They don’t have to drive (Uber), they don’t have to shop for groceries (Amazon Fresh), they don’t need to run errands (Task Rabbit), and they don’t even need to walk their dog (Wag). We’re moving toward a world where people are either working or playing, which is great for apartment living
Next: Ric Campo, CEO of Camden Property Trust
While we're closing out another record-breaking year, we're looking ahead to one that will be a little bit slower, but by all means healthy and stable.
To get an idea of how the industry is preparing to handle the maturing cycle, we asked five executives across the country to share their thoughts on current market conditions. Here, they reveal what surprised them this past year, what indicators they're watching now, and what has them excited about the year ahead.
RIC CAMPO
The ever-cautious but optimistic CEO of Camden Property Trust has cashed in on this cycle, selling off billions in assets. As the market matures, he’s still planning for the worst and hoping for the best.
What have been the biggest surprises or upsets in the past year for the apartment industry?
One of the biggest surprises was investors buying properties and paying what we consider [to be] very high prices and low cap rates for older properties.
There wasn’t a big spread between what an investor would pay for a brand-new property at 5 years old or [younger and] one that was 22 years old. We ended up selling $1.2 billion [worth] of older communities that had an average age of 22 years and sold them on a cash yield for a little less than 5%.
I’ve never seen cap rates that low for that age of an asset, and I’ve never seen the spread between newer properties and older properties as tight as it is today. That’s why we backed the truck up and sold a lot. Since 2013, we’ve sold $3 billion [worth] of assets and haven’t bought any.
Where do you see the most potential or opportunity for 2017?
We feel like there are two opportunities that continue to be positive. The first is redevelopment opportunities in our own portfolio. We have 52,000-plus apartments in 151 communities. We can invest in those properties by upgrading the kitchens and baths and improving the resident experience. I think the last three or four years we’ve invested nearly $300 million in that type of investment and we’re making over 10% yield on that.
No. 2 would be development. We continue to develop, maybe not as robustly as we have in the past because we are late in the cycle, but we’re still getting a lot better development yields from an acquisition perspective. We actually haven’t bought a property in three years.
We’re a big net seller rather than a net buyer. Probably the most potential for my business is investing in the people and systems and culture, because we’re later in the cycle here and what’s most important is to keep the residents you have, and investing in people and processes and technology that improves the resident experience is something that’s the biggest areas we invest in, as opposed to transaction-type investments.
When things slow down, a lot of companies skimp on investing in their systems and people. How are you making it work?
Investing in people and culture gives you a competitive advantage in a more competitive environment. The Camden folks do much better in a competitive environment because our competitors are whining while we continue to invest in things that improve the resident relationship with our employees.
We’re going back to a more mature market, and I fundamentally believe that the best investments are in your people and making sure they’re the most competitive out there, [whereas] our competitors are trying to improve their margins by cutting employee investments.
What are the biggest threats for 2017?
The biggest unknown is what the economy is going to do in 2017. There’s a fair amount of risk, because we’re late into this recovery, and recovery is fueled by low interest rates globally. How long and how much that changes and how it unwinds, no one knows. Where people get in trouble in their planning is they think the current status of a market is going to be there forever and they overleverage and pay too much for properties. Then they get in trouble when they can’t refinance their debt. The economy is cyclical. If you run your business conservatively and plan for downturns, you should be fine.
Next: Jim Butz, CEO of Jefferson Apartment Group
While we're closing out another record-breaking year, we're looking ahead to one that will be a little bit slower, but by all means healthy and stable.
To get an idea of how the industry is preparing to handle the maturing cycle, we asked five executives across the country to share their thoughts on current market conditions. Here, they reveal what surprised them this past year, what indicators they're watching now, and what has them excited about the year ahead.
JIM BUTZ
Developers could have a tough year ahead as costs climb and rents stagnate, especially at the top end of the market. The CEO of Jefferson Apartment Group says it’s time to focus on garden-style apartments outside of urban areas.
What do your anticipated starts look like in 2017 compared with 2016?
In 2017, we anticipate starting 1,200 units in four communities in various states. Total production [should be] $260 million.
Where do you see the most potential or opportunity for your business?
Non-urban, train-oriented metro areas are very good, creating town centers without the cost of downtown locations. Garden apartment acquisitions are solid for cash flow.
How is the labor shortage affecting your pipeline and what are you doing to cope?
Construction costs continue to increase due to increased profit margins from subcontractors and labor issues. The combination of costs and delays will significantly reduce new starts in the next few years.
The rising costs of materials and labor have pushed many developers to build luxury products to maintain profit margins. With the deluge of luxury product still needing to be absorbed, and costs of materials and labor still a problem, what type of product are you seeking to develop?
[We’re aiming for] a balance of well-located garden apartments with high-density product in low-supply town centers.
How are you adjusting to tightening construction lending standards?
With more equity [and] nonrecourse, low-leverage loans. [That’s] more expensive but smartly safe.
How positive do you feel about the market for next year?
We continue to see our leasing pace and rents doing well. Costs and land are up. Banks are increasing their rates and lowering LTC, so new starts should slow. [That’s] good for all in the short term.
Next: Brad Cribbins, COO of Alliance Residential's management division
While we're closing out another record-breaking year, we're looking ahead to one that will be a little bit slower, but by all means healthy and stable.
To get an idea of how the industry is preparing to handle the maturing cycle, we asked five executives across the country to share their thoughts on current market conditions. Here, they reveal what surprised them this past year, what indicators they're watching now, and what has them excited about the year ahead.
BRAD CRIBBINS
For the COO of Alliance Residential’s property management division, next year will be a test to find out who’s at the top of their game.
Which markets do you see having the most potential?
The markets are relatively healthy on the fundamentals. It’s really about submarket locations and specific opportunities that exist within the submarkets as opposed to blanket-brushing the larger metropolitan areas. With that said, Seattle, Portland, Los Angeles, and San Diego we think are all strong. Then, Phoenix, Dallas, Denver, Atlanta, Nashville, South Florida, and Boston are the ones I’d call out of our portfolio that have the most opportunity.
Where are you starting to see concessions?
In the Pacific Northwest and the Atlanta markets, we’re seeing one month free. In Phoenix, we’re seeing one to one and a half months. One and a half is trending in the Scottsdale market, in particular, because it’s had an unusual amount of supply recently. In the central markets, there’s a fairly good disparity.
Dallas is seeing one month free, but in Houston you could see two to two and a half months free. We made a pretty big bet in Texas relative to our development plays, so that’s a market that’s feeling soft to us. Long term, we think it’s going to be good, but right now it feels soft.
We’ve heard some mixed commentary on Denver. Some are really positive and others feel the fever has broken. Where do you sit?
We’ve been hearing about Denver for about three or four years, that the market is overheated. We’ve built a couple of projects there and the leasing velocity has been strong. The overall performance on our portfolios has been good. Generally speaking, the fundamentals of what make apartments really strong right now is the demographics we’re seeing with millennials and renters by choice because of lifestyle choices. Denver is one of the most predominant places in the country for that lifestyle dynamic. You have to be measured looking at the future, but what we’re seeing today, based on operational fundamentals and lease-up activity, [is that] Denver has remained very strong.
Property management has done well this cycle with the onslaught of new product coming to market. As development slows down, how are you preparing for potentially fewer opportunities for new business?
I still think you’re going to see a fairly aggressive [level] of inventory come in in 2017. It’ll probably tail off in 2018 by the first or second quarter. Even in that scenario, I just don’t see it having the same level of drop-off that we saw in 2007 or 2008.
From a management standpoint, it’s not equal to the opportunity that you’re seeing in terms of the inventory that’s been so strong. There’s a strong opportunity, because there’s been so much new development that if you don’t have a strong operator who can execute, then you’re going to get yourself in trouble when the market retracts. There will be lots of opportunity inside of that arena, presuming you’ve got relationships throughout the country with different ownership groups who may be seeing some stress in their capacity of leasing up or operating these deals and are looking for a top-tier provider who can actually drive to the yield they were trying to get initially.
Next: Mike Schall, CEO of Essex Property Trust
While we're closing out another record-breaking year, we're looking ahead to one that will be a little bit slower, but by all means healthy and stable.
To get an idea of how the industry is preparing to handle the maturing cycle, we asked five executives across the country to share their thoughts on current market conditions. Here, they reveal what surprised them this past year, what indicators they're watching now, and what has them excited about the year ahead.
MIKE SCHALL
The apartment industry has treated everyone well so far, but recent job-growth reports and dampened rent growth could be signs of things to come, says the CEO of Essex Property Trust.
Where do you see the most opportunity in 2017?
We’ve been very active in two areas. First, we’ve originated preferred-equity investments in existing shovel-ready development deals. Rapid changes in apartment development dynamics, including double-digit construction cost increases and very conservative bank construction lending parameters, have created this opportunity. Second, we continue to grow our institutional co-investment platform, taking advantage of the extraordinary positive leverage—the spread between cap rates and the seven- to 10-year mortgage rates—in the apartment markets.
What markets still have the potential for more rent growth?
Generally, Southern California has the best growth potential in the short term. More specifically, the areas of Southern California that have muted levels of supply, such as the San Fernando Valley and Woodland Hills. Seattle led our portfolio in rent growth in 2016 and carries significant momentum into 2017.
Do you think cap rates will continue to compress or start to expand?
Many investors expect upward pressure on cap rates given [the] deceleration in rental growth. We don’t agree with this assessment, for two reasons: First, stock-market investors often focus on short-term trends, while the real estate markets are more focused on long-term growth rates. Second, the extraordinary amount of positive leverage in the system creates exceptional cash flow in a yield-starved market. We recently completed a 10-year fixed-rate mortgage below 3%. If similar financing is applied to an average-quality apartment acquisition, the cash on return can exceed 6%.
Do you see any changes in the equity markets?
With decent U.S. economic growth expectations in 2017, we don’t see major changes in the equity markets. However, we could see greater volatility given the expectations of Fed rate increases, the forming of asset bubbles given extraordinary low interest rates, and the continuation of muted growth rates.
What surprised you in 2016?
2016 has been another industry-leading year for Essex. However, certainly the rate of deceleration of job growth, leading to muted rent growth, in Northern California was unanticipated. A year ago, reported job-growth numbers in San Francisco and San Jose were in excess of 4%, compared to 2% to 3% by the end of 2016. Interestingly, job growth in Seattle hasn’t experienced this deceleration, even though it has a similar job base as the Bay Area.
How are you changing your strategy to tackle slowing rent growth?
We’re funding more of our activities through dispositions and have focused on building occupancy, especially as we approach year end and its normal seasonal slowdown.