Over the past quarter-century, Trammell Crow Residential has been a multifamily development bellwether, producing an average 6,700 units of apartments annually. Despite stress in the capital markets, Trammell Crow was able to pull 8,400 starts out of its development pipeline in 2008, even after starting 10,200 units in 2007. Then, the streak came to a screeching halt. Last year, the company broke ground on zero units. Nada. Nothing. Zippo.
“It was the first calendar year in our company’s history that we did not commence construction on any new apartment communities,” says Charlie Brindell, president and CEO of Dallas-based Trammell Crow. “We had about 1,300 units in the pipeline that we hoped to start but were unable to start principally due to a lack of construction and development financing. In the private markets, debt and equity simply have not been available at meaningful levels.”
Last year, quite frankly, was the worst year of multifamily housing production in history, or at least since the U. S. Census began tracking apartment development, according to National Association of Home Builders (NAHB) vice president and senior economist Bernard Markstein, who tracks single-family and multifamily permits, starts, and completions for the NAHB. “Multifamily starts in 2009 were much lower than we were anticipating and much of that was just failure to get financing,” Markstein says. “We knew that weak demand would pull things down, but multifamily projects almost ground to a halt in 2009. And for 2010, we are talking worse than 2009 with only 87,000 units expected to start.” Skeptical that the number of starts will dip that low? Consider that Alliance Residential, which was among the top 15 multifamily builders in the country with 2,269 units developed in 2008, will not be breaking ground on any new projects in 2010, preferring to instead grow via asset acquisition. Or Camden Property Trust, which announced in February that it would recognize an $85.6 million charge for the fourth quarter of 2009 and would cease capitalizing interest and expenses on eight of the company’s 13 land parcels being held for development, with the remaining five parcels not breaking ground until after a mid-year market reassessment.
Alliance and Camden aren’t alone by a long shot: Across the country and throughout the industry, companies have shuttered entire development divisions, reassigned development staff into property management roles, or have otherwise put all thought and inclination of new multifamily construction starts on permanent hold.
The reason for the collapse in development is quite clear: There’s simply no money in the game. Recession-shocked capital providers have not had debt or equity monies that meet the manageable expectations of most developers; there’s been less money than ever coming into completed developments via ancillary revenue and effective rents; and there’s been seemingly no financial profit in the investment of ground-up construction when existing product can be had via acquisition at significant discounts to replacement costs.
“We’re not doing any new development this year,” sums up Bob Faith, CEO of Charleston, S.C.-based Greystar Real Estate Partners, also among 2008’s most prolific multifamily builders with 1,968 units delivered. “We want to look at where the freight trains of opportunity are, and the opportunity right now is buying well-located assets below replacement cost with troubled capital structures at trough rents.”
According to Brindell, Trammell Crow plans to account for some 2,000 starts in 2010, and several public REITs with established development acumen, including Highlands Ranch, Colo.-based UDR and Alexandria, Va.-based AvalonBay Communities, likewise plan to pull the trigger on select deals in the pipeline. “Given improved clarity on the economic front, reduced construction costs, and significant firming of the capital markets, some development opportunities are becoming attractive, and we think a modest level of new development activity is warranted,” says AvalonBay president Tim Naughton. “But we are going to be very measured in our approach, and we have not publicly identified any particular development deals in our pipeline that we plan to start construction on.”
Regional development firms, as well, are keen to break ground in 2010 with the expectation that any unit deliveries within the 2011 to 2013 window will hit the market at a time when effective rent improvements are the hottest they’ve ever been. “We are contrarians, and we continue to believe that the best time to develop apartments is at the depth of a recession,” says Farmington Hills, Mich.-based Village Green Cos. chairman and CEO Jonathan Holtzman, who joined Minneapolis civic leaders and US Bank officials at a ground-breaking ceremony for Mill District City Apartments in October and has vowed to likewise begin construction on 156 apartments in Ann Arbor, Mich., this year. “The entitlement, design, and construction process takes years,” Holtzman explains. “We’re not attempting to ‘market time’ the economy, but if we start developing in a recession, it is pretty likely that as we start delivering apartments, it will be into an improved economy.”
Finally ... Financing
Even in the most recession-stressed regions, multifamily development is no longer out of the question for submarket-hardened builders who have a talent for navigating notoriously tough agency finance paperwork and whose market-smarts say absorption and employment is on the uptick, while vacancies and effective rent losses have bottomed out. Scottsdale, Ariz.-based MC Cos., for example, is looking at 672 units across three projects, one currently under development and two that will break ground in the second quarter of 2010. All there projects are in Tucson, Ariz., no less.
Smaller, CHeaper, Greener, Better
Multifamily developers breaking ground in 2010 are likely to be downsizing in square forrtage and upsizing on affordability
Bye-bye, McMansions. Courtesy of the recession, millions of jobs have vanished, and along with them consumer desires for oversized, overloaded, and ultimately unaffordable opulence has vanished too. Nowhere is the downsizing trend more prevalent than in apartment development, where builders struggling to get units out of the ground are leaving luxury behind in favor of middle-market basics.
“There has been a shift from higher-end, A-plus projects to more of a B-grade, cost-effective project and affordable housing,” says Marc Padgett, executive vice president of Jacksonville, Fla.-based Summit Contractors, which plans to break ground on 984 units this year. “Right now people [want] practical, eco-friendly projects that are affordable and close to where they work. The projects that will break ground—particularly in the largest markets with the lowest vacancy rates—will have some type of green affiliation and very affordable rents.”
Three communities currently under development by MC Cos. in Tucson, Ariz., bear out Padgett’s prediction. “We are investing in B-plus building construction, not A properties,” says Ross McCallister, principal and co-founder of Scottsdale, Ariz.-based MC Cos. More affordable doesn’t mean chincy, though. MC units are ranging from 850 square feet to 900 square feet with design amenities that include 9-foot ceilings and ceramic tile, as well as upgraded appliances and plumbing fixtures.
Though Charleston, S.C.-based Greystar Real Estate Partners has put a hold on development for 2010, company CEO Bob Faith and his team are nevertheless tracking the trend toward smaller, more livable spaces as they anticipate a wave of echo-boomers and cost-conscious empty nester demographics embrace rental housing over the next five to ten years. “As the development cycle comes back, the people who play to the psychographic profile of the renter are the people who will have the most success. That can mean smaller units for financially-conscious renters, maybe even more investment in community areas,” Faith says. “It will be an opportunity to change the way an entire generation thinks about rental housing.”
“Yeah, I know. We’re crazy,” says Ross McCallister, MC Cos.’ principal and co-founder. “But there are some basic market and business fundamentals driving this—confidence in the longer-term economy, construction costs at a 10-year low, and the ability to remove construction and permanent interest-rate risk through HUD’s 221(d)(4) program. When we can get 40-year, fixed-rate money at 5.75 percent and costs are making deals feasible, we say it’s time to strike while the iron is hot.”
Construction financing via HUD’s 221(d)(4) program is likewise fueling most of the development underway by Jacksonville, Fla.-based Summit Contractors, including a 360-unit market-rate apartment in Madison, Ala.; a 312-unit project in Antioch, Tenn.; a 200-unit community in Ashland, Tenn.; and a 180-unit development set to break ground in March in Jonesboro, Ark. The 221(d)(4) program administered by the Federal Housing Administration provides mortgage insurance for the new construction and substantial rehabilitation of apartment projects and includes both construction and permanent financing up to 90 percent of replacement cost. Loans are non-recourse, but the application process can be rigorous, with processing typically taking between four and six months.
“HUD-financed properties are essentially the projects that are getting the green light in today’s environment,” says Summit executive vice president Marc Padgett. “We have seen very few projects with financing in the conventional markets getting a go. The ones that do will be smaller projects that, due to their size, are viewed as less risky by lenders.”
“We are still seeing both garden-style and mid-rise,” says David Minno, principal at Lambertville, N.J.-based Minno and Wasko Architects. “Smaller infill-related projects that are financeable is where the market is going, but we have a few clients who have a lot of cash and are still pursuing larger projects albeit with smaller units and higher densities. However, they are their own gap financing and are putting more skin into the game.” Because of real and perceived market risk on the part of both developers and lenders, as well as the inability to source affordable gap financing for mega projects, ground-up residential high-rise and tower construction will be nonexistent in 2010.
Regardless of product type, today’s capital climate for construction financing is redefining what it means to put skin in the game, with necessary equity commitments clocking in at a minimum of 40 percent, according to UDR executive vice president Mark Wallis. “That is why you are seeing the 221(d)(4) programs—they finance a high proportion of the deal and the permanent financing is built in. But those loans are more difficult to get done, and I don’t think that they are particularly suited for doing a great deal of volume.”
REITs such as UDR and AvalonBay have access to public market equity as well as lines of credit to launch communities out of the development pipeline, but Wallis says public operators will likely remain cautious with where they place their bets as the economic recovery unfolds. “Everyone is pretty optimistic about the future, and people are being conservative because it is smart to be conservative.”
In particular, Wallis says firms are being choosy about equity as they continue to weigh the age-old development vs. acquisition conundrum. While a relatively few amount of deals are trading, multifamily owner/developers are nonetheless evaluating on a case-by-case basis when and where to place dollars, considering not only what properties are currently on the market, but what buys they might miss out on if they choose to deploy capital into ground-up construction. “When it comes to raised equity, development is competing with acquisitions, which is always the dynamic,” Wallis says. “It is an opportunistic exercise: What’s for sale? Do I like that deal? Does it fit my markets? So there is a holdback, not just because of tough construction financing, but on the decision to use capacity and possibly miss out on a good buy.”
Follow the Money
The cost benefits of beginning development now could outweigh those acquisition considerations in short order, however, as construction crews eager for work—and materials distributors eager for sales—have pushed labor and building supply costs to palatable lows. “Anyone who can get a project out of the ground right now will recognize more product for their dollar than may ever be seen again in our careers,” says Padgett of the construction cost climate across Summit’s Southeast and Sunbelt markets.
Revenue-hungry municipalities are also making it easier on multifamily builders who, after all, are delivering jobs and a permanent tax-base in addition to paying construction and development-related fees. Though highly dependant on specific markets, zoning and density restrictions are generally loosening, making it possible for developers to increase unit counts and thus the eventual NOI upshot on their deals.
And for once, the density trend corresponds to lifestyle and aesthetic choices of consumers repelled by the perceived bigger-is-better overindulgences that fed into the recession. “Everyone is looking to do smaller product all the way down the line,” Minno says. “Planning and zoning boards are relaxing a little bit on units-per-acre because they need the tax and fee revenues, and the incoming generation of renters is willing to accept a lot less space. They come with a backpack and an iPhone and are ready to go, so we are all thinking through that market quite a bit.”
The Time is Now
There’s no question about it: Preparing for the cyclical return of apartment development is job No. 1 for the present. With opportunistic builders such as Summit and MC Cos. already pulling projects out of the ground; private companies beginning to bank land; and REITs indicating a 2010 return to development, it’s clear that if you have not begun site selection, design, and entitlement processes, the time to start is now.
“Banks are starting to verbalize that they need deals, and a lot of us are wondering if these advantageous hard cost construction prices will stay with us, plus interest rates are pretty good,” Wallis says. “I think people are quietly getting plans done, meeting with contractors, squeezing out entitlements, improving site plans, and attempting to get a little bit more density as they prepare to develop and deliver in that 2011 to 2013 window.”
Despite Greystar’s temporary kibosh on ground-up construction, even Faith recognizes an eventual confluence of development cost deflation, rising renter demand, and short submarket supply of new multifamily housing stock that will make building hard to resist. And while Greystar isn’t gassing up the backhoes yet, the company is banking land assets in preparation to ramp up its development pipeline. “We’re putting together an entitled site fund to buy and bank land in great markets around the country so we will be able to take advantage of development opportunities,” Faith says. “To the extent that the capital markets continue to choke off the ability of new development to be put into place, you’ll see dramatic rent increases when demand returns, and then you’ll have the movement back into development make a lot of sense again. It’s coming.”
The ultimate proof positive of the return of multifamily construction will likely come from the banks: When extremely tight underwriting nevertheless begins to produce the dependable and consistent yields expected from a multifamily industry poised for rent growth, greater capital availability in the financial markets won’t be far behind.
As Trammell Crow breaks ground on the first of its expected 2,000 starts, there are glimmers of hope that financial markets might already be reflecting those new realities. “As we sit today, all of our units will be financed with conventional bank construction and development financing and third-party equity along with equity from Trammell Crow Residential,” says Brindell, who adds that the equity requirements are not substantially increasing.
“The more important stat is projected yield on total development cost, which for our properties is in excess of 8.25 percent today, and that’s what is allowing these properties to get financed,” Brindell continues. “Bank financing is going to be inclined toward strong sponsors with strong balance sheets, and they will be underwriting that as closely as they underwrite the underlying fundamentals of the assets being financed. It is a return to Development 101.”