What was the biggest factor in these sluggish fundamentals? Executives disagree. Some point to job demand. “As entry-level jobs are created, people leave home, school, or their roommates and create demand for housing,” says Leonard Wood, director of Wood Partners in Atlanta. “The younger folks are more prone to rent.”
Others believe the low interest rates that fueled the ongoing housing boom qualified as the biggest thing affecting their occupancy rates. “We still found a strong desire for people to purchase homes in those markets where housing costs were low to moderate because the interest rates were lower than we expected,” Sentinel's Weiner says.
But high-priced markets like the Washington, D.C., metro area, where detached homes fetch eye-popping prices, did see strong home-buying demand for multifamily product. “Housing in our market is fantastic for condos, which has taken a lot of apartments off the market,” says Bob Murray, president of KSI Management Services, a developer and owner in the D.C. area. (Of course, the apartment market in Washington also ranks among the best in the country right now.)
In markets where housing costs were more modest, single-family homes provided the stiffest competition. “From a supply-demand standpoint, we had to factor single-family home supply into the picture,” Genry says. “Home starts stayed at a high rate, and interest rates remained low. Homebuilders had aggressive pricing, and aggressive financing options were available.”
Silver Lining While low interest rates stimulated condo conversions and hurt apartment fundamentals, there was an upside to this trend. Apartment owners “were killed by condo and saved by condo,” says Peter Linneman, principal of Linneman Associates, a strategic advisory firm in Philadelphia, and the Albert Sussman Professor of real estate, finance, and public policy at the University of Pennsylvania's Wharton School of Business. “They were killed by condo in the sense that they lost rental demand due to the condos. But for everyone who was killed by losing tenants, they were saved by somebody buying out their end of their development at twice what anyone would have paid for it as a rental.”
The numbers agree. In 2003, buyers spent $29.6 billion on 415,626 units, according to Real Capital Analytics in New York. In 2004, that number jumped to $49.4 billion on 548,009 units. Sentinel was one of many multi-family companies that profited from the high interest in buying apartment properties. “While it was a tough year operationally, we managed to close a high number of sales at unprecedented prices,” Weiner says.
Many of these sales were to condo converters, who paid good money for their new buildings. Thanks to the strong demand for condos, these converters could make more by selling the individual units than apartment owners could make by renting them out, which drove up property prices. Picerne Real Estate Group, which built 4,135 units, sold existing apartments and new product to converters in 2004—and its CEO, David R. Picerne, expects even more in 2005.
Traditionally, this had only happened with top-of-the line, Class A properties. “Not too many years ago we thought there was a difference between buildings designed for rentals and buildings designed for condos,” Weiner says. “What the conversion market showed is that if interest rates are good enough, virtually every building has potential of being sold as a condo.”
While condo converters pushed apartment prices ever higher, they weren't the only force in the market. Institutional investors, private investors, unlisted REITs, and 1031 exchanges all joined the fray in 2004. “Apartments, compared to Treasury bills and the stock market, still look pretty good,” explains Wood, who isn't surprised by the industry's popularity with investors. “The cap rates historically have a 200-basis-point spread between them and 10-year T-bill [rate], and that's about where it is.”
High-Price Properties The flip side of the high cost of apartment buildings right now is that it's difficult to piece together a portfolio today. In fact, given the skyrocketing prices, Weiner says buying traditional apartment properties was nearly impossible in 2004. “If we bought something, it was off-market,” he says, “as opposed to going out and bidding, which turned out to be a relatively futile exercise with all of the condo converters in the market.”
Manning, who would like to add more market-rate product to his portfolio, found the same thing. “It's been challenging because of the cap rate decline that's occurred over the past couple of years,” the Boston Capital president says. “While the yields are definitely less than they were four years ago, they're attractive relative to alternatives.”
Given all the bidding competition from 1031 exchanges, condo converters, and institutions, Manning turned to one of his company's core strengths: development. “That ability to achieve higher yields in new construction is directing our efforts in that direction,” he says. “In affordable housing, every deal we do is in new construction and substantial rehab. We've taken advantage of that skill set and focused on more new construction transactions.”
But costs for building new are rising as well. Condo developers can afford to pay more for land than apartment developers, especially in infill areas, and will drive up prices. “The land is not easier to buy,” says Bruce Ward, president of Alliance Residential Co., a developer, owner, and manager in Phoenix. “Sites near entertainment, amenities, and 24/7 environments are getting more difficult to get.”
Building materials and labor are also getting more expensive. “Virtually every commodity and all labor [saw] just across-the-board increases,” says Wood, which started 6,016 units in 2004. “Our costs were up over 10 percent last year and another 10 percent this year. That's a pretty meaningful change in construction costs.”
Not everyone sees those increases as a bad thing. Linneman, for one, thinks the multifamily market remains overbuilt, with fundamentals continuing to struggle until there's a better balance between supply and demand. “I still think the multifamily market is being overbuilt, but now it's being overbuilt as condos rather than rental,” the real estate professor says. “If the condo demand dries up, they're all going to become rental units. That's a flood of competition, especially when you think that half of all condos are being sold or pre-sold to people who will rent” the units out.
Others see the combination of demographics (the entrance of echo boomers, baby boomers, and immigrants into the rental and condo markets) and social trends pushing even more multifamily building in the future. “We have a movement in this country for smart growth,” Wood says. “That's beginning to get some traction. That's a trend that inevitably leads to higher density. And, higher density will benefit multifamily for-rent or for-sale.”
Whether these trends push occupancies, soak up excess supply, and bring better fundamentals in 2005 is anyone's guess. But until more jobs are generated and interest rates rise, Manning and his counterparts must continue to wait for the apartment market's elusive recovery.
Click to Lease Apartment owners see a big increase in online leasing.
Last year was full of surprises, but some were more remarkable than others. “If there's one single thing that was a surprise, it was the fact [that] people shop and lease an apartment through the Internet,” says Chris Genry, United Dominion Realty Trust's CFO. “We've seen a tremendous increase in the rate of traffic and the willingness to fill out an application and select a unit.”
Others agree. Gregory Mutz of AMLI Residential says that 22 percent of his company's leases came from the Internet last year. (Four years ago, that figure was virtually zero.) “People are becoming used to using the 'Net for shopping and doing all kinds of things,” says Mutz, the CEO and chairman of the Chicago-based REIT. “Everybody is doing more and more business via the Internet, and we're no exception.”
The opportunity presented by online leasing pressed both AMLI and UDRT to spend more dollars marketing to customers over the Internet. “You can go to our site and do the 360-degree views inside and outside an apartment home,” Genry says. “Then you can fill an application online and reserve an apartment online.”
Real-time availability is also an important component. “If you click on our site, we'll give you the rent at that moment for a unit,” Mutz says. “People want to know that. They don't want to know ‘it's between $1,030 and $1,240 a month.'”
Mark Hafner, director of strategic partnerships for Greystar Real Estate Partners, a large apartment manager and builder based in Charleston, S.C., sees Internet marketing and leasing growing even more sophisticated—and quite personalized—in the future.
“Ten or 11 months after you sign your lease, you'll not only get e-mails from competitive properties, but you'll get targeted ads with customized advertising highlighting the amenities and special offers that you're most likely to respond to,” Hafner predicts. “Expect to get ads for communities closer to where you work.
“The search engines will know that location because you've probably mapped out a dozen sets of directions from [your work-place] to restaurants,” he adds. “If you write a [message using Google's Gmail program] complaining [that] your property ‘doesn't allow pets,' expect to see banner ads for a pet-friendly community that's got a doggie play area.”