Yes, you’ve heard it countless times before, but make no mistake: The Echo Boomers are coming. Some 70 million of them are filtering through the prime renter age demographic of 20 to 34 over the next decade, and they’ve either been burned or have seen friends get burned in the single-family sub-prime fracas. They’re tech-savvy, willing to pay a premium for quality in design and service, and are gradually getting sick and tired of the roommates they doubled up with or the parents whose homes they’ve grudgingly accepted as an economic refuge of last resort. Juice up the job market, and they’ll be unleashed into the multifamily apartment sector, which, by the way, has seen little (if any) new development action going on two years now.
Indeed, the long-term fundamentals for the multifamily apartment market look great: Shadow market inventories and concessions are expected to eventually burn off; renters will likely double-down into one-bedroom floor plans and trade-up in product class; and millions of new renters will flood the market just as the supply shortage becomes more tangible. By all accounts, the years between 2011 and 2015 should be the best the multifamily industry has ever seen, with supercharged rent growth made possible by the pricing power of stratospheric occupancies. It’s shaping up to be a huge business-growth banquet that everyone will be invited to. The only ticket to entry? You have to get punched in the stomach a couple of times with 2009 to 2010 market realities before you can move forward.
“Somewhere along the way, if the economy is growing at 3 percent to 4 percent by 2011 or 2012, we’ll have to add 1.5 million to 2 million jobs,” explains Hessam Nadji, managing director of research services for Encino, Calif.-based multifamily brokerage and advisory services firm Marcus & Millichap. “When that happens in combination with the shortage of supply in the construction cycle, that’s when a true multifamily rent recovery begins to occur. From 2012 to 2015, those three years should be among the best, if not the best, in modern history for rent growth. But at this moment in time, multifamily rents are still falling.”
Falling also are multifamily occupancies, with a national vacancy average hitting anywhere from 7 percent to 15 percent (depending on data source and statistical methodology), and additional pain is expected throughout the course of the year. “Our view is that we are not at the worst of the market yet, but we are getting there,” says Peter Muoio, managing principal of New York-based independent real estate research and consulting firm Maximus Advisors. “If you cobble together several sources, the national vacancy rate is hovering somewhere around 8 percent. We think that will even go a little bit higher in 2010. We are near the peak of vacancies, but they will not begin to improve until we are heading into 2011.”
As with all things rent-related, wide variances exist from region to region, market to market, and neighborhood to neighborhood, but generally speaking, things have been bad across the board since the fourth quarter of 2008 and the entirety of last year, with operators exposed to markets in the Southeast and Southwest (including Florida and Arizona) experiencing some of the greatest deterioration in rents and occupancies. “We have individual properties that are 100 percent occupied, but you can contrast that with some in the portfolio that are in the high 70s,” says Rob Couch, president of Atlanta-based Lane Co., an owner/operator and fee manager of some 27,000 properties, mostly in the Southeast. “If you had to characterize our entire portfolio across the board, occupancies are in the mid-80s. I’d like to think that we bottomed out a couple months ago, but we are not yet seeing improvements.”
Passing the 8 percent national vacancy metric puts multifamily apartment operators in a historically-perilous position, and the close watch on fundamentals for signs of bottoming out shouldn’t be underestimated. One positive sign: Net absorption is on the rise. Positive absorption beginning in the third quarter of 2009 jumped to 9,789 units in the fourth quarter, even as developers delivered 28,000 of the year’s 120,000-plus units to the U.S. market during that period, according to a year-end sector analysis by New York-based real estate analysis firm REIS. Still, delivery of those units further weakened the market, particularly from a concessionary standpoint. “Newly-completed properties represent intensifying competition for existing buildings given the difficulty of attracting new tenants and retaining existing ones,” the REIS report notes, “and it is reflected in the massive decline in asking rents.”
Positive absorption, however, could very well signal an end to the occupancy drain that has been sucking the life out of asset net operating incomes (NOI). “The worst of it is over,” Nadji asserts. “Third-quarter net absorption last year was positive for the first time since all of this began. Rents continue to fall, but the first sign of stabilization is that you have positive absorption. Some folks are projecting another full point drop in vacancies in 2010, but I just don’t see it. We think occupancies will fall a little bit more by the time it is all said and done, but we are looking at 2010 as a year of stabilization.”
Painfully Obvious
There’s little secret why multifamily rent fundamentals have been hit so hard: Job losses, the shadow market of single-family and condo rentals, and the phenomenon of residents doubling up have all stressed occupancy levels and the corresponding pricing power that enables owner/operators to push market rents. In and of themselves, the market stressors to multifamily are not necessarily a new phenomena in an industry that historically competes with the single-family home market and is dependent on both job and household creation. But the current, simultaneous collusion of negative business trends has not been seen before by multifamily market watchers, who remain wary of short-term cycle improvements.
“While the shadow market and doubling up might not in and of themselves be so damning, when you begin to put those factors together, it becomes a serious problem,” explains Terry Slattery, president of Norfolk, Va.-based For Rent Media Solutions, the parent company of internet listing service (ILS) ForRent.com. “Neither of those things are going to change anytime in the near future, at least not until this economy turns around. I’ve been at this for more than 20 years, and I don’t think anyone knows exactly what is going to happen.”
Clearly, markets that saw intense overbuilding on both the single-family and multifamily side—and we’re talking the Phoenixes and the Las Vegases of the world—are seeing fundamentals plummet just as drastically as their once meteoric rise. Several multifamily operators with high asset concentrations in those markets—including Bethany Holdings Group, The Bascom Group, and most recently, Fairfield Residential—have been forced into survival mode and even bankruptcy. And firms remaining in the market are not oblivious to the continued threat posed by poor rent fundamentals.
“Where you first saw the rapid escalation in rents and construction activity is also where you are seeing the greatest stress,” says Jeff Olshan, vice president of multifamily asset management for Irvine, Calif.-based Passco, a 1031 exchange owner/operator and fee manager of 12,000 units in markets across the country. “So the competition in a market like Phoenix is exaggerated and exacerbated by the tremendous amount of supply and constrained demand from cohabitation, from renters moving back in with family, from trade-downs, and from moves into single-family shadow rentals.”
Milestone Management regional vice president of property operations Beth Van Winkle is keenly aware of the relative difference in regional rent fundamentals—her markets include Phoenix, Austin, Houston, and San Antonio. But despite the geographical market balance hedging her portfolio (San Antonio and Austin are expected to lead major MSAs with job growth approaching 3 percent next year, according to Marcus & Millichap), Van Winkle nevertheless describes a 2010 likelihood of average portfolio rents and occupancies remaining flat at best.
Research data across the board backs up those assumptions. Average rents in the Phoenix/Mesa/Scottsdale metro area are $695 with an 87.1 percent occupancy, according to RealFacts, a Novato, Calif.-based apartment research firm. Marcus & Millichap likewise sees asking rents in Phoenix declining from a 2009 year-end average of $748 to a 2010 projected year-end average of $729, assuming a 12.6 percent vacancy. In Austin, RealFacts reports an average 2009 rent of $807, while Marcus & Millichap finds an average 2009 year-end asking rent of $844 and projects virtually flat asking rent growth in 2010 to $849. San Antonio, meanwhile, seems to be looking at further softness. Although average 2009 rents checked in at $712, according to RealFacts, Marcus & Milli-chap reports year-end asking rents of only $685, a figure they anticipate to remain flat across 2010.
Market realities that Milestone knows all too well. “Our Texas markets have been fairly well-insulated, and we did not take as big of a hit there,” Van Winkle says. “We think we’ll bounce back fairly rapidly starting in the first or second quarter in Texas, but I am still very concerned about our Phoenix and Las Vegas markets, which, not surprisingly, remain in the lower tier of our portfolio. But we have seen flattening in those markets, and do anticipate the possibility of an uptick, but not until mid- to late-2010.”
Preparing Portfolios
With occasional spikes as new communities came online in 2009, Van Winkle has maintained occupancy levels across her portfolio in the low- to mid-90 percentiles, a feat she attributes to the market experience and dedication of Milestone on-site staff as well as to the unfortunate, but necessary, use of rental concessions.
“2009 was a year of strong concessions,” Van Winkle says. “Portfolio-wide, we have seen concessions almost double from where they were in 2008. In new construction lease-ups, market concessions have gone from two weeks to even three months in some instances, and in stabilized assets have likewise gone from zero or two weeks to a pretty standard one-month concession. We have tried very hard to maintain occupancy, especially in light of these types of concessions prevalent in the market.”
Though not atypical to multifamily markets navigating recessionary conditions and combating poor rent fundamentals, concessions in the current cycle have been exacerbated by the lease-term transparency available to American consumers immersed in cyberspace. The real-time availability of prices and available discounts has armed rental prospects with valuable data as they enter the leasing office demanding a deal. “The public has so much in front of them that allows them to compare prices, and with the downturn in the economy, everyone is shopping everything,” says Bruce McClenny, president of Houston-based multifamily market research firm Apartment Data Services. “That obviously contributes to concessions, and concessions are like the flu: Once they start in a submarket, all of the communities have a hard time not capitulating. Resistance is a difficult discipline when you feel you have to get your share and that you have to match the market to do it.”
While managing to stabilize occupancies with the use of concessions takes a chunk from effective rents, most multifamily operators have seen little choice when it comes to wheeling and dealing with prospects. Lease-term flexibility and great customer service can be a market differentiator, particularly as renewals play into rent recovery. Yet when it comes to revenue realities, the reigning management mantra is heads in beds. “Our philosophy is that a good resident in the apartment is better than letting it sit empty because we can’t get the rent that we ought to be getting,” says Lane Co.’s Couch. “An apartment sitting vacant for any period of time is lost money. We’re not Sears or JCPenney where if you don’t sell it today, you can sell it tomorrow. Once you lose a day of rent, it’s gone. You don’t get it back.”
Flexible Balancing Act
The good news is that concessions—like occupancies and effective rents themselves—seem to be bottoming out, and experts expect a burn-off to begin in 2010 and accelerate in the following 24 months as market fundamentals swing back in favor of owner/operators. Lease-term flexibility will likely assist in that process as property managers, whether backed by yield management software or not, continue to adopt and utilize unit-specific lease optimization strategies.
“We’ve been offering flexibility with up to an 18-month lease term, and we’ll go all in between. Whatever you want, we will customize it and customize your move-in day,” says San Mateo, Calif.-based Prometheus senior vice president of asset management John Ghio, who points to lease-term flexibility as one part of a larger customer service restructuring at Prometheus that has produced sustained rent fundamental improvements despite the economy. (See “Service Revolution” on page 40.) “One of our brand pillars is effortlessness, and flexible lease terms have been incredibly successful in that regard as we reach out to our target demographics.”
Managing move-in dates and lease expirations will be critical as the market turns. While longer-term leases with locked-in rates can offer security to both renter and property manager in an uncertain economy, they also can retard effective rent growth as markets return. Likewise, a lease expiration matrix with a preponderance of shorter-lease terms needs to be managed carefully to minimize renewal volatility, particularly during slower lease-up seasons. “Flexibility plays well in this environment for both the owner and the tenant,” says Olshan of Passco, who expects lease flexibility to wane as rents recover. “But maintain no more than a 10 percent turnover in any one given month to allow you to properly manage and maintain stabilized occupancy. As pricing power returns, you’ll see a return to eight- to 13-month lease terms from the wider six- to 18-month lease terms. People always gravitate towards the bottom line, and the bottom line coming out of the downturn will dictate that you shorten that flexibility.”
Of course, exactly when multifamily rent fundamentals will exit from the current downturn is still anyone’s guess. Van Winkle describes any level of prognosticating to be little more than crystal ball thinking but joins the industry in its near unanimity when it comes to expectations of a powerhouse-era for multifamily rents sometime within the first half of the decade.
“In contrast to other property segments where our view is that high vacancies will persist and keep rents low for a long period of time, our view on the apartment market is for a somewhat quicker recovery,” adds Muoio of Maximus Advisors. “If you are preparing your portfolio now by looking at your submarket supply constraints, if you are looking at the prospects of local and regional job growth, and if you are preparing for the release of the suppressed [Echo Boomer] demographics, you are right, right, right on target.”
Just hold your breath and get ready.
Service Revolution
Multifamily operators lean on brand and customer service enhancements to improve rent fundamentals in a down economy.
Career asset manager and self-described “math guy” John Ghio knows true bottom-line results when he sees them. That’s why the senior vice president of asset management at San Mateo, Calif.-based Prometheus was understandably pleased when properties in the firm’s beta test of its new customer service platform began regularly outpacing their control group peers in terms of prospect traffic, lead-to-lease conversions, lease closings, and resident retention and renewal efforts.
“When I see the numbers changing because of a customer service effort—and changing to the point where you know it’s not a statistical aberration—I get pretty excited,” Ghio says of the service program that has retooled property tours, guest cards, marketing materials, and resident relations to reflect a more light-hearted boutique and retail approach to property management processes. The 12 Prometheus properties that have converted to the platform have seen an increase in referrals and a 29 percent jump in lease signings versus non-converted properties, including a 40 percent rise in the number of residents who sign a lease on their first visit (only 13 percent of first-time visits close on a lease at Prometheus’ traditional properties).
Boutique and concierge-centric customer service revamps aren’t new to multifamily, but retooling the tenets of traditional property management has been uncommon over the past year or two as the industry attempts to focus on block-and-tackle operating basics.
Prometheus isn’t the only firm reinvesting in customer service and marketing to improve its rent fundamentals. Take Atlanta-based Lane Co., which is leaning heavily on its brand to help improve occupancies battered by the recession.
“We’re going to keep giving excellent customer service,” says Lane president Rob Couch. “Everyone tends to offer the same physical attributes as everyone else. You can manage those sticks and bricks to a certain degree, but this is really a people service business. You want great people who want to take care of equally great people—that’s really what it amounts to. We’ll be doing everything we can do to get the Lane name out there and make sure people know that we are here.”