July column for Builder & Developer now online

My column for the July 2011 issue of Builder & Developer magazine is now posted online.

For this issue, entitled "Tracking Shadow Inventory," I've been recently working on a project for a multi-family client to track non-traditional apartments in Southern California such as REO units, sales of non-owner-occupied homes and compare both the cost of ownership versus these apartments as well as what the new owners could rent them for and break even. Since the subject seemed so timely, I thought it was well worth covering it in more detail.

From the column:

...For apartment builders and owners, today's low interest rates means that potential tenants can often find a nicer and larger home for close to what they would otherwise be paying to live in a typical apartment. In some cases - such as when putting 20 percent down and borrowing the rest at 4.5 percent or so for 30 years - the monthly payment for both attached and detached homes plus taxes and HOA fees (when applicable) could still up to 25 percent less than what a tenant would pay for a traditional apartment...

To read the entire column, click here.

To read the entire July 2011 issue in digital format, click here.

A rebound for apartment builders?

After a couple of years in the doldrums, it looks like apartment builders are finally gearing up again for an anticipated leap in demand to occur once the economy rebounds and potential renters now doubling up with roommates (or living with their parents after boomeranging home after college) strike out on their own. From a Wall Street Journal story:

This year, real-estate investment trusts, or REITs, are expected to start close to $1 billion in new multifamily projects, according to real-estate research firm Green Street Advisors. While that still is less than average, it is a significant increase over the $100 million of development starts in 2009.

Analysts caution that the increase in construction doesn't mean there has been an improvement in the business. Apartment vacancy is at a record and unemployment, essential to the sector's health, remains elevated.

But operators are betting that limited new supply, combined with an improving economy, will lead to ideal market conditions nationwide starting in 2011 or 2012...

To be sure, there are risks. Given the multiyear construction window, companies have to start now to be ready in time. If the economy weakens further and recovery is delayed, landlords may be forced to keep rents low or offer free rent to get leases signed...

Landlords also are excited about demand. The 20-to-34 age group, prime renting age, is expected to increase by five million in the next decade, according to Hessam Nadji, managing director of Marcus & Millichap, a real-state-investment brokerage firm. People who moved home or who bunked with roommates during the downturn also might ink leases as the economy improves.

Moreover, construction costs "have fallen rapidly in the last two years," said Tom Toomey, chief executive of apartment owner UDR Inc. A unit that would have cost $300,000 to build two years ago could now be built for as little as $220,000, Mr. Toomey said...

Apartment renters now getting caught up in foreclosures

Last year, when I was renting out an investment property in the Southern California desert, I found myself competing on price with homes that were larger, in better neighborhoods and offered nicer appointments. "How could this be?" I asked myself, before being forced to drop my asking rent by 20%, which was ok because it still at least paid the mortgage. The answer? These owners were desperate, and likely trying to get any cash in the door to stave off default and foreclosure. Although I'd try to explain this to potential tenants, they only thought of the short-term benefit, clearly not worried about the potential midnight knock at the door by a Sheriff with an eviction notice.

This year the downturn that hit the single-family and condominium home market is moving to commercial markets, which includes apartment buildings. For Phoenix-area renters at apartment complexes owned by Bethany Holdings Group, they're getting caught up in a meltdown that will very likely rob them of their deposits because the law doesn't protect them when there is a change of ownership. Given that, I wonder how many will simply take a hatchet to the kitchen counter and invite neighborhood animals to mark the carpets? From an MSNBC story:

Nicholle Krause first noticed the weeds sprouting in the usually well-manicured grounds of her 320-unit apartment complex in Chandler, Ariz., in December. Soon, signs of neglect began multiplying: Garbage spilled over from the dumpsters, the water in the swimming pool turned a slimy pea green and the grounds were infested by swarms of bees — especially alarming because Krause is severely allergic to bee stings...

It wasn’t until early March that Krause and other residents learned why the complex – the alluringly named Alante at the Islands — was rapidly going to seed. The property owner, Irvine, Calif.-based Bethany Holdings Group, had abandoned the complex and a dozen other large rental properties in the greater Phoenix area after defaulting on hundreds of millions of dollars in loans.

As panicked renters in Arizona began holding public meetings to explore whether they could walk away from leases, recoup security deposits or sue, it became clear that the scale of the mess was far larger than they had realized. Companies under the Bethany umbrella owned at least 60 — and possibly many more — large residential complexes across the nation, all of which are now believed to be in bankruptcy or receivership, potentially affecting tens of thousands of renters.

The Bethany Group meltdown highlights how few protections exist for renters caught in the foreclosure crisis. That’s a situation that some experts say is becoming much more common...

Click here for full story.

Renters gaining upper hand as vacancies rise

Although the rental market in Southern California started weakening over a year ago, the recession is now giving tenants the upper hand to renegotiate lease agreements -- even mid-stream -- in various markets around the country. In some areas such as downtown L.A. and Long Beach, previous conversion projects re-converted back into rentals and new condos dumped onto the marketplace at once can easily spike vacancy rates and require landlords to offer concessions they would've found previously unnecessary. From a Wall Street Journal story:

As the housing downturn deepens, rental rates are falling in many major U.S. cities, including New York and Los Angeles, and tenants are finding they have greater leeway to renegotiate their leases.

Early in the housing crisis, former homeowners were starting to rent again, supporting demand for rentals. Now, with more newly constructed condos being converted into rental units, landlords are struggling to keep buildings occupied. Apartment rents nationwide fell 0.4% in the fourth quarter from the third quarter -- the first drop since 2003, according to Reis Inc., a New York City-based real-estate research company. Apartment vacancies rose to 6.6% in the quarter from 5.7% a year earlier.

In some major cities, the declines have been far steeper. In Manhattan, rents fell on almost all kinds of apartments in 2008. Rents of studio apartments fell 7.4%, and rents of one-bedrooms and two-bedrooms in buildings without a doorman fell 5.5% and 5.6%, respectively, according to a report released Tuesday by the Real Estate Group of New York, a Manhattan-based brokerage firm. In Miami, 60% of rents decreased in the fourth quarter, and 45% of rents in Los Angeles declined. Rents did buck the trend in a few cities. During 2008, rents increased 2.3% in Pittsburgh and 4.2% in Houston...'

Some landlords and property managers say they have never encountered so many tenants looking to bargain. Mitchell Rattner, president of Home Equity Savers in Riverwoods, Ill., owns 50 condo complexes and homes around Chicago with a partner and says that requests by tenants to negotiate were almost unheard of until fairly recently. In the past 10 months, he's discounted two of his tenants' rents midlease to keep them from moving out. "If they're good payers, we will give them a discount," he says...

It may be easiest to negotiate in cities like Miami and Las Vegas that have been hit hard by home foreclosures. There, renters are getting a boost from a "shadow supply" of rental units: Investors who have scooped up foreclosed homes are renting them out so they don't have to sell into a declining market. Such investors "are undercutting a lot of the normal rental rates so they can attract tenants quicker," says Elizabeth Olds, real-estate economist with Boston-based Property & Portfolio Research Inc.

In some California cities, vacancy rates are being boosted by the conversion of new condo projects into rentals, says Patrick S. Duffy, principal of MetroIntelligence Real Estate Advisors, a real-estate consulting firm based in Los Angeles. In downtown L.A., where there are a lot of new condos, the vacancy rate was almost 10% in the fourth quarter, compared with an L.A.-wide vacancy rate of 4.5%...

Click here for full story.

As stocks and home prices crater, apartment market remains strong

I'd imagine that some apartment investors with long-term bets on the rental market are feeling somewhat vindicated by the news that, at least according to data tracker RealFacts (an alliance partner to MetroIntelligence and Beacon Economics), rents and occupancy levels continued to hold up during the third quarter of 2008. From an AP story via the L.A. Times:

Apartment rents, as well as apartment occupancy, across the country were virtually unchanged in the third quarter of 2008, according to RealFacts, a San Francisco-based apartment data research firm.

And while more than a million homes have been lost to foreclosure in the last two years and with banks readying for another 1.5 million repossessions, apartment buildings have remained solvent. To date, there have been virtually no foreclosures on large apartment buildings, according to RealFacts...

In the San Francisco Bay area, with one of the highest housing prices in the country, average rents for the third quarter were $1,637, or 1.2 percent higher than the $1,618 they cost per month in the second quarter.

In the Riverside-San Bernardino area of southern California, which has one of the highest foreclosure rates in the country, rents were $1,157 in the third quarter, slightly down from $1,162 in the second.

And in the Las Vegas area, also hit hard by foreclosures, rents were $887 in the third quarter and $886 in the second...

The data collected by RealFacts comes from more than 3 million apartments in complexes of 100 units or greater.

Click here for full story.

Shadow rental market now impacting apartment rents

Although large apartment buildings in most U.S. markets have managed to remain profitable during the housing slump, the oft-discussed 'shadow' rental market (i.e., single-family homes rented out to pay the mortgage) is now having an impact, but not as much as the impact from a slowing economy. One reason cited? People doubling up with roommates or moving back with family. From a Wall Street Journal article:

For the past year, apartment buildings have been one of the few bright spots in the real-estate industry as people forced out of the home-buying market by foreclosures or the credit crunch have turned to renting.

But now the specter of job losses is beginning to spread the gloom into that sector as well. As would-be renters are doubling up in apartments or moving in with friends and families, rents and occupancy rates are beginning to fall in many cities...

Job losses bode poorly for apartment-company stocks, which have outperformed their real-estate rivals so far this year. The Dow Jones Residential REIT subindex is up 14% year-to-date, while the overall Dow Jones Equity REIT index, which includes hotels, retail, self-storage and office properties, is down 1.8%...

Investors have been buoyed by the 1.5 million rental households that have entered the market in the past year, including buyers locked out of the for-sale housing market and those who defaulted on their mortgages. The one downside of the housing crisis for apartment owners has been the "shadow market," made up of unsold homes that owners have put on the rental market.

But that competition isn't nearly as big a problem as job-loss trends. "A lot of folks think it's the shadow market that's softening rents. It's really a jobs issue," says Richard Campo, chief executive of Camden Property Trust....

The biggest impact from job losses could be seen in cities such as Charlotte, N.C., and Atlanta, which haven't seen large shadow markets develop. "That group in the middle is starting to show signs of slowing," says Haendel St. Juste, an analyst at Green Street Advisors Inc. "When you look at the markets that are starting to slow, it's spreading beyond the markets that were burdened by housing."...

For investors, concerns about falling rents and rising vacancy has resulted in a decline in prices for apartment buildings. The "capitalization rate," which measures the relationship between the price and cash flow of properties, dropped one-quarter of one percent from the second quarter of 2007 to second quarter of this year...

The availability of credit from government-sponsored Fannie Mae and Freddie Mac has buoyed values and fueled new deals. Turbulence at the mortgage titans, which together with Ginnie Mae hold 35% of the mortgage debt on multifamily housing, riled apartment owners last month as investors worried about the fate of Fannie and Freddie. But those worries dissipated as the housing bill signed into law last month made the government's implied guarantee of Fannie and Freddie's $5.2 trillion in mortgage securities more explicit.

Apartment cap rates down; prices rise in 2007

According to our friends at apartment data provider RealFacts, 2007 was much better for the multi-family rental market than it was for new home sales. The company, which tracks apartment data for over 12,200 investment-grade apartments in multiple markets and states, is still crunching numbers for 2007 but has provided some preliminary conclusions in their latest newsletter:

Although 2007 has ended, we are still researching apartment sales transactions for that year. As of early March, we had found details of 1017 sales. Chances are we will find some more in the coming months, but we certainly have enough to spot some trends.

The first conclusion we can draw is that sales volume is more or less unchanged from the previous year. We have 1027 sales of complexes in the database for 2006, strikingly similar to the number of sales for 2007. Since our database covers 12.200 complexes, that suggests that 1% of apartment complexes change hands in a year.

Generalizing about a database that covers so many different MSAs is dangerous, because it blurs the details of individual markets. But let’s live dangerously and say that prices per unit and per square foot have gone up in 2007 while cap rates have gone down. The following table summarizes the changes state by state,

	2007		2006
State	Av.CapRate	Av.PPU	Av.CapRate	Av.PPU
AZ	5.8%	$93,025	5.9%	$79,223
CA	5.3%	$181,161	5.1%	$177,043
FL	6.0%	$93,997	6.5%	$109,401
CO	5.0%	$92,605	4.9%	$90,587
IN	6.8%	$53,891	7.3%	$58,243
KS	6.5%	$74,709	6.8%	$86,192
MO	6.5%	$53,066	6.9%	$53,475
NV	5.3%	$123,987	6.0%	$123,386
NM	6.5%	$90,159	6.8%	$60,907
OK	6.4%	$33,879	7.2%	$39,309
OR	5.0%	$102,440	5.8%	$87,500
TX	6.8%	$62,379	7.3%	$60,268
UT	6.2%	$89,394	7.0%	$50,436
WA	6.0%	$122,720	5.2%	$110,528

To continue with this dangerous act of generalization, we can say that prices have been going up and cap rates down in the twenty-first century. The exception to the trend came in 2005, when prices went up so fast due to sales to condo converters that they fell in 2006. In future newsletters, we’ll look in more depth at sales in some specific markers, where there have been high numbers of transactions.

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Demographics point to strong future apartment market

A good catch on the Lansner on Real Estate blog this morning about apartments. The National Multi-Housing Council is predicting that 75 million 'echo boomers' will put upward pressure on rents given that construction (aside from the over-building in the for-sale market) has not kept up with demand. What does that mean? Once the inventory overhang in single-family homes and condos is absorbed (which contributes to the 'shadow rental market'), the opportunity for multi-family investors looks very bright indeed:

“The outlook for the apartment industry going forward is very strong,” said Mark Obrinsky, HMHC chief economist. “The nation’s 75 million echo boomers are already entering the housing market, and most begin as renters. … Strong immigration levels add even more demand for rental housing.”

Obrinsky said apartment owners are benefiting from restraint during the housing boom, which kept them from overbuilding. “As a result, they have escaped the oversupply problems plaguing the single-family sector,” Obrinsky said.

Renters nationwide are expected to increase by nearly 4 million households over the next 10 years, with half of those likely to rent apartments, according to the council. In recent years, construction has only met two-thirds of the apartment demand. With the vacancy rates little changed over the last five quarters, apartment owners continue to be able to get modest rent increases.