Apartment revenue will stabilize. Cap rates will rise. Multifamily property sales may accelerate. But there won’t be a big sell off of distressed properties.
These were among the major predictions for 2010 put forth by multifamily soothsayer Linwood Thompson at the 2009 Multifamily Executive Conference in Las Vegas. Every year, the managing director for research and brokerage firm Marcus & Millichap does his best to predict the notoriously unpredictable apartment market’s performance over the coming year. And every year, he reviews his predictions from the previous year.
Though particularly hard on himself for failing to predict the magnitude of job losses this year, as well as the full extent of declining property sales, Thompson got much more right than wrong. Among other things, he accurately predicted that cap rates would rise and that the market would divide itself into two camps—people who believe in the long-term fundamental value of the apartment market, and investors looking for price discounts.
“We now have a third camp as well,” Thompson said. “You now have a growing number of distressed projects, with more sellers forced to sell.”
CMBS holders and banks, in particular, are faced with a burgeoning portfolio of distressed properties. They hold about 36 percent of the outstanding multifamily debt in this country. CMBS holders have eight to 10 times more properties in the service department than they did a year ago.
Thompson indicated that the banks and CMBS holders would, for the most part, take their time to release these properties. They would first want to figure out whether to sell them individually or in bulk. Some may want to improve the properties before they resell.
The calculations will be easier on Class C and D properties that will be the first to come to market. It may take longer for banks to relinquish Class B and Class A properties. “I don’t think we’ll see a rush to put these assets on the market,” Thompson said.
In any event, Thompson doesn’t think that we’ll see a big sell off with “RTC-type pricing” on the multifamily side, though we may in other commercial asset classes.
As for individual investors, he believes that most will hold on to their properties for the long-term, until apartment fundamentals improve. Owners may be unwilling to give discounts. “If I had a problem with a loan coming due in 12 months, and I was worried about my ability to refinance, I would put that property on the market today.”
Thompson is worried about projects built from 2005 to 2007 that may have come on the market without sufficient demand. He predicted a disproportionate share of foreclosures among those projects. One of the bright spots in the market, though, has been the GSE portfolio, which he characterized as a “stabilizing factor” in the market.
In the meantime, apartment transactions are still happening, but average prices are dropping as cap rates rise. “There’s been a lot of cap rate erosion over the past 18 months,” he said, adding that 80 percent of sellers won’t accept today’s rates.
In the meantime, pricing has fallen 25 percent to 40 percent, depending on market and asset class. “There’s been a 25 percent devaluation of Class A apartments in major markets,” he said.
The market is no longer pricing all asset classes the same, which was the case in the fourth quarter of 2007. Spreads have come roaring back into the marketplace.
At the same time, the mix of buyers bidding on apartment projects has shifted. Most traditional institutional buyers, worried about buying an asset that will devalue in the next year, have left the building. But private buyers have returned with a vengeance, looking for long-term bargains.
Thompson said the kinds of purchases being done today tend to fall into two buckets. There are the private buyers that may put 30 percent to 35 percent down. “They can sometimes manufacture an 8 percent to 9 percent cash-on-cash deal out of the blocks.” And there’s the private buyer looking to buy with heavy leverage by re-engineering debt.
Though he remains bullish about the market’s long-term prospects given demographic demand, Thompson believes that multifamily will remain fractured in 2010. Buyer expectations will continue to push up cap rates, which have gone up from 1.25 percentage points to 2.75 percentage points in the past 18 months.
That has led to a major adjustment in pricing. Depending on the asset class, multifamily properties have fallen between 25 and 40 percent during the last year and a half.
Thompson is optimistic that more deals will be made next year. He expects sales velocity to pick up 20 percent to 30 percent late in the year as investors worry that they may lose out on the best deals. Meanwhile, at the property level, owners may see revenue stabilize.
“But I don’t think you see any rent increases. You may see some reduction in concessions late in the year,” Thompson said.
We'll have to wait another year to see which of Thompson's predictions are right.