Amid pitched competition that has driven down cap rates, identifying assets that will provide targeted returns will increasingly force multifamily investors to adopt new investment strategies during 2014.
Purchasing properties with below-market rents, subsequently strengthening occupancy and raising rents, and then selling the property for a handsome profit was a winning strategy coming out of the recession, but no more. Most of this type of opportunity in major metros has been exhausted, leaving investors to determine where to turn next. Some are making a transition to a “buy-and-hold” approach to investing, acquiring targets that will provide stable income streams for the next five to seven years and serve as a hedge against the potential onset of inflation.
Some Seek Riskier, Higher-Yield Properties
Meanwhile, other investors are broadening their search for properties that have higher risk profiles and greater potential for significant value appreciation. Many secondary and tertiary submarkets of major metros hold properties that fit this profile, and an increasingly large share of deal volume in most markets will occur in these areas. In addition, secondary and tertiary metros continue to gain favor with investors in their search for properties with higher yields than their counterparts in the nation’s most prominent urban centers. The smaller metros in the Midwest, in addition to thriving areas such as Austin, Texas, will see significant inflows of equity capital during 2014, and debt providers are sure to follow closely behind.
Austin, in particular, stands out as the type of market that out-of-area investors will gravitate to in greater numbers in the year ahead. Unlike secondary metros that lack a diverse set of economic drivers to generate rental housing demand, Austin can boast government employment, a major university, and a booming tech sector as key economic engines. Austin’s economy will strengthen further over the next year, with local gross domestic product forecast to surpass $100 billion for the first time in history. Meanwhile, vacancy may rise to a more normal level next year as the metro records another surge in completions, making asset and submarket selection an imperative consideration for investors.
In Florida, capital will continue to migrate north from the three-county South Florida region to the center of the state and Jacksonville in the northeast corner. Deal volume in Jacksonville has been notable recently for the increased presence of large investors and institutions seeking core holdings that provide higher returns. As a wide-ranging metro area with several hubs of economic activity, Jacksonville will continue to attract large investors in the years ahead. Expanded access to debt, meanwhile, will also enable smaller investors to complete more transactions.
Good Returns, Strengthening Economies Encourage Investors
The strength of the investment markets in all metros rests heavily on investors enjoying continued access to the capital markets. From an equity capital standpoint, new capital continues to emerge in the multifamily segment, spurred by the lack of adequate returns available in other asset classes. Debt capital is also expanding, and, in many metros, lenders are competing keenly to provide acquisition funding. Higher interest rates appear certain at some point in the near term and will most likely affect pricing on low-margin properties, meaning primarily Class A assets. Properties on the lower rungs of the quality scale, however, will not see any price adjustments in the near term.
Strengthening metro economies will also boost apartment operations and encourage investors. Through October 2013, more than 80 percent of the jobs lost nationwide during the recession had been replaced, and many metros have already added more jobs than were lost during the downturn. The surprisingly robust number of workers hired nationwide in October despite the federal government shutdown that month erased many doubts about whether the economic recovery is sustainable. Economic growth and job creation will gain momentum in 2014 as demand for goods and services rises.
Finally, the recovery in the single-family home market may potentially raise vacancy and lower rent growth in several metros in 2014, but several offsetting factors are also in force that will prevent a broad-based flight to homeownership. The rise in 30-year mortgage rates during 2013 has likely relegated many marginally qualified prospective home buyers to the rental segment. Also, a lack of new homes being built at affordable “entry points” will thwart home buying aspirations.