In 2002, three forces – a national recession, low interest rates for first-time home buyers, and an oversupply of new apartments–came together and created a "perfect storm" that crashed into the multifamily market, negatively impacting operating performance by putting upward pressure on the national vacancy rate. To stem the tide of declining demand, owners re-priced their rental rates through increased concessions and outright rental rate decreases, helping to stabilize the vacancy rate. The decrease demand for apartments is a root cause of the decline in operating fundamentals for the multifamily industry.

The economic environment has not only impacted the revenue side (through increased concessions and decreased rents and occupancies) but also the expense side. The recession has decreased state and local government revenues and, as a result, property taxes are increasing, putting additional negative pressure on financial performance. Increased insurance and marketing costs also are putting pressure on earnings.

But multifamily owners have benefited from low interest rates – many have refinanced at the historically low rates. However, low interest rates are a double-edged sword, as residents take advantage of the same rates to become homeowners, thereby reducing occupancy. Additionally, developers encouraged by the low interest rates, continue to build new projects hoping that they time the delivery to the inevitable uptick in demand.

Moving Past Roadblocks According to Reis Inc. research, vacancy rates increased in 47 of the 50 markets they survey – Washington, Southern California, and South Florida bucking the trend. Occupancy levels have fallen by 1 to 3 percentage points in every region. Nationwide, apartment vacancy was 6.3 percent at the end of 2002, an increase of 2.5 percentage points in the last five quarters. Effective national average rents dropped 2.9 percent over this same time period to $857 at the end of 2002, according to the Reis survey.

There appears to be no short-term catalyst to return the industry to it previous high-water marks. Multifamily property sales, however, have remained strong with dollar volumes increasing, capitalization rates declining, and average-per-unit prices escalating. The financing market also remains sound with strong demand, pricing, and valuations coming from the government sponsored entities, conduit lenders, and life insurance companies, among others.

Why the continued strength in light of the less than stellar performance? To the broader investment marketplace, the relative returns and risks of the multifamily sector are more attractive than other available investment opportunities. In today's marketplace, a sub-8 percent cap rate for a multifamily property looks attractive when compared with a sub-4 percent Treasury instrument.

The principal risks are different, but investors are comfortable with the long-term value associated with multifamily, which is further supported by the positive demographic trends of echo boomers and immigrants.