With interest rates low, apartment starts on the rise, owners pushing rents, and net operating income rising, things are definitely looking up in the multifamily industry. Nowhere was this sense of optimism more apparent than during the CEO Power Panel at last week's MFE Conference in Las Vegas.
“I don’t recall a time in the last 40 years that I’ve been more optimistic about our prospects over the next several years,” said industry veteran Steve Bell, CEO of Bell Partners, which has a $5 billion portfolio that includes market-rate and seniors apartments.
“2011 will certainly be an offensive year,” said Tom Toomey, CEO of UDR, brandishing his trademark unlit cigar. “We’ll be raising capital, doing a lot of transactions. We’ll be out building, redeveloping back to '07, '08 levels. We’ve been averaging about $1 billion in buying and selling, which will continue.”
“2011 will be a very good year for rent growth and NOI growth,” seconded Mark T. Alfieri, COO of Behringer Harvard Multifamily REIT, a publicly registered, non-traded REIT. Alfieri is in the middle of a roughly $1.5 billion capital raise. “It will be a great time for acquisitions. The [deal] pipeline is as full as it’s been in six months.”
New Business Opportunities Emerge
That should translate into more business for the best property management companies, as more properties come up for bidding. “The No. 1 thing on our mind for 2011 is looking for substantially more transactions than there has been,” said Walt Smith, CEO of Riverstone Residential Group. “What that means for property managers is that you need to win more deals than you lose.”
Smith plans to continue the company’s focus on paperless invoicing and accounts receivable, along with the company’s integration and cultural development. Riverstone is a combination of a half-dozen companies. Among other efforts, Riverstone recently signed a contract with Behringer Harvard for the next year to bring its property management in-house.
Bell hopes to use the strong investment climate to appeal to more institutional investors. Most of the company’s money in the past has come from high-net-worth individuals. “We want to expand our footprint,” he said, listing Arizona, Texas, and Northern Virginia as potential targets.
At the same time, Bell doesn’t want to lose touch with the basics that enabled his family-owned business to grow. He has brought in several high-placed professionals from other companies, and he wants them to understand the company’s culture. Younger people in the business seem overly focused on the number and don’t spend enough time analyzing properties and their amenity mix.
“Our company was started in '76 as a family business. I enjoy personally visiting our properties. We want to extend that going forward,” he said, adding that everyone has overpaid for properties during this last cycle.
Looking at Rents, NOI, and Cap Rates
Alfieri is relieved that he can forecast increasing rather than declining NOI over the next several years. “We’re predicting strong growth over the next four five years. We have some fully occupied properties in Vegas. We’ve been able to push rents in some places….As long as interest rates stay low, buying at a five and six cap will work for us.”
Toomey, whose company operates in 23 mostly coastal markets, added that Wall Street has baked 3 percent to 4 percent NOI into its 2011 projections for public REITs. But he thinks the industry could do even better than that. “We’re not getting any push back on rent increases,” he said. Then turning to the audience, he asked, “Why aren’t you increasing your rents?”
Smith said his company has been able to achieve rent growth of 3 percent to 4 percent this year, and he predicted that rent growth will be “pretty strong” next year. Riverstone has been able to push rents in the Northeast, in some Northern and Southern California markets, and downtown Seattle. “We’ve shrunk loss to lease everywhere but here in Las Vegas, where we are still getting beat up.”
NOI at Bell Partners rising along with resident retention. “We’re seeing some nice increases in occupancy. [Renters] are living with us longer than they did two three years ago,” said Bell, who is worried about cities raising their property taxes to pay for budget deficits. Even so, low interest rates work strongly to the industry’s advantage. “It’s hard not to generate some pretty good returns with rates below 4,” Bell said.
While they agreed on NOI increases for next year, the executives offered different forecasts for cap rates. Toomey predicted that they would be flat “because interest rates aren’t going anywhere.” Alfieri agreed that if interest rates stay low, so will cap rates.
But Smith said that as NOI rises, some institutions and banks will see an opportunity to get rid of distressed deals. “I think you’ll see cap rates go up slightly. Banks don’t really want to take title on these distressed deals. I think we’ll see Class B move up a quarter to half point. There are people throughout the country ready to buy.”
The self-effacing Bell said he thinks cap rates will rise next year, though he added that he has “been consistently wrong about interest rates and cap rates. I still think that they are going up. As long as there are few alternatives—if you are 55 and 60 years old—where can you put money and generate the kind of cash flow that you can from apartments?”
Toomey argued that cap rates don’t matter as much as other metrics, like what you are paying per door for a property, and how “you feel about that versus replacement cost. I think there’s another 10 percent, 15 percent inflation in asset value down the road.”
Alfieri agreed that when you can buy properties below their replacement costs, and wait until the market comes back, “you can make good money. Even at 5 cap, I can buy at 80 or 90 percent of replacement costs. That feels good to me.”
Old, New Money Still in Play for Apartments
The panelists agreed that a large number of investors, particularly foreign investors, are poised to enter the apartment market. Toomey believes that they are waiting for the results of the November election. “I think what’s holding back growth in America is resolution of the political landscape and the impact that it will have on jobs,” he said.
“We’ve got to do a better job of controlling expenses in running the government,” said Bell. He added that current uncertainty about job prospects certainly works to the advantage of the apartment market. “If you think you might lose your job, you certainly won’t go out and buy a home… I think we’ll see increasing opportunities for the apartment business.”
Smith said the federal government need to reduce spending and raise taxes. “I just don’t see any way around [a tax increase]. We’ve been paying for two wars with borrowed money,” he said.
None of the participants, though, want to see the multifamily programs run by Fannie Mae and Freddie Mac go away. “I’d like to see nothing done to GSEs,” said Alfieri. “My instincts tell me its going to be a government entity.”
Two thirds of the properties managed by Riverstone have a Freddie or Fannie loan on them. “I can’t believe they would change the main source for affordable housing, said Smith, adding that the programs proved their importance during the recession.
Consolidation on the Rise
The panelists, all working for big companies, argued that industry consolidation would increase. Smith said are lot of smaller local and regional management companies have seen their fees squeezed in recent years. “A lot of these smaller companies probably aren’t going to survive in their current form,” he added.
Toomey believes that some new apartment REITs may materialize next year. There used to be 34 public apartment companies, compared to the 11 public REITs today. He thinks that number may go up to 15. “But investors have been very picky about what they buy. There aren’t a lot of private portfolios that fit the public profile.”
Toomey said there may be an opportunity for public REITs to emerge that chase properties other than the Class A coast properties that virtually all the public REITs today prefer. Alfieri agreed, saying it wouldn’t be a bad thing to have some more stable markets such as Texas and Minneapolis in a portfolio. He added that for companies to go public they need to have a limited number of joint ventures and very transparent books. “I think you will see a couple companies come out early next year.”
Alfieri’s company may eventually go public. Behringer may own 60 to 70 properties in the next two to three years. “We’ll be an operating company looking for a potential exit. We are a closed-in fund. If we can get to a 1.5 billion market cap, we’ll be a perfect IPO or a great acquisition target for a public REIT.”
Alfieri wasn’t alone in projecting growth for his company. Smith said Riverstone would like to grow by 50 percent within four or five years. Toomey said that he’d like to take UDR from $8 billion to $12 billion or $15 billion, so that it becomes eligible for stock indexes. In the meantime, he hopes to push average rents from $1,200 to $1,600.
“I can’t think of a brighter place to be than the multifamily arena,” Toomey said.