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In a lively discussion before an audience of more than 100 developers and owners from around the nation, Apartment Finance Today magazine’s Editorial Advisory Board painted a positive picture of the outlook for multifamily housing in 2006. But they were quick to point out that the brightness of the outlook depends a lot on where you stand.
The following is an edited transcript of The Apartment Industry Leadership Roundtable Discussion, sponsored by Apartment Finance Today magazine.
The discussion took place March 8, 2006, in San Diego, Calif., as the opening event of Apartment Finance Today’s Developer Conference. The participants included members of the magazine’s Editorial Advisory Board as well as invited guests (see sidebar). Andre Shashaty, editor of Apartment Finance Today magazine, moderated the discussion.
Andre Shashaty: Before we begin our discussion, I would like to introduce two industry leaders and give them a few minutes to set the stage for our discussion. First, I’d like to introduce Doug Bibby, president of the National multi Housing council and ask him to say a few words about what’s happening in Washington DC as it affects our industry.
Doug Bibby: It is total war. You have the battle lines drawn, and the Republicans and Democrats don't like each other. They're not cooperating with each other.
Let me talk about what we think is going to happen in 2006 or the current session of Congress: not much of anything legislatively, frankly. There are going to be patches and fixes along the way, but there's just too many big issues that can't be solved very easily.
Tax reform, as proposed by the Joint Commission, is going nowhere. One of the principal reasons is because the mortgage interest deduction is to be preserved and untouchable..
The alternative minimum tax is going to be patched. Otherwise, you're going to have somewhere between 15 and 20 million people pulled into the AMT next year, and so Congress has to do something. So they've got to find revenue offsetting that. That's very, very difficult in today's climate.
Extension of current rates on capital gains and dividend income will happen. It will go beyond 2008. It will happen. Again, they need to find revenue sources.
The Estate Tax, the so-called "Death Tax," will likely be permanently extended. As you all know, it is due to be repealed, if you will, in 2010, which means that the stepped-up basis goes away, people get hit with all kinds of capital taxes – capital gains taxes and recapture. We are pushing for keeping the stepped-up basis and increasing the exemptions within the tax.
And then lastly, Katrina, we have spoken out very firmly about this. Having FEMA run a housing program, both in the short-term and the long-term, was an unmitigated disaster. It continues to be an unmitigated disaster, and we will continue to speak out to try to get an appropriate housing policy effectuated there.
Shashaty: Doug is understating a little bit how hard NMHC has fought to get the federal government to implement an intelligent program for housing families displaced by Katrina. Doug, can you tell us a little more about what policy you were proposing and how the White House responded?
Bibby: Yeah. I think you all may recall back in 1995 we had the Northridge earthquake, and 55,000 people were displaced at that time. And they used HUD’s housing voucher program to get those people into long-term housing very, very quickly and efficiently.
The problem is that the House of Representatives is dug in opposition to vouchers. They tried to convert the program to a block grant for two straight years. And the opposition to such a program and the use of vouchers is what derailed us.
This is what could have been a grand slam homerun for the administration and getting these people into apartments and back on their feet and into communities where they could work and live. And unfortunately, spending a billion dollars on trailers, putting people up in hotel rooms and on cruise ships wasn't exactly the best approach to take.
Shashaty: Next, I would like to introduce a very special guest, Ron Terwilliger, chairman and CEO of Trammell Crow Residential. They're based in Atlanta, but they're very active here in Southern California.
J. Ronald Terwilliger: Up until 2000 Trammell Crow Residential was for all of the '90s, at least, exclusively in market-rate multifamily rental housing. Since then, we moved into affordable rental housing using Sec. 42. Although, with the cost increases in construction, it's been really hard for us to make anything work now. And we moved back into the condominium business.
So our business plan for this year is to build 3,000 new condominiums, most of them in downtown San Diego here; and 6,000 new rental starts, most of them in the Southeast and the Southwest because with land costs having escalated so much, combined with construction costs increases, it's just virtually impossible in California and the Northeast and Atlantic to make any sense out of rentals in the conventional sense of the word.
2005 was really another exceptional year. It was a great year for apartment absorption. Unfortunately, many of us were digging out from extremely low rent levels. By our assessment, the rents beginning 2006 are very close to where the rent levels were starting in 2001, so that's, essentially, five years of flat rents.
We think this is going to be a terrific year for rental housing. We think effective rents – not nominal rents -- but effective rents, will go up in the high single digits in many markets, if not the low double digits. And in fact, in some of the markets we saw last year, they went up low double digits. You know, obviously, just eliminating one-month of free rent gives you 8%.
So it was just a really different and terrific year with absorption better than any time since 2000, which was the last great market for rental housing.
Condos last year reached a 20-year high in new construction at 150,000. And that's really almost double what they were two years earlier.
And probably more to the point, by our measure, 180,000 apartment units were purchased last year for condo conversion. So you're almost at a point where there may be negative growth in market-rate rentals because of so much conversion combined with a large percentage of the new development in rental housing being tax-exempt or government programs.
On the rental side, we are very focused on rent trending. Going in yields using current rents and assuming away concessions, which areburning off in most markets, are somewhere around five, maybe five to six. And so we had a seminar a couple of weeks ago with our investors, and I brought up the trending approach again.
We are projecting forward four years, four and a half years. And to try to convince an investor, you know, that you're going to have great rent growth for four years. But it's a dimension that we've never faced before.
So I'm encouraging our people to aggressively trend rents at least in the next couple of years because it's hard to sell a 5% yield. Even though cap rates are at 5%, it's just really hard to sell that going in yield. Never before have we faced this.
Homeownership rates have been increasing. Now, to the benefit of the rental housing industry, it seems to be stabilized about 69% now, and to me, the whole game is whether this stabilizes, backs off a little bit, or continues forward. If it stabilizes, we see demand for almost 300,000 market-rate units a year on average. If it keeps going, there's virtually no demand, as there has been in the last few years.
And finally, the real good news for rental housing is that the difference between owning, and the principle and interest payments to own, versus renting is at a 20-year high also. Not because mortgage rates have gone up, and of course, they will if the 10-year keeps moving, but because the price appreciation in single-family and condominiums has been so extreme that now more and more people simply can't get there even with loose mortgage standards.
So the consequence, we think, is a terrific year, presuming a good economy in 2006 and probably in 2007 for rental housing. So we're trying real hard to convince our investors to trend rents for four years and believe those yields will get back up to 7, 7 and a half, 8.
Shashaty: Now we’ll go around the room and ask our other panelists to introduce themselves and comment on how they view the health of the apartment market nationally or in the regions they serve.
Kenneth Bowen: I think that we are in a good time right now for the purchase of multifamily properties in terms of the outlook for the NOI growth. I do think that there are plenty of reasons to think that rental income will increase through the burn off of concessions, through increased occupancy, et cetera.
It's still difficult in terms of finding acquisitions that are clearly home runs at the price that you need to pay today. I think we have some very interesting things going on in terms of cap rates and financing.
A big move toward a lot of interest-only financing, which is really necessary in order to make financing work at lower cap rates. The question is, you know, how long an interest-only period, and by the time amortization kicks in, will you then have enough NOI growth to pay the amortization component too.
Michael Berman: We've done a fair amount of condominium lending over the last six months, both new construction, as well as conversions, mezzanine, as well as whole loans. So we're keeping a pretty careful eye focused on what's happening in the condo world.
And I can tell you that we have pulled back from the aggressive lending that we were doing. The time frames that Ron alluded to, a deal that's going in the ground today, you know, you've got two, three years before that transaction is in the sales stage.
In the conversion arena, we're trying to stay on projects that have been entitled and are through the legal process, but even there we're pulling back to wait to see how our portfolio does.
Cap rates, I believe, are unsustainable where they are. It's pretty clear to me that cap rates generally are – across product types –a little bit lower than they should be. And in particular, I think we've seen aberrations in the multifamily sector due to the condominium markets.
The inverted yield curve, also, clearly, is going to have implications. It has never been a sustainable situation in any economy that we've seen. As the short rates have gone up, and from indications that I've heard from the Fed, we probably aren't quite done with the short end going up. That, obviously, puts pressure on all the floating-rate debt that's out there.
Holli Leon: We certainly have seen improvements in occupancies, decreases in concessions, values are higher than ever, cap rates are lower than ever, and the one saving grace to all of this is that there's just been so much equity going into acquisitions, it's really been what's made lending, for most of us, tolerable on these acquisitions.
As rates are ticking up, 25 BPS in the most recent month or two, 50 BPS since this year began, we've definitely seen our pipelines affected. So what that means is deals that we have under application, if they have been under application for a couple of months, the economics of those deals may not work quite as smoothly as they did when we first took them in, and that presents a lot of challenges to us.
Certainly, every loan that we're working on is what I refer to as "hand-crafted." Sometimes I feel like a little cobbler making each shoe one at a time because each deal just has to be so custom tailored to win the business.
And also, to reiterate, interest-only has just become such an important component of virtually every deal because this is what helps the purchasers or the owners make the cash flows work and their returns work, and so it's just been so integral to figure out how to structure deals with pretty much maximum interest only.
And then, I guess, finally, as the stock market continues to remain static, and you know, we saw it finally got up over 11,000, and now it's back down under 11,000, this just fuels the whole real estate market in general. So I anticipate that will continue this year.
Adrian Corbiere: You know, Ron said it's hard to sell a 5% yield to an investor. Let me tell you, Ron, it's pretty hard to sell four-year trending to a lender. I've known Ron for quite a while, and we'll have to work on that one.
You know, every economist I've heard this year had talked about the strong fundamentals, and I think if we look at the multifamily watch list at Freddie Mac, we've had a big watch list largely as a result of not enough cash to really cover the debt service. And so we put a lot of these properties on the watch list, but they still have been performing because of all the equity as a result of the low cap rates. We're now taking properties off the watch list because fundamentals are improving. So we're optimistic about 2006 multifamily financing.
Tom Szydlowski: Our $10 billion portfolio covers the nation. It has a concentration in the mid-Atlantic regions. What we have found is improved fundamentals all over, less so in the Midwest, though, than on the coast and in the southeast.
We've seen the improved economy, strong employment helping out here, and we see a lot of strength in the lower and middle areas of the market. The high-end on the rental side hasn't rebounded as much on our properties, except in markets where there's a lot of condo conversions.
So you really look at the condo market helping the high-end rental market. If you don't have as strong a condo market, we see the high-end rental market not being affected as much.
Steve Wood: Berkshire Residential Development is part of Berkshire Group. And Berkshire Residential Development had its business plan approved Jan. 6 of this year. The best thing that I can say about what we believe is that we started this development group January 6th of this year. We believe that there's play in the development market for apartments, and that's the reason we started this organization.
We are sitting on the East Coast. We're in markets right now from Washington down through Florida. We are competing in areas where excessive condominium growth has been going on, and -- but we're starting to see some pull back on that, and we're starting to see some opportunities there.
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Michael Berman, president, CWCapital
Douglas Bibby, president, National Multi Housing Council
Kenneth Bowen, senior managing director,Red Mortgage Capital, Inc.
Adrian Corbiere, senior vice president,Freddie Mac
Daniel Epstein, chairman, ConAm Group of Cos.
Mel Gamzon, president,Senior Housing Investment Advisors, Inc.
R. Lee Harris, chief operating officer,Cohen-Esrey Real Estate Services, Inc.
Charles Krawitz, managing director,LaSalle Bank Multifamily Finance Group
Holli Leon, executive vice president for production,ARCS Commercial Mortgage Co., L.P.
Andre Shashaty, editor, Apartment Finance Today magazine
Tom Szydlowski, CEO, Reilly Mortgage Group
J. Ronald Terwilliger, CEO, Trammell Crow Residential
Steve Wood, president, Berkshire Residential Development
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