It sometimes seems like every day, another apartment building is sold for a record price. But is now the best time to sell?
A 250-unit building in Chicago’s Old Town neighborhood recently went for $158 million, or $632,000 per unit, a new record for the Windy City. In Washington, D.C., the 125-unit District Apartments recently sold for $76 million, the highest per-unit sale in the city’s history. In that same market, a 914-unit building sold in March for $322.4 million, one of the highest prices ever registered in the area.
The record prices being paid for these and other “trophy” apartments aren’t likely to subside any time soon, either, as new and established investors look to capitalize on a sector in which interest rates remain low, yields are immediate, and new supply is trying to catch up with rising demand.
Apartment buildings have been hot investment commodities for a while. In 2012, their sales volume hit $65.8 billion, just shy of the record $66.2 billion set in 2005, according to estimates from Washington, D.C.–based CoStar Group. There were 270,263 apartment units under construction in the top 100 metro markets as of the end of the first quarter of 2013, according to Carrollton, Texas–based MPF Research. The key barrier-to-entry markets are building at levels well above their historical norms, with Seattle leading the pack with 10,789 units currently under construction, which is 186 percent above the metro’s annual average from 1998 through 2008 (see chart).
Nationally, apartment construction is in line with historical averages for the aforementioned 10-year period, says Greg Willett, MPF’s vice president of research and analysis. “It’s not more product than the nation can handle.”
Indeed, New York and Los Angeles are building apartments at rates that would add only about 1 percent to their respective existing inventories. And the 13,129 apartment units under construction in Houston would add only 2.2 percent to that metro’s inventory, according to MPF.
On the other hand, Austin, Texas, is currently building 12,690 units, which would add 6.8 percent to its inventory. And Jacksonville, Fla.—with one of the lowest occupancy rates in the country—has new stuff in its construction pipeline that would increase its inventory by 3.4 percent.
The apartment sector is performing admirably despite an economic recovery that’s seen only modest job growth, which typically fuels rent appreciation. “There’s a strong belief that as job growth recovers, demand will continue to be very strong,” observes Brian McAuliffe, senior managing director for global real estate services provider CBRE.
McAuliffe says he can’t remember a time during his 30 years in the business when he’s seen such diverse capital sources chasing after apartments. These newcomers include high–net-worth families, whom, he says, usually park their money elsewhere, and international capital.
“The apartment sector is receiving so much attention because investors clamor for immediate cash yields on their investments,” McAuliffe says. “And it’s not uncommon to sell a $100 million property to an investment group that has never purchased a building before, or hasn’t bought one in 10 years.”
What makes one building so much more attractive to investors than others? Location, as always. But, also, the rents a building can fetch will “dictate the caliber and quality of the property,” says Ryan Severino, senior economist and associate director of research for New York–based Reis. He adds that buildings with a host of amenities—such as theaters, wireless Internet, gyms, and coffee bars—will inevitably be worth more because they cater to a specific (and presumably well-heeled) clientele. “You can’t just have a rectangular pool and a couple of treadmills anymore.”
McAuliffe adds that the “ideal” target customer is a “renter by choice” who “is willing to pay rents that exceed 2006–2007 levels.”
So, how wide open is this investment window of opportunity? Willett says apartment buildings are going up in some metros, like New York, San Francisco, and Seattle, where previously only condos would have penciled out financially. This is because land prices have come down and construction costs have been manageable. “So it’s really a once-in-a-lifetime opportunity” for investors to get into higher-quality apartments in some of these areas, he says.
To that end, Willett points to REIT Behringer Harvard, which during the recession “broke the freeze” when it paid higher prices for apartment buildings. Behringer Harvard, he says, is now funding development.
There are only so many apartment buildings that have what it takes to command top dollars from investors, however. And more developers appear intent on hoarding the better stuff, observes McAuliffe, who points to REITs that have “dominated” the new supply chain and are now building assets to hold for their own accounts.
Over the past 24 months, big institutional investors such as JPMorgan Chase, UBS, and Prudential have been executing “build-to-hold” strategies by teaming with local operators to build apartments. “In the past, there were merchant builders, but not so many anymore,” McAuliffe laments.
Severino still sees pent-up demand for apartments among young people, as evidenced by the number of new buildings that come on line almost fully occupied. And rent appreciation isn’t expected to dampen renter demand, with most estimates forecasting rents rising at a 3.5 percent to 4 percent annual clip over the next few years.
Rising interest rates, which historically have been the “nemesis” of real estate, says McAuliffe, could have a significant impact on debt and what investors will pay for buildings. As it stands right now, investors are kicking in a lot more equity, to the point where, McAuliffe quips, “the equity required to build one building today would have built two buildings 10 years ago.”
But he also thinks there’s plenty of room for interest rates to rise, noting that around 250 basis points separate the return on 10-year Treasuries and apartment buildings’ cap rates.
However, even in all equity deals, “interest rates are a benchmark,” says Severino. And he wonders how avid investors’ interest will be in the apartment sector if, toward the middle of this decade, “monetary policy might not be so accommodating,” rents aren’t increasing as expected, and investors start questioning the price tags of buildings with low cap rates.
So, now might not be the absolute best time to sell, but that time seems to be coming sooner rather than later.
John Caulfield is senior editor for MFE sister publication Builder.
The traditional barrier-to-entry markets are building at levels well above their historical norms
Metro Units Under Construction Today’s Construction vs. Annual Average, 1998–2008
Seattle 10,789 186%
San Francisco Bay Area 14,028 176%
Washington, D.C. 19,457 166%
New York 16,054 147%
L.A./Orange County, Calif. 17,768 130%
Boston 6,558 121%
Source: MPF Research