Miami—More than 180 developers and owners heard from top multifamily industry leaders at the 2007 Apartment Finance Today Conference here in February. Several speakers said the biggest challenge and greatest opportunity for the industry is providing housing for people in low-wage jobs. But building so-called “workforce housing” is nearly impossible in most markets because of high costs, said Thomas S. Bozzuto, chief executive officer of The Bozzuto Group.
The only way to address the needs of working people is by preserving older housing that is already affordable, he said, adding that preservation alone will not do enough to meet this growing need. New construction is very hard to deliver at rents affordable to people earning at or near minimum wage, said Bozzuto, who served as a Congressional appointee to the Millennial Housing Commission and is serving his second term as a gubernatorial appointee to the Maryland Housing Commission. The Bozzuto Group is engaged in the development, construction, and management of rental and for-sale housing.
The cost of housing has grown faster than incomes for low-wage workers, said Anthony Downs, a senior fellow at the Brookings Institution, a private, nonprofit research organization specializing in public policy studies. Downs was for 18 years a member and then chairman of Real Estate Research Corp., a nationwide consulting firm advising private and public decision-makers on real estate investment, housing policies, and urban affairs.
“The classic answer has been slums,” he said. “Today, it’s overcrowding.” The problem will get worse unless governments begin working with developers to provide more housing, said Downs.
Meanwhile, the U.S. economy is slowing down but is unlikely to enter a recession, he said. The steady flood of capital into apartments will continue, and the biggest risk owners face is the possibility of an apartment construction boom. That scenario could occur in 2008 if it becomes more efficient to build than buy, even at today’s high construction and land costs, Downs said.
Although such a surge would address the need for housing, it would also reverse the supply-demand imbalance that has helped owners prosper in recent years. “We need 400,000 apartment units to be built per year, but in the 1990s, we only built 268,000 per year on average,” said Downs.
Developing new apartments is still very costly, but land prices have softened now that there is less competition from condominium developers, Bozzuto said.
The supply of half-built and unsold condominiums was described as both a threat and a potential opportunity. Can a developer make money taking over a “busted condo” and retooling it as rental housing? Yes, said Bozzuto, but it’s very difficult, especially on half-completed projects that have some occupancy by buyers.
Downs attributed the low cost of debt relative to Treasury securities to the fact that securitized lending has reduced perceived risk, not actual risk. He said underwriting has become a simple process of determining “Can I sell this piece of paper to another guy?”
Lenders speaking on several panels at the conference noted that borrowers had shifted risk onto lenders, who have stretched their underwriting to be as liberal as possible.
Capital remains widely available and cheap, according to lenders who spoke at the conference. Thousands of mortgage bankers want to increase their volume of apartment loans, said Thomas A. Schissler, a director for APF/Wachovia. “It’s a real street fight,” he said, referring to the competition among mortgage bankers.
Several developers and owners talked about the challenge of finding acquisitions at reasonable cap rates. “The biggest challenge is not to overpay,” said Richard Kelly of LumaCorp, a Dallas-based apartment management and renovation company.
A key concern among owners is the fact that operating costs (especially taxes and insurance) are rising faster than rents in many markets.
Downs, Bozzuto, and others said the best opportunities were for housing aimed at low-wage workers, students, and people of all ages who want to live in downtown locations. They also see good potential in buying failed condos and converting them to rentals, a strategy that some call “condo reversions.”
Looking ahead at rental housing demand
A projected slowdown in the U.S. economy is likely to have little negative impact on the apartment industry, said Linwood Thompson, managing director of Marcus & Millichap. Although the weakening single-family business is undermining consumer confidence, Thompson predicts a “very, very strong bull run” for multifamily properties.
The demand for rental housing should exceed supply in 2007, he said. A host of factors is constricting supply. Infill sites are increasingly expensive and complicated to acquire. Even perimeter sites aren’t as plentiful and are costly. Traffic congestion and increasing construction costs are factors. Plus, many communities actively oppose development. Adding to these supply-side constraints, the U.S. population will increase by more than 13 million people by 2010. So the demand for rental housing is expected to increase significantly.
On the “macro level,” the condo bust is “a blip on the radar screen,” said Thompson. The slowdown in the condo market affected the velocity of deals but not apartment pricing, said Thompson. He said plenty of capital exists in the multifamily market, but now instead of 20 offers for a typical property, there might be 10. “It’s a sign that buyers are wiser,” said Thompson.
Not so positive about the market was Sam Chandan, chief economist for Reis, Inc., a New York City-based real estate research firm.
Chandan said more apartments were added to the market than there were renters last year. Net absorption was negative 19.1 percent in the fourth quarter 2006, even worse than the negative 4 percent that was registered a year earlier. Completions, which dropped to 80,000 units in 2006 as developers focused on condos, are rising only modestly. Still, U.S. apartment markets recorded their 19th consecutive quarter of asking-rent, he said.
Renting may become more appealing than in the past due to increasing press coverage of the merits of apartment renting versus home buying, said Jack Kern, research director for Archstone-Smith Trust.
Opportunities in seniors housing
If you’re an apartment developer with a strong reputation in your local market, then this might be the perfect time to jump into the seniors housing business. “There’s a huge opportunity,” said Mel Gamzon, president of Senior Housing Investment Advisors, Inc. Gamzon moderated a panel on “Debt and Equity Options for Seniors Housing.”
That’s because seniors rent apartments based largely on word of mouth. So experienced owners and operators of seniors housing are eager to partner with local companies to create new seniors housing. Local apartment operators should contact seniors housing organizations like the American Seniors Housing Association and the National Investment Center to find potential partners. “The national owner operators would certainly consider deals,” Gamzon said.
Investors also are paying more than ever to purchase completed seniors housing projects. Capitalization rates, or the income from a property expressed as a percent of the sales price, have dropped from between 10 and 12 percent to about 8 percent in recent years, according to the panel. The panel also noted the necessity of experience in running these properties well and touched on opportunities to build condominiums for seniors and to convert conventional apartments to seniors housing—deals that can live or die depending on the distance of the walk to the elevator.
Goodkin shares development secrets
Lew Goodkin has seen it all. A market analyst based in Miami and the founder of Goodkin Consulting, he offered up the fruits of decades of experience in the apartment business during a packed lunchtime presentation.
Tremendous demand exists for inexpensive rental apartments and condominiums, and it isn’t being met, Goodkin said. “Price is the ultimate amenity for a lot of the market,” Goodkin said. Building to meet this demand should become a little easier in 2007. Goodkin expects the cost of construction to drop between 10 percent and 15 percent, at the same time as land to build on becomes more affordable.
Pitfalls abound on the path to development. Here’s some of the advice that Goodkin gives his clients and that he shared with conference attendees.
First, Goodkin urges developers to build as much flexibility as they can into their projects, especially if they might eventually want to sell.
For example, buy a little more land than you need for a planned development. Later, you can use this land to build another phase of apartments or new amenities for the community. Developable land can also add to the value of a community if sold: Poten-tial buyers like having the flexibility to build.
Build a project that is good enough to convert to condominiums, especially if the community is located in a better neighborhood.
Also, think creatively about how apartment assets might be repositioned. Goodkin remembers the swinging singles apartments of the 1970s. After the trend was worn out, he remembers how the South Bay Club apartments were repositioned to become Oakwood Corporate Apartments. “It was the same product and the same facilities, but the owners enjoyed a substantial increase in monthly rent rates,” Goodkin said.
Good research can be the key to understanding what a market needs and how a project can fill that need.
Goodkin also pointed out several opportunities to buy land and apartments. First, while many apartment investors concentrate on buying large developments, it can pay to consider small communities with just 20 to 60 apartments. These developments are often owned by individual investors who haven’t put much money into the properties, so there may be an opportunity to add value and raise rents.
Also, land from failed condominium deals will soon start to go into the hands of bankers, who will put these sites up for sale for considerably less than the going rate of a developable site in 2006. “There’s an awful lot of great sites owned by condominium developers that are not going to be built as condominiums,” he said. “I see a lot of development opportunity in the short term.”
Goodkin recommends working closely with local officials. These officials are often eager to encourage projects to mix uses like residential and retail space or mixed-income developments, and some are willing to offer developers the right to build higher density in exchange.
Developing relationships with equity
A developer can never have too many strong relationships with equity investors, according to the panelists at “Finding Equity Partners You Can Live With (And What to Do if You Can’t),” moderated by Douglas Culkin of the National Apartment Association.
“It’s a slow, hard process to develop that credibility,” said Tom Moran of Moran & Co. But all that work pays off when trying to find an investor for a complicated project.
The panel also explored options from outright sales to new loan products that are almost as flexible as equity investments.
Equity investors like pension funds are now buying up apartment properties even through capitalization rates, or the income from these projects expressed as a percentage of their price, has often slipped below 5 percent. Investors justify these prices because they are still lower than the replacement cost of the properties.
Developers are using a new kind of flexible loan to reposition their properties: collateralized debt obligations, which allow owners to use money raised on Wall Street. The interest rates are high, around 300 basis points over the London Interbank Offered Rate for a three-year loan. But the loans can be very large, giving borrowers more cash to invest in a project, increasing their ability to raise rents.
Know when to hold ’em
If you’re thinking about selling a community of fully-occupied apartments, it’s a good idea to raise the rents, even if a few of those apartments empty out. That’s because buyers tend to assume that they can increase the occupancy rate at a property themselves. “It’s better to push rents and let occupancy slip,” said Jeff Hawks, principal with Apartment Realty Advisors.
That’s just one of the secrets revealed by the panelists at “Cashing Out: When and How to Take Your Gains.”
Also, don’t re-paint a property before you sell it. The new buyers will want to do that for themselves and choose their own colors. And whatever you do, don’t refinance the property, even if you can get a great interest rate on the loan. “The superior transaction is offered free and clear,” said LumaCorp’s Kelly, who moderated the panel. “Assumable financing takes out a buyer’s creativity.”
An old loan will lower the sales price of a property, though it might be even more expensive to prepay the loan. Ask how much the buyer will discount the property because of the loan. Also, lenders might offer some perks to buyers who assume an old loan. Some accept annual financials prepared by management instead of quarterly financials by accountants.
The panelists told apartment owners to assess their properties once a year to see if it might be a good time to take money out of a property, either by selling or by holding the property and taking out a new loan.
How to survive the condo crash
Miami now has more construction cranes looming over its skyline than any other city in the world, other than Shanghai and Dubai. A lot of these projects are in serious trouble, according to Jack McCabe, president of McCabe Research and Consulting.
McCabe moderated “Condo Development & Conversions: How to Buck the Downturn.”
Investors have run from condo markets like Miami, McCabe said, leaving many projects unable to close sales on their units once they are finally completed.
But some developers with strong locations still succeed, like Tibor Hollo, president of Florida East Coast Realty. Condominiums are pre-selling respectably well at Villa Magna, Hollo’s 787-unit condominium project planned for the last developable patch of land in Brickell, Miami’s financial district.
The panelists also gave an update on condo markets from Chicago to New York City, where condominium sales are still going strong. But prices have dropped 20 percent in Washington, D.C. And in Florida, the production of condominiums overreached demand by 75 percent in 2006, according to condo analyst Jack Winston of Goodkin Consulting.
How to find, structure, and finance profitable deals
Many apartment owners and operators actively are exploring Class B and C deals.
“There aren’t a lot of core deals out there anymore,” said panel moderator Samuel “Trip” Stephens, chief investment officer for ZOM, Inc., an Orlando-based residential development and management firm.
Multifamily owners have to be willing to entertain many financial strategies simultaneously to get deals done, said Robert Hart, president and CEO of Kennedy Wilson Multifamily Management Group. One recent acquisition in Southern California took a year for Hart’s firm to complete. The financing looked “like a layer cake,” Hart said. The firm utilized bond debt, equity financing, and Fannie Mae financing, plus it brought in a Japanese partner to complete the deal.
Panelists discussed what markets were hot and what were not. One hot market where C-plus” product is being snapped up is the Pacific Northwest. Another sizzling market that’s expected to lose some steam over the next two years is California’s Inland Empire, where new construction finally is slowing down. The high cost of construction is slowing production almost everywhere, said Robert Given, executive vice president of CB Richard Ellis.
In the Miami area, between 15,000 and 20,000 units are expected to come online over the next 18 to 36 months, said Given. “There’s no oversupply of housing in general, even though that’s five times what had been the limit historically,” said Given. He said what is lacking is housing that’s affordable to low-wage workers.
New ways to improve your bottom line
One good way to tack dollars onto your bottom line is to do what you can to retain tenants, according to speakers on a panel on net operating income.
“What you can save on turnover will add dollars directly to [your bottom line],” said Jerry Rosen, president of Investment Real Estate Advisors.
The primary way to prevent turnover is to provide properties with good maintenance, said LumaCorp’s Kelly. “And I pay for it,” he said.
Apartment owners should look to the hospitality industry as an example, said moderator R. Lee Harris, president of Cohen-Esrey Real Estate Services, Inc. A speedy response to tenants’ problems is something that tenants appreciate and remember. They are likely to refer the property to friends and family.
Raising rents is another way to boost net operating income. Panelists discussed how to address the issue with tenants. Rosen said making in-person contact is important. “You call the tenant into the office. Explain that the rent has to go up, and ask ‘What can we do you make you stay?’” said Rosen. “Maybe it’s installing new carpet. It’s worth it.”
Utilities may be another area in which apartment owners can cut costs. Operators should find out if they are paying sales tax on tenants’ utilities at their properties, said David Richitelli, vice president of utility expense management for San Diego-based ista North America, a energy and water metering and billing firm. He said apartment owners are paying taxes on tenants’ utilities unnecessarily. Each state has different laws on this, he said. If they’ve overpaid, “owners can collect the back money,” said Richitelli.
Rosen stressed that owners should charge the highest rents possible.
More advice from panelists:
• Have maintenance staff look for other problems while they are fixing something else in the unit.
• Remember tenants’ names.
• Let residents stay in a model unit if their unit isn’t ready for move-in. Provide a move-in gift like a gift certificate to a nice restaurant for the inconvenience.
• Provide high-speed Internet access.