To be an apartment renovator in 2009, you didn’t need a snappy design or product sensibility or even construction expertise. Instead, you needed to be Carnac the Magnificent.
Why need a dose of magic? Because to confidently do a rehab last year, you needed to be able to project the return on investment you expected to achieve. And as apartment owners know, 2009 was not the year to be projecting rent increases. In fact, rents fell 4.7 percent nationally from the fourth quarter of 2008 to the fourth quarter of 2009, according to CBRE Econometric Advisors, part of Los Angeles-based commercial real estate services firm CB Richard Ellis. So not surprisingly, nearly every company that participated in Multifamily Executive’s first Apartment Renovation Index (ARI) survey reported declines in the number of units renovated from 2008 to 2009.
“With the inability to have any pricing power, we saw less demand for the upgraded units,” says Keith Knight, vice president of capital improvements and national accounts for Rochester, N.Y.-based Home Properties, a REIT that completed 2,128 rehabs in 2010. “We think the market was much more price-sensitive, due to the economy and unemployment rates.”
Apartment owners’ difficulties getting rent boosts out of rehabs forced them to cut back on the number of units renovated and scale back on their overall renovation packages. Most of these owners also don’t expect to pick up the pace dramatically in early 2010 as credit continues to remain tight and unemployment holds down rents. Despite the dire outlook today, renovation executives believe they will eventually find rehabs to be a worthwhile area to sink their cash.
No one seems to boast a bigger footprint in the apartment rehab sector than Denver-based AIMCO, which has about 60 people who work on its rehab teams. From 2005 to 2009, the REIT invested $1 billion in conventional rehab work, turning 170 properties comprised of about 70,000 units. Those numbers plummeted in 2009 to an investment of $56 million across 33 properties. And 2010? AIMCO only has four active projects planned to the tune of $7 million.
“Rehab has gone from 60 to zero,” says Dan Haefner, executive director of multifamily management for Raleigh, N.C.-based Drucker & Falk, echoing sentiments heard throughout the industry. “There are very, very few places where you can get rent growth. As a result of that, there’s no reason to do the rehab.”
Need more examples? Take Memphis-based Mid-America Apartment Communities, which plans to renovate about 2,000 units this year (it renovated roughly the same number in 2009), in hopes of achieving $70 to $80 per month in rent increases. But it’s finding a lot more success in the $30 to $40 range. Last year, the REIT renovated 2,000 units at 55 properties in its portfolio after turning 3,700 units in 2008. “If you do the math, there are a lot of properties that started out of the box that we shut down,” says David Nischwitz, senior vice president and director of property redevelopment at Mid-America.
And that frustrates Nischwitz. He liked some of the renovations he had in the pipeline. A lot. For example, he’d like to upgrade the flooring, appliances, lighting, countertops, and plumbing at one of his properties (the Sanctuary at Oglethorpe) but hasn’t started yet. That’s because Mid-America tried a similar renovation at another unnamed property in Atlanta and was unable to achieve the desired rent increases. “The renovation where the real rent pop happens hasn’t presented itself,” he says.
At least Nischwitz isn’t alone. In the past two-and-a-half to three years, Houston-based REIT Camden Property Trust renovated 11 properties, about 4,000 units, throughout the United States; last year, it only turned two properties. Meanwhile, Highlands Ranch, Colo.-based REIT UDR, which renovated between 200 and 300 units every month from 2004 to 2008, completed a total of 363 unit renovations in all of 2009. In 2010, UDR expects their renovation pace to decline further, to between 100 and 200 units for the full year. “The premium we needed to get was $100 to $150 per month,” says Jerry Davis, UDR’s senior vice president of operations. “Residents weren’t willing to pay that.”
And he’s right. According to the ARI results, most companies doing renovations have had to forego expectations—of both their pipelines and the returns that can be achieved. For example, as Mid-America’s renovations fell 50 percent from its peak, rental price points fell 30 percent. “Not only were we doing fewer units, but we were investing less per unit,” Nischwitz says.
Less is More
Even in good times, a “typical” apartment renovation doesn’t really exist. That’s even more true in the current economy.
UDR has a repositioning package to move a Class B property in a Class A market (with only one such project under way as of press time). Its strategy includes kitchen and bath upgrades—the firm has a separate kitchen and bath value-add program that replaces cabinets and countertops and costs about $10,000 to $11,000 per unit—as well as structural changes such as moving walls inside a unit; exterior upgrades; and/or revamped amenities. “We may change the architectural dimensions and the roof line may change,” Davis says.
For Philadelphia-based Madison Apartment Group, the multifamily operating arm of Philadelphia-based BPG Properties, renovation staples may include kitchen cabinets, countertops, wood flooring, and plumbing and lighting fixtures. Home Properties may do a complete kitchen, bath, and millwork package or in some cases a ‘kitchen only’ package, if the bathroom is still in good shape
And for Camden, there’s no cookie-cutter renovation at all. “We don’t have a standard,” says Mike Archer, the company’s national facilities director. “We don’t have an A-, B-, or C-type upgrade. We evaluate each one separately.”
Without a standard with which to adhere, it’s easier for renovators to adjust on the fly. In times where rents are squeezed, they can adjust their renovation investment downward and still choose to touch-up a unit. “If you look at a kitchen, bath, and second bath, we always try to do the kitchen first,” says Knight of Home Properties. “Maybe that gets a $30 or $40 premium in a market. If the market will bear it, we’ll do the millwork, baseboards, doors, trim, and bathrooms as well.”
But in Home Properties’ markets, it can do even less than that. The firm will do a doors and hardware package only. “If we can get $10 a month per unit by upgrading fixtures, we’ll do that because they’re generating a 10 percent return for us,” Knight says.
Mid-America has also had success scaling back its renovation packages. For instance, it renovated the flooring in more than 100 units at its Lighthouse at Fleming Island apartment community in Jacksonville, Fla., for a rent increase of around $20 per unit. “It’s not a big number in investment, but it was a huge success,” Nischwitz says. “That $20 improvement was well-received. People were grabbing up the units.”
Camden can make upgrades to its light fixtures, plumbing fixtures, ceiling fans, window blinds, and add new paint for a rent increase of $40 to $60 per month in some markets. It will also put in washers and dryers when possible, which can score an extra $35 to $50 per month.
While apartment firms can tweak a faucet or fixture fairly easily, cabinets are a different story. “The costs of cabinets are the biggest percentage of cost in a renovation,” Camden’s Archer says. “You can replace ceiling fans and carpets and vinyl very easily compared to cabinets.”
Some companies have found a cost effective way to make the cabinets look new without really pulling them—a lifesaver when rents are falling or remaining flat. “We can update a cabinet face and make the cabinetry look brand new for $450 to $550 per unit,” Nischwitz of Mid-America says. “It’s a very good product. It’s been proven to take the wear-and-tear.”
If the cabinet frames are in good shape, Camden, too, will re-face or replace drawers and doors. That helps them last another 10 or 15 years. But there’s a caveat. “You have to be careful with that—you’re saving cabinets that will be very out of date in five to 10 years,” Archer says.
Customer preferences also influence a renovator’s course of action during a downturn. For instance, Drucker & Falk will e-mail existing residents and offer upgrades such as a new accent wall for $5 more in rent per month. Home Properties does something similar. “If a customer says that they’d like to have their unit renovated, we’ll do that,” Knight says. “It brings another $75 to $100 per month. We get them into a unit temporarily, do the renovation, and move them back.”
The drop in renovations over the past few years has had one major impact on the fate of future renovations—it has left a lot of units out there, frozen in time, that apartment owners can touch-up when rents start moving.
“If I still have 100 units left in a property that I started three years ago,” says Madison Apartment Group’s president Joe Mullen, “then I may only do 30 units in 2010 because the market is not there. Obviously, I will extend this value-add program another year or two.”
The downturn has also given renovators time to think about what their next moves will be. UDR is currently conducting feasibility studies about the possibility of adding more repositioning projects to its pipeline. So is Camden. “We’re looking to see what we want to do in a down time to prepare for the uptick in the market,” Archer says. “We’re scouting throughout the country to find opportunities. We’re trying to identify properties to do in the second and third quarters of this year and into next year.”
Right now, Archer says Camden’s investment decisions will take a quarter or two to finalize, but he thinks the nadir of the rehab downturn will be in the second half of last year and first three quarters of 2010.
AIMCO, which sees rehabs as a place to invest when existing apartment prices get crazy, doesn’t just expect to turn the spigot back on either. Dan Matula, senior vice president of development for the REIT, doubts the company will ever redevelop like it did between 2005 and 2009. Instead, he could see the pipeline go back up to $75 million to $125 million a year. “We continue to have a deep pipeline,” Matula says. “We continue to evaluate which opportunities make sense. But for us to do development, it has to be more attractive than other investment opportunities.”
Still, there are some other external factors that could start up the redevelopment engine. Competition often plays a role for Haefner. As Class A properties have cut their rents to compete with lower-grade assets, those Class B assets may need to renovate to compete. “We have some stuff that’s being impacted by higher-quality assets,” he says. “As the markets have softened, the rents have compressed, too. What used to not be as close of a competition before will be a closer competition today. That forces you to do some rehab, too.”
Repositionings could also be a more palatable way for a company to get upgraded product than to go through the development process—during which financing is very difficult to come by. And then, those people who do buy properties, some of which may have been ill-maintained because of cash flow problems, may want to fix them up.
“Fast forward to 2010, where people clearly have capital, and the market has picked up on the acquisitions side,” Madison Apartment Group’s Mullen says. “I think people will go after solid B properties in A locations and then try to perform that value-add scenario.”
That’s why a company like Home Properties, whose bread-and-butter is buying older properties in great locations and perking them up, sees great potential in the next few years. “We think there is a good pipeline of rehabable apartments coming down the road,” Knight says. “I know our acquisition guys are looking forward to this year.”