When the apartment industry was mired in a serious recession in the early 2000s, many people called it a "perfect storm"–and it's easy to see why. A poor economy and low interest rates pulled people out of apartments, while a flood of new construction saturated demand for rentals.
Now the economy has improved, interest rates are up, construction has slowed, and rents are on the rise. So the question is: What to call this? In other words, it looks like smooth sailing.
"In 2007, we're drafting behind some of the best apartment metrics you could ever hope for," says David Fitch, president and CEO for Gables Residential, a large apartment owner and developer based in Atlanta.
Yes, 2007 looks very promising. But that doesn't mean multifamily executives won't continue to monitor some key trends as they look ahead. Here are a few variables on everyone's mind.
After years of deep discounts and empty apartments, 2006 brought strong rent growth to just about everyone in the apartment industry, no matter where a company's portfolio was located.
The reason? Simple economics. Condo conversions and unworkable construction and development costs for new projects reduced the supply of apartments, while a strong economy added to demand.
Will 2007 bring more of the same? Maybe, maybe not. While most apartment executives do expect rent growth in the coming year, the double-digit increases could remain solidly a 2006 trend. The reason: Apartments will be working off higher 2006 numbers, and it could be difficult to significantly improve over those. "But I think to have pretty good percentage numbers on top of what were pretty good numbers in 2006 will confirm the expectations that the multifamily space is terrific," says David Neithercut, president and CEO of Equity Residential, the giant Chicago-based public apartment REIT.
Scot Sellers, chairman and CEO of Archstone-Smith, a public apartment REIT based in Englewood, Colo., agrees. "When we look across our markets, we think next year could be better just because people can still afford higher rents," he says. "We look at our residents' incomes in New York City, Washington, D.C., and Southern California. Yes, they're paying a lot of money. But they can still afford more."
To Ron Terwilliger, chairman and CEO for Atlanta-based Trammell Crow Residential, rents look like they have returned to the high point of 2001's first quarter–before the apartment industry felt the full economic impact of the dot-com bust. And, with home prices still high, Terwilliger expects rents to continue rising in 2007. "Homeownership has become costly," he says. "People don't feel the need to buy a home if they think they're getting in at the top of the market."
There's just one shadow on these sunny expectations: the economy. While Equity's "extremely bullish" rent growth projections don't require "significant" new jobs, Neithercut admits, they also don't include the possibility of "a major economic disruption." With the for-sale housing market softening, that's a worry in many quarters. And Neithercut is watching a few statistics closely himself. "In some markets, residential construction jobs have represented a significant percentage of new jobs," he says. "I'm wondering if it won't have some kind of modest impact on expectations next year."
While Neithercut worries about demand, Christy Curry Freeland, co-CEO of management firm Riverstone Residential Group, frets about supply. As new condos reappear in certain markets as rental units, apartment rents at her properties feel the pricing pressure.
In Delray Beach, Fla., for example, rent growth reached the teens. Then a wave of converted condos showed up as rentals. Now Freeland finds her leasing agents giving away concessions. "I think you're going to see some of those impact your ability to rent," she predicts.
The Dow Jones reached unmatched highs in 2006, lessening investors' interest in apartments. Right? Not so, according to Eric Bolton, CEO of Mid-America Apartment Communities, a public apartment REIT based in Memphis. "There's still a lot of money chasing multifamily real estate," he says. "When you look at all of the long-term projections for multifamily and rental, [the returns] are still very compelling."
Strong fundamentals might drive demand even higher. Apartments have been "a great investment vehicle," Archstone's Sellers says. "As we're in an economy with stars aligning for rent growth, everyone wants to own the product. There's no shortage of demand for development capital as well as for acquisitions. People are willing to be aggressive."
The mix of buyers has changed, though. Tenants-in-common, or TICs, which are groups of buyers who pool their money to buy assets, are slowly disappearing from the scene. "We don't see them as much as we used to," Bolton observes. "Sooner or later, that influence runs its course, as these owners that sold these properties get wrung out of the system."
The same is happening with condo converters as condo sales slow around the country. "We are no longer seeing knockout bids by condo converters that are eliminating our ability to try to get some of these assets," Equity's Neithercut says.
Leverage buyers have also slipped away. As interest rates rose and property prices remained steep, many leverage buyers could no longer make the numbers work on an apartment deal. "When the 10-year [Treasury note] got up to 5 percent and change, that might have knocked a few people out," Neithercut believes.
Of course, with rates sliding downward, this group of buyers will rebound. "The leveraged player will come back," predicts Tom Toomey, president and CEO of United Dominion Realty Trust, a public apartment REIT. "Leverage costs are down."
But they'll have plenty of competition. Institutional investors, public apartment companies, and foreign investors, particularly Australians, are expected to continue their capital splurges in 2007. "You will see continued escalation from foreign investors," Toomey says. "The American dollar is weak. They are buying the U.S. cheap."