Ron Johnsey is contrarian by nature. When it’s popular to zig, he zags.
In three decades working in and studying multifamily, Johnsey, president of Dallas-based research firm Axiometrics, has developed a bias toward an outlier’s view of what’s happening and what’s coming next. This time, though, it’s different. Strangely, he’s finding no counterpoint position to argue.
“Everything is just ripe for a robust apartment market,” Johnsey says. “I’m always looking for problems. But these numbers are just some of the strongest I’ve seen.”
Johnsey has company aplenty. Market researchers, Wall Street analysts, REIT executives, big multifamily players, and small alike can scarcely quell optimism over practically a sure bet for a bountiful 2012. For multifamily enterprises’ most basic building block, rents, is going up. A heady crossroads of undersupply and swelling demand suggests almost assuredly energized net operating incomes, fresh infusions of yield-starved investment, a stream of new construction, and even greater profit in the near term.
By and large, players have reversed the losses they incurred from the Great Recession, and rents are nosing boldly toward unprecedented highs. After national rent growth of 2.3 percent and 4.7 percent in the prior two years, Greg Willett, who heads the research and analysis team at Carrollton, Texas–based MPF Research, forecasts 4.5 percent growth in 2012 but suggests that 6 percent growth would hardly come as a shock.
Not everyone harbors unchecked optimism. The wet blanket takes several forms, each consequential: An anemic recovery limits income and jobs growth; a potential for more economic shocks emanates from the euro zone debt crisis; divisiveness sends fissures through an election-year–emboldened policy landscape; and, closer to home, a specter of oversupply clouds the horizon.
Last year’s third and fourth quarters reminded apartment owners they weren’t out of the woods yet. The U.S. credit downgrade and European fears resurfacing seemed to cool the market and slowed rent growth. But even discounting for the negatives, no one debates whether things will improve in 2012. Saving for economic Armageddon, everyone’s got the 12 months ahead as positive. The question is by how much? Will 2012 beat 2011? And what about sustainability?
Annual Rent Growth
In early 2010, REIT executives began to detect tightening in their properties. After playing defense since 2008, a flow of new demand meant they could now begin to push rents. After two years of capitulation to softness, rents jumped 2.3 percent in 2010. Things got even better in 2011, no matter which source you believe. Axiometrics clocked effective-rent growth at about 4.4 percent, while MPF’s figure was 4.7 percent, and New York–based Reis measured rent growth at around 2.3 percent last year.
Charleston, S.C.–based Greystar, an apartment owner, manager, and builder with more than 180,000 units in 34 states and 100-plus markets, rolled up rent growth in the 4.5 to 5 percent range. “2011 will end up being viewed as a strong year,” says Andrew R. Livingstone, an executive director for Greystar.
Despite a year-end tail-off, Rick Graf, president of Dallas-based apartment owner and manager Pinnacle, remains “cautiously optimistic” for 2012. His outlook illustrates the extent of his optimism. He expects rent growth to jump in many of his major markets—going from 3 percent to 5 percent in Texas, 6 percent to 8 percent in Seattle, 8 percent to 10 percent in the Bay Area, and 5 percent to 6 percent in Southern California. Greystar’s Livingstone agrees. “My sense is that in 2012 there will be 3 to 6 percent rental growth,” he says.
But multifamily owners do need to be concerned about hitting the ceiling of what their renters can pay. With wages dropping as a share of the overall economy, the question lingers—how long can landlords push the envelope?
Existing-home sales volumes don’t correspond consistently with rent trends, nor do they diverge in a predictable way. In 2004, 2005, and 2006, as more than 6 million existing homes sold annually, rents grew by 1.7 percent, 3.6 percent, and 3.2 percent, respectively. And, at the depths of the recession in 2008 and 2009, while existing-home sales barely eclipsed 4 million, rent rates fell 0.3 percent and 4.1 percent, respectively. So it’s possible for the rental and for-sale markets both to surge and stall in step with one another. Still, many regard a resurgent homeownership market as a risk for rentals. In 2003, for example—the first year existing-home sales exceeded 6 million—rents fell 0.6 percent, their biggest decline following the tech crash.
In certain markets, highly affordable for-sale houses may begin to wrest renters away from their leases. “In our forecast, we’re assuming a pretty big move in the loss of renters,” Willett says. “The economy has been pretty healthy for a while, and there’s not much of a premium to buy versus rent.”
Reis senior economist Ryan Severino also sees for-sale’s resurrection as apartments’ loss. “While credit conditions remain tight, it’s difficult for people to come up with money and get a down payment. But at some point, if housing prices remain cheap enough, people will be enticed back in.”
As occupancies have risen from the low to mid 90s in the past couple of years, apartment owners have gained pricing power. In fact, with occupancies at 94.8 percent nationally as of early January, according to Reis, Severino says it may now be the moment for owners to hit the gas on rent increases. “We didn’t have a tremendous amount of job creation and we got vacancy declines and rent increases [in the past year],” Severino says. “Add [more job creation] to an already tight marketplace, and it’s sort of like throwing gas on a fire.”
Owners have gone so far as to welcome move-outs. They “seem to be focused on maximizing revenue through turnover in leases,” says Sarah Bridge, founder and managing member of RealFacts, a Novato, Calif.–based rental data provider.
In fact, it may make sense for owners to cap occupancy at 95 percent. Amid rising rents, vacancies open a window of opportunity for jacking up the price.
Still, Greystar’s Livingstone says that some of his renters are balking at price increases—at a certain point, owners may not be able to find replacements who can pay more until wages move up.
“At what point do renters feel they’ve hit the wall with what they can afford?” Willett says. “It’s really hard to calculate when that picks up. Over the remainder of the decade, I think that’s our key challenge.”
In the past, nothing has aborted a budding recovery so calamitously as building too much. Builders ache to build. Were they to cobble together the debt and equity, they’d all start the construction engines tomorrow. “I think we’re in the mode of trying to make hay while we can,” Pinnacle’s Graf says. “There’s some caution in the wind, but [builders] are trying to get deals in the queue.” After a pre–market-crash completions peak of 3,320 units in 2008 and 3,114 in 2009, new multifamily units coming on line plummeted to half that total in the past two years.
The next 12 months could bring a slight uptick, but experts think it unlikely that new units will clog the multifamily freeway with oversupply this year. “Oversupply is not a 2012 question, but it could start to show up in some markets by 2013,” Willett says. “Washington, D.C., and Dallas are two markets you have to watch, but even in those markets, I don’t think it [will be] there yet in 2012.”
Others set the clock ticking on excess supply at an even later date. That’s when rental owners in markets like Seattle, with 25 deals in the permitting stage or in process, could see a lot of new competition in a hurry. “Once you get into 2014, that’s when we start seeing the occupancy rates fall,” Johnsey says. “That’s when you see more supply come into the market.”
The problem could be an even bigger issue in historically overbuilt markets like South Florida. With no apparent memory of the recent bust, developers there supposedly have as many as 25,000 units on the way. If that becomes a reality, apartment owners in the Sunshine State could be swimming in a flood of new competition.
But one saving grace may be what happened the past couple of years. When new supply fell below 1,800 in 2010, many argued that there weren’t enough apartments being built to replace what was lost, much less satisfy new demand. That could give developers a cushion as they build over the next couple of years.
“Limited new construction will be a strong positive for apartments in 2012,” said Jay Lybik, VP of market research for Chicago-based Equity Residential, at the National Multi Housing Council Apartment Strategies Conference last month.
Surely, an exhilarating ride awaits multifamily this year.