Multifamily investors, owners, and brokers had a very active 2019, with record-breaking acquisition volume, and 2020 is underway with optimistic expectations. “We expect sustained enthusiasm and capital for multifamily investment through 2020, along with deep pools of debt capital to finance buying activity. This landscape should help bring reluctant sellers to the market and keep investment activity at very high levels,” says Richard Barkham, CBRE’s global chief economist and head of Americas research.
Even though the overall mood is positive, the year ultimately will be defined by November’s presidential election as questions about the cost of capital, millennial movements, and rent control wait in the wings.
The Land of OZ
The debate about the effectiveness of Opportunity Zones and who really benefits is still going on even though the deadline for maximizing tax incentives passed with the end of 2019. But there are still chunks of capital out there looking for a home.
Novogradac & Co., a financial services company based in San Francisco, lists 264 OZ funds loaded with $6.72 billion of equity as of January. Over 8,700 designated OZs are scattered across the country waiting to be improved.
The hurdles standing in the way of making deals pencil in those locations remain in place, but Bob Hart, president, CEO, and founder of Los Angeles–based TruAmerica Multifamily, says he sees the potential for some big-city OZ action.
“I think there will be a sizable amount of big developments in the infill urban areas like Queens, Inner Harbor Baltimore, downtown LA,” says Hart. “If I were to guess percentage wise, it would probably only be 5% to 10% of the development pipeline overall, but I think it’s increasing, particularly as the time frame is melting down for the tax benefits.” Hart believes even with the tax breaks, OZ deals are still beholden to the market in terms of entitlement challenges, labor costs, and rent rates on the finished buildings.
Added Value
While OZs are a small, yet potentially potent, piece in the multifamily puzzle, the opportunity offered by value-add deals still beckons. Jason Morgan, principal at Morgan Properties, based in King of Prussia, Pa., killed it in 2019 with value-add but says he sees things tightening up.
“We have acquired over $7 billion in total acquisition volume comprised of 50,000 units,” says Morgan. “As we continue one of the longest cycles in our country’s history, each year becomes harder to invest capital into interesting opportunities. Many investors will continue to flock to the sector into 2020 given the fundamentals, continued job growth, and the low-interest-rate environment. The result will likely be continued cap rate compression making it challenging for buyers to compete.”
Value-add is Hart’s bread and butter, and he says he still sees room for growth. “It’s the space that is probably the most desirable, from a durability of cash flow and an ability to grow income, and it’s the largest demographic swath of the multifamily cohort,” he adds. “There’s plenty of capital finding its way into Class B, which is driving investment sales both on the buy and sell side and also driving renter demand. I think you’re going to continue to see lots of growth in Class B over a long period of time.”
Controlling Rent
Rent control plays the role of villain in multifamily deal-making by clamping a lid on revenue growth for building owners, operators, and renovators. At the same time, affordability issues are forcing municipalities to cast about for any possible solutions for lowering housing costs. Morgan believes capping rents won’t fix anything. “There is a huge affordability problem in this country, but rent control will not solve it,” he says. “In fact, rent control exacerbates the housing shortage. It pushes investors out of the market and current owners to their breaking point.”
Hart sees shades of gray within the rent control debate depending on the approach being taken in different parts of the country. In California and Oregon, he likes the wiggle room that’s pegged to the Consumer Price Index.
“The recent state law allows a wide enough spread, 5% over CPI, which still gives a pretty wide latitude for landlords to move their rents to market, and you still have preserved vacancy decontrol,” he says. “Oregon passed a very similar law, I believe it is 7% of CPI. It hasn’t really affected that market, but Oregon has been a little softer overall. There’s plenty of new construction.”
However, Hart is not happy with New York’s version of rent control, referring to it as “draconian” and bemoaning portfolio writedowns and stagnant property values.
Big Picture
The projection wizards at CBRE also point to concerns about rent control and note a 9.2% year-over-year drop in multifamily investment in New York during the first eight months of 2019. Investments in LA dropped 9.8%, but San Francisco came up 7.4% and Portland increased 23.5%. The firm notes that Illinois and Washington state are now on a new rent control legislation “watch list” for the year.
CBRE also predicts a slight slowdown in overall apartment demand with the vacancy rate going up 20 basis points to 4.5%, which would still be below the long-term average of 5.1%. It is calling for a fall in rent growth from an average of 2.6% to 2.4%. Economic growth is expected to slow as apartment demand will slide to 240,000 units—about 20% less than 2019’s 300,000 units. Reflecting what’s currently in the pipeline, permits and starts will fall this year while deliveries increase.
CBRE refers to “solid fundamentals” while describing a slowdown that will not become a crash thanks to millennials. “Part of it is millennials delaying lifestyle changes that move them into homeownership,” says Jeanette Rice, head of multifamily research, Americas, for CBRE.
“More people are staying in multifamily because they want to, because of the urban lifestyle, because of new product, because of not wanting to be tied down to a mortgage,” she says. “Some are staying in because of the high cost of housing or their inability to save for a down payment. That is keeping demand at peak levels and new supply is being absorbed as well.”
Nobody seems to be particularly concerned about interest rates, and even worries about the recession that was predicted last summer by an inverted Treasury bond yield curve have stopped making headlines.
“In October of last year, The Wall Street Journal economists were asked, and 37% thought we’d be in recession in a year,” says Rice. “Today it’s 25%. Our economists expect a slower 2020, but with enough growth to create jobs and achieve wage growth for the workers. We are not officially projecting a recession—not right now.”
Geography 101
When looking for hot real estate markets in 2020, it wouldn’t hurt to take a look at the leaders of 2019. Rice’s No. 1 market is the Mountain West, an area with population growth that is coming at the expense of California. “The Mountain West is best in the U.S., and the market leaders are Phoenix and Las Vegas,” she says. “They are getting well above average rent growth. The California situation is one of a high cost of doing business and a strict regulatory environment—the business situation has caused a lot of people to leave.”
Rice is also high on what’s happening in Beantown. “In the Northeast, my favorite market is Boston. It’s had population growth, more than a lot of the other Northeast markets. Boston is an outlier because it’s a center for biotech and finance. It’s expensive to live in Boston—from a multifamily point of view, it’s good because it’s keeping people from buying homes.”
Other names that rise to the top of her list include Atlanta; Charlotte, N.C.; Nashville, Tenn.; and Austin, Texas. “I really like Atlanta. It’s been building a lot over the years with rent growth over 4%, so it’s in a good position to be a leader. Atlanta is still the economic capital in the South.”
Hart is even looking beyond the usual suspects and going down another level in terms of city size. “I think we’re going to see the rise of secondary and tertiary cities in America getting more and more investor demand for product. I think it’s still an improving environment for investing,” he says.
Election Impact
The big wild card in the year ahead is the same one that appeared in 2016—the presidential election. Many experts are predicting that deals will be happening earlier in the year as opposed to later as the nation pauses in November to pick leadership.
“From a transaction standpoint many of the principals and brokers will tell you the year will be front-end loaded with respect to transactions because of the ambiguity associated with the election period; that’s what happened in 2016 after Donald Trump got elected,” says Hart. “There was some ambiguity in the markets, about which way things were going from an investment standpoint. So I think if anybody is going to get deals done, they are going to get them done in the first six to eight months of the year.”
Experts are predicting a smooth, uneventful ride through the beginning of 2020. “Multifamily cap rates should be broadly stable, with slight compression possible,” says Barkham. “Investors should not count on significant appreciation returns, but income returns will remain steady. The best opportunities are in suburban markets, smaller metros, and metro leaders.”
