Just because it seems like cap rates can’t go down any farther, and many formerly favorable markets will be flooded with supply, that doesn’t mean everyone wants to sell.
There are many good reasons to buy and hold too. And, they are many of the same reasons the apartment sector has been a favorite of investors over the past few years.
Pent-up demand from Echo Boomers (with 21.8 million individuals ages 18 to 34 living at home in 2012, according to the Census), and the promise of economic growth in 2014 and 2015 mean the apartment market hasn’t hit its ceiling.
“Although the rate of acceleration is slowing and pricing is a concern, apartment fundamentals are still generally healthy,” says Lili Dunn, chief investment officer for Greensboro, N.C.–based Bell Partners. “Rental housing benefits from strong demand driven by robust rental household formation, which is fueled by demographic trends and, to a lesser extent, job growth.”
Economists believe the apartment market still has a lot of upside over the next four or five years, at least, pointing to about 2.2 million new jobs created in 2013.
“That is a recovery,” says John Sebree, director of Calabasas, Calif.–based Marcus & Millichap’s National Multi-Housing Group. “It’s a lethargic recovery. But it’s still a recovery that’s gaining speed. This year, depending on whom you talk to, we’re anticipating 2.7 million to 3 million new jobs. These new jobs will continue to increase the formation of new households.”
And, Dunn doesn’t think there will be an oversupply of apartments to sap the demographic-driven demand. She points out that the supply in the pipeline is expected to decline after hitting 300,000 units in 2014, and thinks supply concerns are overblown. “New supply is also still within reasonable levels of long-term averages,” she says.
While many well-heeled investors are starting to dispose of their apartment holdings and chase yield in other asset classes, some economists think weaknesses in those other sectors—such as office and retail—will help apartment investments maintain their value.
“Some people are still risk adverse about other property types and are taking a long-term hold approach to this,” says Ryan Severino, senior economist and associate director of research at New York–based Reis.
With these economic tailwinds, Severino doesn’t expect to see a market implosion like the one that occurred in the late 2000s, where condo converters, not buying on a cap-rate basis, pushed prices to unsustainable levels.
“Even in the markets where cap rates are rising, it isn’t like 2008 and 2009, where we had a massive expansion in cap rates that clobbered the market,” Severino says. “I don’t think you’ll see that performance from the underlying economy or see demand erode like that [again].”
Brokers and market researchers are concerned about where pricing is heading, but aren’t exactly planning for an Armageddon-like scenario.
“Unless something blows up, I don’t see a hard crash,” says Dan Fasulo, managing director at New York–based Real Capital Analytics (RCA). “But I guess, who does see a hard crash? By just looking at line graphs we [have] leveled off. Cap rates aren’t moving lower. The rate of increase in pricing is slowing. You can expect more of that over the next couple of years.”
