James Duncan knows not all markets are created equal. The CFO of McLean, Va.–based Jefferson Apartment Group (JAG) is watching various markets across the nation with cautious optimism, but he isn’t writing off the slower markets just yet.
While some institutional investors are scaling back their appetites in potentially overheated markets, Duncan believes it hasn’t made a huge dent in the overall liquidity available for multifamily developers looking to strike a deal.
“I think they’re being more cautious relative to their investment in markets that could have some supply issues,” he says. “And where we’ve seen others get too cautious or pull back a little bit, we’ve seen other equity providers step in.”
Duncan was one of about 100 professionals who responded to apartment finance today’s annual CFO Strategies Survey. The survey was conducted in early summer to peek into the thoughts of some of the industry’s best and brightest as they rev up strategic planning efforts for the upcoming year.
As more new units come on line every day, and inflation begins in earnest, Duncan is closely tracking how the second half of the year pans out, which will give a good indication of how much rent growth to budget for next year.
“I think we’re keeping our eye on certain markets as the supply really starts to deliver into the market during the second half of this year and how that will impact our traction to raise rents,” he says.
Duncan and 77 percent of the CFOs surveyed say they plan to raise rents in the next year.
Build Versus Buy
Since JAG’s inception in June 2009, the firm has had a hand in the development of about 3,600 units. The company expects to hit 5,000 by the end of next year and also hopes to widen its impact in the property management arena.
JAG will be starting three developments in the second half of this year. But that doesn’t mean the company’s acquisition activity has been pushed to the side. Duncan says 2013 has definitely been a year for buyers.
“Debt rates have increased here over the last five weeks [in June and July],” he says. “But, they’re still at historic lows, so if we find the right opportunities, we think it’s a good time to buy.”
And as employment figures begin to grow across the nation, demand will absorb the apartments in the current pipeline, though, “it may not be as robust as over the last 18 months,” Duncan says.
So, as rent growth slows, competition to attract and retain tenants will grow fierce next year. Creative solutions to offer something extra to tenants, while boosting net operating income, have become a focus for many firms.
For instance, pets have brought and will continue to bring money into owners’ pockets, as grooming stations, dog parks, and specialized fees are increasingly added to communities.
“Somewhere between 25 and 35 percent of our tenants have a pet,” Duncan says. “We think that’s something they value.”
Managers are increasingly exploring other options to boost NOI, such as passing on more utility costs to residents (see chart, page 29).
“We’re continuing to push to make sure utility and trash costs are allocated to our residents,” Duncan says.
Markets on the Watch List
Jay Hiemenz is hopeful that the first markets to feel the effects of the recession are now, finally, making their way out. The CFO of Phoenix-based Alliance Residential Co. is keeping a close eye on specific markets, such as Atlanta and Phoenix, that may have room for more growth, while using aggressive research and marketing tools to keep NOI in the black.
The company, which owns and manages market-rate, affordable, and student housing units, has seen a broad spectrum of improvement across the board, with markets that were hit hardest by the recession making a comeback behind the hot primary metros.
Atlanta is starting to gain momentum while Phoenix is seeing positives in both job growth and rent growth. “It’s almost like the ones that have improved over the last year haven’t bounced back all the way yet,” Hiemenz says.
Residents in the 24- to 35-year-old age range are fueling the demand for rental housing as the improving economy creates an opportunity for Millennials to venture out into the housing market. However, many in the demographic are not eager or able to buy homes, creating the perfect driving factor to sustain the rent-growth momentum seen over the past few years.
“The unemployment in that key renter segment is down,” says Hiemenz of Gen Y. “That’s creating demand that really wasn’t in the market in the last few years.”
Nonetheless, there are still plenty of markets playing catch-up and working toward a more stable economy. Las Vegas is one key market where Hiemenz has pulled the reins in a bit tighter as the local market struggles to find its footing.
Yet, there are still good opportunities in the market, beyond new construction.
“I don’t see us doing development in Vegas next year, because the market is still in recovery,” Hiemenz says. “But we’ve been doing acquisition there in anticipation of a recovery.”
Austin, Texas, has been at the top of many developers’ lists over the past few years. Forecasters had tabbed Austin as one of the nation’s hottest markets, but it is now walking a fine line between being in balance and being overbuilt.
Hiemenz, however, is keeping a watchful eye on the metro without sounding the alarms.
“I don’t think, yet, it’s at risk,” Hiemenz says. “But it does have a big pipeline, and it has a big demand.”
As far as rent growth, Hiemenz expects to continue pushing rents in markets across the board by varying degrees. For the first half of this year, Alliance’s team saw roughly a 6 percent increase across its portfolio, Hiemenz says.
In the next year, he expects to see it continue by about 4 percent. Some markets are able to withstand a larger boost than others, he says.
“In Vegas, I’d say you’re looking at rent growth in the 1 to 2 percent range, and then it goes all the way up to where we’ve seen areas, like Seattle, that still have almost double-digit rent growth,” he says.
Other notable markets include the major metros of California, and the major Texas cities, where rents are expected to increase by about 5 percent.
“I don’t see any market that’s going backward,” Hiemenz says. “We’re still really good—above inflation—for rent growth.”
Cap Rates to Rise
Hiemenz believes it’s a seller’s market now, and that, as interest rates rise, today’s aggressive cap rates may be as low as they’re going to get for some time.
“Most of the things are achieving the target valuations we had hoped for,” he says.
About 47 percent of those surveyed say they expect cap rates to rise next year. Hiemenz agrees and adds that interest rates will probably grow by about 25 basis points over the next year.
But owners are carefully watching the market as they predict how much value a property may have in the coming year, leaving a buffer for what the exit price may be on quickly turning acquisition opportunities.
And as Alliance continues to focus on urban locales, it also plans to cast a wider net, to areas that haven’t been shown as much love in the downturn but can fuel the demand for success.
“There are a lot of suburban locations for which there may not have been enough capital demand but for which there’s probably good renter demand,” Hiemenz says. “I think the best opportunities for us on the development side include broadening our base to look more so at suburban locations that might have been overlooked in the early part of the cycle.”
Risks of Oversupply
Finding financing in some markets is easier than in others.
When the recession began, Washington, D.C., became the hottest metro in the nation for new construction and acquisition activity. The city was a beacon for the recovery, the first market out of the recession. But now, options are becoming scarcer in markets that may have peaked too soon and are starting to wind down.
The Bozzuto Group, which has a large presence in the Washington, D.C., metro area, is moving forward with developments in the area despite the fact that many industry experts are skeptical of the District’s health.
In fact, about 15 percent of the multifamily financial professionals surveyed pegged D.C. as one of the markets most at risk of overbuilding, while about 10 percent also chose Seattle as an at-risk market.
The Greenbelt, Md.–based company’s CFO, Dan Murphy, says the risk of overbuilding is short term.
“I feel confident that when you look out on a 24- to 36-month basis, supply and demand will have equalized well. D.C. is still a strong market going forward.”
For the past two years, about 70 percent of the company’s construction loans have been financed with banks, while 30 percent have come from life companies in longer-term executions.
“Some of the assets we anticipate being long-term–hold assets, and we wanted to get the financing that matched that strategy,” Murphy says.
And even though conduit lending has made a comeback on the permanent debt side, Murphy says it’s not an option for Bozzuto. “We’ve tried to avoid CMBS in the past and have continued to avoid it so far,” he says.
Cautious Growth
Murphy believes there are fewer equity investors circling around the D.C. metro due to the perceived risk of overbuilding. Although many are viewing the D.C. market as having hit a plateau for rent growth, Murphy doesn’t believe there will be a ceiling to hit just yet.
“People are choosing to rent as a lifestyle choice,” he says. “There isn’t as much of a ceiling on it because there’s a direct correlation to homeownership, and people choose to pay more in rent if it fits their lifestyle.”
Still, the health of the single-family market is something to watch while crunching numbers for the upcoming year. Murphy says multifamily developers shouldn’t panic just yet but should keep a watchful eye on job growth and employment numbers as key indicators.
“It keeps us cautious about whether we can increase rents and whether the market can absorb the units that are under construction because of the concern about job growth,” Murphy says.
