Buss

Pittsburgh—Looking ahead for the balance of the year, the performance of the multifamily sector can generally be summed up as a mixed bag, according to a recent study by PNC Real Estate Finance, based here.

Sector fundamentals significantly improved last year, but what exactly spurred that improvement is the question, says Nicholas Buss, PNC senior vice president and author of the report. On the plus side, Buss, citing figures from REIS Inc., notes that the national multifamily vacancy rate fell 100 basis points to 5.7% at year-end 2005, hitting its lowest point since early 2002. Yet, that drop in vacancy was driven mainly by the impact of the hurricanes and condominium conversions, both of which are temporary phenomena.

Total absorption last year was about 47,200 units, a respectable number that surpassed the prior two years, says Buss. “But--and this is a big but--nearly two-thirds of this demand occurred in the third quarter, resulting from the displacement of households as a result of hurricanes Katrina and Rita,” he adds.

Houston absorbed 15,200 units between July and September last year, representing half of the total national absorption during those three months. Dallas/Ft. Worth, Austin and San Antonio, along with other Texas markets, also saw significant absorption gains during that period, but most of the activity could be attributed to the hurricanes, and therefore is likely temporary and somewhat artificial, Buss states. It’s still too early to tell what the trend will look like, he says, “but don’t be surprised if apartment demand lags in Houston during the first half of 2006.”

Exempting the impact of the hurricanes, Buss says that demand actually languished in 2005. Not counting third-quarter numbers, quarterly net absorption was a mere 5,700 units, significantly less than the 9,400 units absorbed each quarter in 2004. The economy remained strong, as did job growth, and national homeownership rates were relatively unchanged last year, indicating that the mass exodus from the rental segment had run its course. So what could explain the stagnant demand for rental units?

One factor, says Buss, is the shadow rental market, driven mainly by speculators who put condo units on the market as rentals. And while quantifying the impact of the shadow market is difficult, he notes that the trend will probably continue and even grow as several new condo developments will start to hit the market at year’s end and in 2007. Another possible explanation is that would-be renters took advantage of favorable conditions in the single-family home market and purchased a home. Many of these buyers were young singles and non-traditional households, which would have otherwise rented. The good news, he says, is that this trend will likely taper off during the course of the year.

The supply side isn’t helping matters, either. At this time last year, Buss notes, experts projected that new deliveries would total about 110,000 units in the 90 markets tracked by REIS. The real figure, however, is that only 78,000 units were brought to market, the lowest level in a decade.

Although completions were lower than usual, deliveries still outweighed overall demand by two to one. Excluding hurricane-induced demand, that figure jumps to between three to one and four to one. From those numbers alone, a market observer would expect vacancy to rise. The main reason it didn’t, Buss says, is because many units originally planned as rentals ended up coming to market as for-sale residences. According to REIS, almost 118,000 existing rental units were converted to condominiums in 2005, nearly double the 67,000 recorded for the prior year. Condo conversions surpassed the delivery of new rental apartments by nearly 40,000 units. This trend will probably continue, at least for the near term, as long as it makes more economic sense to pay a mortgage on a condo unit than it does to rent.

Landlords, meanwhile, finally got some pricing power last year, as evidenced by a 3% rise in effective rents, marking the largest increase in five years, reports REIS. Absolute effective rents rose too, but the jump was uneven across markets. the median gain for 69 markets was about 2.2%; the national figure was skewed higher thanks to strong performance in just a few markets. Twelve areas alone saw gains of 4% or more in rents. Many of the markets that saw the highest increases experienced a large amount of condo conversions, which depletes the inventory of quality rental stock.

The other factor behind the rental gains was a decline in concessions, Buss says, though for many non-coastal markets like Atlanta, Dallas, Denver and Charlotte, NC, concessions have become the norm and will likely continue to be offered in the near term.

Vacancy improvement also varied between markets. Though the national vacancy fell by 100 basis points, the median decline among the 69 metro areas surveyed was 70 basis points, and 12 markets actually ended 2005 with higher vacancy rates than at the beginning of the year. Only seven regions experienced vacancy decreases of more than 2%. Among these markets are those that had been poor performers during the past few years, including Dallas, Atlanta, Austin, Denver and Charlotte. On the plus side, those declines were driven more by demand than by a lack of supply. However, Buss says, “Landlords have chosen to grow revenue through occupancy rather than rent gains.”

Investors interested in making plays in the multifamily arena do have options outside of the traditional sector. Segments like student, affordable and senior housing provide prime opportunities for developers and investors and the activity in those sectors should increase this year, the executive states. Increased college attendance, a large wave of individuals in their late-teens through early 20s and a lack of modern, updated options will only contribute to the demand for student housing units, Buss points out. However, research is critical, he warns, in order to understand the dynamics of the campus the property serves, the socio-economic status of the students and existing housing options for students. “One factor that cannot be overlooked is timing,” he adds. “Developments must be completed prior to the start of the fall semester. Miss this window and it is bad news for all involved, especially the developer who will likely be carrying an empty project for another 12 months.”

As financing options and single-family home prices have risen, so has the demand for affordable rental units, particularly in places like California and Florida, Buss reports. Further, the Section 42 Low-Income Housing Tax Credit program also serves as an important tool in bringing such product to the market. “While the underpinnings of the program remain strong, developers and investors alike must remain vigilant that proposed projects are feasible from a market perspective--not just a social perspective, particularly as the project must remain in compliance for a period of at least 15 years,” he says.

And with the first wave of baby boomers turning 60 this year, investors could find great returns in the senior housing sector, Buss states. During the next 18 years, about 79 million individuals will become sexagenarians, he relates, and on average, someone will turn 60 every seven seconds. Although housing opportunities appear to proliferate, Buss warns that there are a few caveats, including whether those targeted seniors would even want to rent and the impact of rising health care costs. “Many of the 79 million boomers can expect to live another 30 years after reaching 60,” he says. “Developers and investors should continue to proceed carefully with this product type, but opportunities will continue to grow.”

For the balance of the year, bottom-line performance of the apartment sector will still be dependent on what’s happening in the condo market, Buss contends. If condos remain successful, demand should grow, albeit for the wrong reasons—declining supply versus rising demand. But if the condo market slows, he believes multifamily performance will be more unpredictable. A housing market slowdown should benefit demand, but it could also result in conversion properties reverting to rentals, as well as speculators placing rental units back on the market in order to reap whatever returns they can.

The good news, he says, is that those negative effects would primarily impact the most condo-centric markets. The bad news, however, is that those condo-heavy markets are usually the most dynamic performers on the multifamily rental side and tend to skew national data. “We would not be surprised to find that this time next year we are back where we started, with national vacancy in the 5.5% to 6% range and a market looking for direction,” Buss states. “As always, the apartment sector is never boring.”