The Apartment Market – Recession or Re-Calibration?

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The State Of The Apartment Market

Even in this strange economic climate, the fundamentals of the apartment market are solid. The national occupancy rate for apartments is in the low 90’s. Supply is still relatively low at 1% inventory overall. This means that, on a national basis, there is not a huge oversupply of units. Rental revenues continue to grow at 3-3.5%.

A lot of the positive trends you see in the apartment market are the opposite of what is happening in the home ownership market. People need a place to live and as people lose their homes to foreclosure, they are moving to the most obvious alternative which is apartment complexes.

The apartment market has also been strong for investors. The banks have continued to offer low interest rates and spreads.

Most investors feel comfortable investing in apartments so apartments have become the preferred product class for investment. Returns from alternative investments have not had as favorable returns on a national basis.

Also, the supply and demand of apartments is stable and therefore supports increasing rents and appreciation of value.

This is caused by:

  • Development costs are expensive and sites are difficult to find
  • With gas price and fuel costs increasing, construction costs are high
  • In urban municipalities, it is difficult to get the density needed to give the investors economies of scale
  • Because of the strength of the apartment market, investors have been willing to accept lower yields (cap rates), which has allowed prices to appreciate.

Historic Recessions in the Multifamily Market:

THE EARLY 80’S:

  • Interest rates spiked to the high teens (15-19%)
  • Properties with adjusted rates experienced foreclosure as investors felt the impact of negative cash flow

THE LATE 80’S:

  • Congress changed depreciation rules
  • Syndication investors were destroyed so there was a shortage of investment capital
  • Savings and Loans went into default
  • There was a high number of foreclosures and write-downs of loans

What Lies Ahead

As demand for apartment units increases, analysts are not sure the US apartment industry will be able to meet the demand. Land is scarce and construction costs are more expensive.

Development in urban areas, where demand is more reliable, is inherently more expensive. Complexes are leaning towards mid-rises or high-rises versus garden-style.

Current rents with density allowances do not justify the cost of developing more apartment units. This will cause absorption to increase and put more pressure on rents to increase. These factors should cause increased value of apartments in the long-term.

Because of the overall financial climate, as investors we will need to accept LTV’s in the 70-75% range. The valuation, marketing, and management phase will be more critical than ever for banks. Banks will be looking for greater liquidity of the sponsors and stronger global debt coverage ratios.

Overall, the fundamentals of the apartment market are stable or improving in most markets, thereby demonstrating that the apartment market is not going through a recession, but merely a recalibration.

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