Checking In With Multi-Family Trends

by Chicago Agent

February 25, 2008

By Gina Dingman, CCIM

Traditionally, one of the positive side effects of a downturn in the single-family housing market is improving fundamentals in the apartment market. While we are still witnessing fallout from the subprime disaster in capital markets and in the housing industry, apartment owners are one of the winners in this fiasco. Current trends indicate a healthy multi-family market in 2008.

Trends emerging in the multi-family sector in 2008 include the continued unwinding of “fractured condos,” immigration and immigration policy issues, more foreign investment and the influx of Echo Boomers into the housing market. We will continue to see new and existing well-capitalized funds that will leverage buying opportunities as undercapitalized developers find themselves stuck with projects that are stalled or dying. Look for more reversions of these projects to rental this year.

Multi-family housing starts in the Midwest were down almost 31 percent last year and it is unlikely that we will see a significant increase in apartment construction in 2008. Why haven’t we seen new construction? Rents in our market haven’t increased enough to justify the risk of new construction, except in urban infill locations or along transit-oriented districts.

In the Twin Cities of Minneapolis and St. Paul, in order to support new stick-frame construction, rents typically need to be in the $1.65 per square foot range, and above $2.25 a square foot for mid- or high-rise projects. Additional challenges developers will face are: the lack of available infill or suburban apartment sites, municipalities’ desire for for-sale and mixed-use projects verses rental housing options and continued neighborhood opposition to high-density development. These issues will continue to hamper the entitlement process, extending the timeline for approvals. With stabilized local occupancy and little planned new construction, occupancy rates will remain steady with small rental rate increases.

After lagging behind the coastal markets, parts of the Midwest are beginning to appeal to pension fund managers, real estate investment trusts (REIT’s) and private equity investors. Chicago moved up to the 13th most desirable multi-family investment market. According to economists at the recent National Multi Housing Council Conference, increasing rental rates, lack of concessions and the relative lack of new construction make the Midwest a bargain compared to much of the country.

Cost and availability of capital continue to put the squeeze on local and regional leveraged investors. This will open up more access to REIT’s, institutions and private equity funds.

While 2007 brought record sales nationally of properties above $5 million with sales totals above $93 billion, the Twin Cities only saw approximately $450 million in transaction volume, the majority of which in both cases took place in the first half of the year. Owners nationally and locally expect to see more buying opportunities in 2008. Building will continue nationally and the impact of the condo shadow market is just beginning to show, which varies greatly from market to market; owners do not expect this to have a significant impact in most markets.

Even though apartment market fundamentals are healthy, pricing and deal volume have been affected by the debt markets. Much has changed in real estate capital markets since the first half of 2007. Since that time, activity level nationally is down by 19 percent, the lowest level since February of 2005, and the credit crunch has made financing more difficult and more expensive. Credit restrictions have also made financing difficult for land acquisitions and new developments may be hindered going forward. The increasing concerns of recession may cause developers to delay projects and land values may be headed for more significant reductions. Through year-end 2007, cap rates for apartments remained stable because of the lack of investment-grade multi-family product on the market.

This year, we expect to see cap rates begin moderating with condo converters out of the picture and more product expected to come to market. The flight to quality among REIT’s, institutions and private equity fund managers will cause us to see cap rate increases in a 50-75 basis point range in Class A product across the country, and 75 to 125 basis points for Class B and C assets in tertiary markets. Also, expect to see underwriting become more rigid because of tighter equity markets.

With the dollar at all-time lows, we are beginning to see changes in the profile of buyers for U.S. commercial real estate. Cash buyers are gaining market share and negotiating leverage. These and other factors are continuing to drive demand for multi-family properties.

Gina Dingman, CCIM, is the vice president investment services of Colliers Turley Martin Tucker. E-mail her at gdingman@ctmt.com.