Posts Tagged ‘apartments’
PWC’s Quarterly CRE Review
PwC’s quarterly commercial real estate review just hit my desk. I have a particular affinity for this survey-based review — it was founded about 30 years ago by Peter Korpacz, MAI, an alumni of the Real Estate Counseling Group of America and an acquaintance of mine. PwC took it over a few years ago, and have done wonderfully with it.
The entire report, at 106 pages, is far too robust for a simple summary. However, a key metric is the review of capitalization rate changes by property type (e.g. — warehouse, apartments) and offices by region (e.g. — Manhattan, DC, San Francisco). A cap rate, of course, is the ratio of a property’s net operating income to its sales price. Declining cap rates on a broad front can indicate the onset of a recession, but differential cap rate changes (rising in one market, declining in another) may suggest differing sector views by real estate investors. By property type, this is what we appear to have today.
For example, warehouse cap rates currently average 5.27% nationally, but this represents a decline by 10 basis points just in the 2nd quarter. Generally, this points to a favorable view of warehouses by investors — they’re willing to pay a bit more for each dollar of prospective income. Conversely, offices in the central business district saw increases of 13 basis points, suggesting a softening of CBD office prospects.
Across various regions of the country, offices in general (both CBD and others) showed either no change or declines in cap rates, with the biggest cap rate declines occurring in Phoenix and Philadelphia. Only Denver and Atlanta showed increases in office cap rates.
Overall, investors expect cap rates to hold steady or increase over the coming six months. Indeed, only among CBD offices and power centers was there any sentiment for cap rate decreases. 100% of investors expect net lease properties to show cap rate increases in the coming 6 months, which portends value softening in that property sector.
We’ve used the nasty “R” word (ahem… “recession”) on occasion here at Greenfield, and PwC seems to agree with us. They expect that the office sector will peak by the end of this year, and a large number of metro areas are expected to move into contraction during 2018 and 2019. They expect 61% of cities in their survey to show retail property recession by the end of this year, but with some limited exceptions (Austin and Charleston).
Industrial properties, on the other hand, should fare well, with only Houston headed for recession during 2017. They also expect 15 other markets, including Los Angeles and Atlanta, to face industrial recession by the end of this year. Further, a large supply of industrial property is expected to come to market during the near term, suggesting an industrial over-supply for the next four years.
One bright spot is multi-family, which continues to “benefit from the unaffordability of single family homes”. Two markets need to play catch-up (Charlotte and Denver) but other markets should fare well, with 40% of markets headed for expansion.
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Now for a little good news….
Globe Street has a great piece about the self storage market, which is doing very nicely lately. Top firms in the fiele had revenue growth of 4% to 5.8% in the 3rd quarter, with net operating income growing 7.3% to 8.6%. ranged as high as 91.7% at Public Storage. The article properly notes that this sector is now joining apartments in strong, positive territory. Overall REIT share performance, as noted in the chart below, certainly underscores this (YTD as of October 2011, data courtesy NAREIT).
While the article correctly notes the strength in this market segment, it doesn’t connect the dots vis-a-vis why. Some of this is obvious, but it bears noting due to the very signficant long-range implications. The more-or-less simultaneous strength of the apartment sector and the self storage sector isn’t coincidental — the popularity of apartments for households which WOULD HAVE been in the owner-occupied housing market is driving the need for self storage. Anecdotal evidence of late suggests that the trend is toward smaller apartments — studios, efficiencies, and one-bedrooms seem to be in higher demand lately, although I haven’t seen this formally quantified as of yet. Given that, not only is there a need for self-storage, there will also be an increased need for SMALLER self-storage units as opposed to larger ones, urban infill units (or at least units near apartment communities) and even self-storage as an adjunct to apartment communities themselves.
Long term? This market risks getting over-build whenever the housing market stabilizes. However, that seems to be several years out. In the intermediate term, one would suspect a strong demand for more units paralleling the demand for apartments.
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Apartment Investing — Cap Rate Divergence
The fact that apartment “cap rates” are declining in the face of rising fundamentals is old news. (For the newbies — the “cap rate” is the ratio of net operating income, or NOI, to value or purchase price. If NOI is rising, then purchase prices must be rising even faster, indicating increased investor sentiment.) Indeed, as of April, nationwide, mean cap rates on apartments were back to early 2008 levels. (Again, for the newbies — cap rates on all property types rose during the recession, reflecting both declining fundamentals AND declining investor sentiment.)
The more interesting piece of news comes out of our friends at REIS, who just released a report today showing that Class “A” apartment cap rates have declined much faster than Class B/C, indicating that high-end, investment grade properties are much in favor today for their income by institutional investors.
Those same investors are wary of lower-grade apartment investments, although REIS suggests that this wariness should dissipate over time. This suggests some significant opportunities for developers, turn-around specialists, and other non-institutions during the coming months.
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Tis the season….
Intriguing mixed messages from the economy. Employment continues to lag, but holiday shopping was up. Go figure?
Two or three things may be in store. First, I’m sure that some of the more profitable businesses, fearing future tax increases, were holding off spending tax-deductable money until 2011 rather than 2010. The key lesson for lawmakers — get some stability and predictability into the tax system.
Second, while “on-line” shopping went up, the unmeasured impact of on-line was the ability to target shopping. Lots of holiday shopping went at bargain prices, and I’m interested to see how much sustainability there will be in the increases. It’s very difficult to imagine, with the underlying instability in economic fundamentals, just how long the shopping bubble can be sustained.
But, on to real estate. What looks good right about now? What looks bad? We continue to be doom-sayers on housing construction into 2011. Normally, in a recession, there’s a build-up of excess supply (construction in the pipeline pre-recession get unsold DURING the recession). However, past recessions rarely have a contemporaneous melt-down in homeownership rates (see the following).
Note that since we began keeping records in 1960, ownership rates have inexorably trended upward but for two instances — this one and the 1980-84 period. After 1984, it took until the mid-1990’s for rates to start trending upward again, and many would suggest that this up-trend was only the result of Greenspan’s “easy money” policies. In a more cautious lending environment, it’s hard to say where the true equilibrium might lie. However, it’s intriguing that the run-up in the 1970’s is often blamed on the high levels of inflation (making home ownership the favored “inflation hedge” for families) and that in the post-recession, low-inflation period of the late 80’s and early 90’s, rates seemed to hover around 64%.
If in fact that’s where the equilibrium lies, then the U.S. has about three more percentage points in owner-occupied homes to absorb. This absorption occurs in one of three ways — growth in the population, conversion of homes to other uses (usually rental in lower-end or transitional neighborhoods), or demolition. Whatever the reason, with the current slope of the trend-line (which, intriguingly, matches the slope of the 1980-84 period), we see that it took about 5 years (2004 through 2009) to get from about 69% to about 67%. At this rate, getting to 64% will take another 7 – 8 years, suggesting a best case scenario of stability in the 2016 range.
This scenario, interestingly enough, matches some of the employment-growth scenarios I’ve seen, which suggest we’re looking at the mid-to-late teens for unemployment to get back down to pre-recession levels.
So, if owner-occupied housing stinks, what looks good on the menu? Apartments. In very rough numbers, we WERE building about 1.5 million homes per year prior to the recession (year-in, year-out, with a HUGE amount of variance from year to year). Now-a-days, we’re building about a third of that or less, suggesting an un-met demand for housing of about a million units per year, more or less. Apartment construction also flat-lined during the recession, primarily because banks simply didn’t have the money to lend for construction financing. (Permanent money comes from other sources, and it’s available, but the construction financing problem is still with us.)
As credit continues to ease — particularly with the recent announcements by the FED in that regard — we can see some strong lights at the end of that tunnel. Good news for construction workers — their unemployment rates have been huge lately, but the same folks who drive nails for owner-occupied homes can also drive nails in apartment complexes. Easing credit in this area will thus fuel job growth, which also fuels consumption, home purchases, etc. Thus, addressing the housing demand/supply problem may be the most important single thing policy makers can do to restore the economy to good health.
From a small northwestern observatory... 