Chasing the Apartment Wave

This article appeared in the WSJ a few weeks ago. I thought it timely to reproduce based on the 6000 or so apartments that Mayor Jim Lane and the City Council have approved or anticipate approving in recent months.

Lane tries to make the case that the free market should determine what is built and he has to grant the zoning for what the free market wants. I argue that (like the experts say) developers build whatever they can finance regardless of the market, and that city government has a responsibility to protect the citizens from instability brought on by bad zoning decisions.

Apartments Lose Luster With Investors
Wall Street Journal


Apartment buildings, one of the best-performing sectors of the commercial real-estate market in recent years, are starting to lose some of their appeal for investors.

Last year, residential rental properties were one of the most sought-after property types, with sales totaling $54 billion by one measure, up more than 50% from the prior year, according to Real Capital Analytics. Average apartment prices per unit, about $102,000 nationally, are near peak levels.

But this year, the excitement is fading. Investors are pushing back on property prices, rent growth is slowing and yields are flattening in some markets.

While few investors believe that apartment buildings will be a bad investment, the best rent rises of this cycle are likely “in the rearview mirror,” said Andrew McCulloch, an analyst at Green Street Advisors, a real-estate investment trust research firm.

Such concern is weighing on the stocks of real-estate investment trusts that own and develop apartment buildings. Shares of Camden Property Trust CPT -0.08% have gained about 1% this year, while sector giant Equity Residential EQR 0.00% is up 2.2%. In comparison, stock prices of industrial real-estate giant Prologis Inc. PLD -0.22% are up 18% year to date, while Brookfield Office Properties Inc. BPO -0.23% has gained 11%. Zelman & Associates, a real-estate research firm, expects net-operating-income growth to slow over the next year at the 10 apartment REITs it covers.

Investors and developers are changing course in response. “Eighteen months to two years ago, you really could have owned apartments in any major U.S. city and made very attractive returns,” said Jay Leupp, a portfolio manager at Lazard Asset Management. Now “we are being more cautious of the apartment investments that we make” and diversifying.

With the Lazard U.S. Realty Equity Open fund, for example, the firm has in the past six months reduced its holdings in apartment operators Equity Residential and Apartment Investment and Management Co. AIV +0.53% and beefed up shares in hotel operator Marriott International Inc. MAR +0.22% and First Industrial Realty Trust Inc., FR -0.33% which specializes in industrial space.

Other investors also are changing tack. “It’s a lot harder for people to buy and make money, as opposed to building and making money,” said Gary Kauffman, managing director and head of U.S. transactions at Parsippany, N.J.-based Prudential Real Estate Investors. Prudential, he said, still will look to buy properties, but is moving more toward constructing new buildings.

There is some worry that a bubble could be forming, fed by low-cost financing and aggressive cash-flow growth assumptions.

Research by economist Sam Chandan of New York-based Chandan Economics, shows that multifamily buyers in competitive large metropolitan areas last year were often too optimistic about their future cash-flow growth. This could spell trouble if the owners don’t meet these targets and then must refinance at higher rates.

But the overall argument for apartments, as Mr. Chandan and others say, remains sound. People need to live somewhere, and apartments have won out as the home ownership rate has dropped.

Over the past five years, renter households have increased by more than four million, or 12%, according to Green Street, helping to explain why the sector was so healthy despite the ailing economy. And while job growth has been weak overall, the upticks have been weighted toward those more likely to rent.

As a result, vacancy rates have dropped to levels unseen in years, allowing landlords to raise monthly rents. In the fourth quarter, the vacancy rate fell to 5.2%, from 6.6% a year earlier, according to Reis Inc. Nationwide, landlords raised asking rents an average of 0.4% in the fourth quarter, to $1,064 a month.

Yet some believe those rent increases can’t continue, especially as the supply of new rental properties rises. Nearly 180,000 units were started in 2011, and some 225,000 starts are expected this year, with an additional 280,000 starts in 2013, according to Zelman.

One market in particular that investors are watching is metropolitan Washington, which is bracing for an onslaught of new apartments even as the area’s main employer, the federal government, slows down hiring. AvalonBay Communities Inc., AVB +0.27% a large apartment owner, is tracking 8,600 new apartment units to open this year and another 15,000 units in 2013.

“In specific markets, with D.C. really being the poster child, we are worried about supply,” said Zelman analyst Dave Bragg.

There also is concern about Seattle, which saw eight quarters of vacancy-rate declines end in the fourth quarter, partially because more than 1,800 apartment units were built last year, according to Apartment Insights Washington LLC. Over 6,000 additional units are expected.

A version of this article appeared March 7, 2012, on page C8 in the U.S. edition of The Wall Street Journal, with the headline: Apartments Lose Luster With Investors.

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