After years atop the commercial real estate food chain, the multifamily sector remains the darling of the commercial real estate investment world, according to Integra Realty Resources (IRR). In its annual Viewpoint study, the commercial real estate valuation, consulting and advisory firm reports that 95 percent of the major U.S. markets it tracks are currently in the expansionary phase of the real estate life cycle.
In the expansionary phase, 95 percent of U.S. metros are experiencing decreasing vacancy rates, moderate-to-high new construction, high absorption, moderate-to-high employment growth and medium-to-high rental rate growth. One of the many multifamily markets in that category is Miami.
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“Miami is definitely in an expansion phase because we’re building new product. There are 2,500 units under construction in downtown Miami and about 7,000 units county-wide under construction,” says Anthony Graziano, senior managing director of IRR – Miami/Palm Beach. Graziano has been with IRR since its inception in 1999. “The new construction, coupled with sub-5 percent vacancies and rent growth at 8 to 12 percent annually — that puts us in the expansion phase.”
Miami is ahead of the national average in several statistical categories, such as Class A and B vacancy rates and rental rate growth. Miami’s rents are expected to grow by 4.13 percent in 2015, compared to the 2.61 percent that IRR is estimating for the U.S. average.
“We tend to have market rents that grow faster than the national average because it’s more costly [to build] in Miami, and it takes more time to produce product to satiate demand,” says Graziano, adding that Miami’s high-rise and urban infill product take longer to complete than a typical mid-rise, wood-frame community in other markets.
Anthony Graziano, Integra Realty Resources-Miami/Palm Beach
Mike Silverman, Integra Realty Resources-Philadelphia
Philadelphia, another market in the expansion phase, has had more than 2,000 units come on line since 2013, according to Michael Silverman, managing director of IRR — Philadelphia. (That total includes only apartment communities with more than 50 units.) The Philadelphia metro area also has 2,100 under construction with completion scheduled for 2015 and 2016, as well as 2,900 units proposed for development with no definitive date for groundbreaking.
“All the recently completed complexes, the ones under construction and the ones proposed total approximately 7,000 units, and that’s all since 2013,” says Silverman. “We’ve never experienced that amount of inventory in such a short period of time. When you think about the expansion phase, that’s a lot of units and we have to make sure there’s enough demand to satisfy that supply.”
Cap Rates Static for Class B
Although multifamily continues to experience expansion in a vast majority of its markets, IRR’s Viewpoint report is wary that the sector may be showing signs of plateauing in terms of capitalization rates. Nationally, average Class B cap rates were basically unchanged in 2014 from 2013, with urban Class B cap rates moving zero basis points and suburban Class B cap rates dipping 3 basis points. In that same time frame, cap rates compressed in every other product type and class, including Class A multifamily.
The lack of cap rate compression for Class B assets is a cause for concern for investors seeking to receive a strong return on their investment, and it may indicate a shift in the market dynamics for multifamily going forward.
“With cap rates for [Class B] multifamily, you’re not seeing the upside that you’re seeing in Class A product. With some of the other asset classes you see this flight to quality and the demand for better assets, and there’s significant upside associated with it,” says Silverman. “You’re not going to see significant rent growth in the Class B product.”
Silverman also says that several Class B assets disappeared from the inventory because they were repositioned into Class A units or other uses.
“Those statistics are sometimes hard to follow because when you’re decreasing the supply of the inventory of the Class B product, the numbers aren’t as clear,” says Silverman.
Graziano points out that Class B products have also experienced a few years post-recession where investors purchased the assets with a mind to renovate them and charge higher rents. For the most part, that trend has already come and gone.
“We were seeing some very low cap rates on Class B in 2012 and 2013. For the stabilized Class B product that’s been renovated, the cap rate compression is over with,” says Graziano. “You’d have to be expecting a lot of rent growth on Class B for the cap rates to go much lower.”
Graziano also opined that the investor pool chasing Class B assets is sensitive to yield and unwilling to pay a premium for stabilized Class B product the way investors are for Class A assets.
Class B Occupancy Higher than Class A
Class B cap rates may not have compressed in 2014 the way they did for Class A, but Class B is outperforming its counterpart in terms of occupancy rates. The Class B occupancy rate in 2014 was 4.36 percent, while Class A occupancy was 4.95 percent.
The windfall of new Class A product hitting the market has something to do with the higher vacancy rate, says IRR. Brand new assets take time to lease up and stabilize, and IRR expects the new supply will likely lead to a downward pressure on rental rates and greater concessions in the next few years while assets are absorbed.
Graziano suspects that the disparity between Class B and A occupancy rates also have to do with the affordability factor, especially for high-profile cities like Miami.
“The spread between the Class A and B occupancies is really a function that the Class B market is more price competitive,” says Graziano. “The expansion of rents in the Class A market has gotten more expensive.”
Here are a few other highlights from IRR’s 2015 Viewpoint report:
➢ Transaction volumes are up in 2014 the most in Columbus, Ohio (234 percent); Seattle (157.9 percent); Philadelphia (154 percent); Nashville (138 percent); Detroit (125 percent); Kansas City (120 percent); Denver (113 percent); Portland (111 percent); Sacramento (109 percent); Orange County (106.5 percent); East Bay (106 percent); and Atlanta (105 percent).
➢ Metros with transaction volumes on the lower end of the spectrum included Palm Beach (3.3 percent); Washington, D.C. (2.6 percent); Boston (-1.6 percent); Broward County (-4.9 percent); and Charlotte (-6.1 percent).
➢ Prices for multifamily communities rose sharply in high-tech markets like Austin (43 percent) and San Jose (29 percent). Price appreciation in Boston, which is also a tech hub, rose only 2 percent.
IRR Viewpoint 2015 is the industry’s annual compendium of real estate valuation, investment and leasing trends and forecasts. The report provides data, analysis, and forecasts on local and national market conditions for seven industry sectors throughout the United States, including capital markets, office, multifamily, retail, industrial, lodging and self storage. The 25th edition of Viewpoint 2015 also includes a comprehensive IRR forecast section that provides forward-looking analysis and commentary on all commercial real estate markets and property types.
To learn more about the Integra Realty Resources and the Viewpoint 2015 report, click here.
— John Nelson