Matt Marshall, NorthMarq Capital
Despite the clichés and naysayers, Boston’s apartment fundamentals continue to trend at the top of U.S. cities’ forecasts. For developers, investors and borrowers, Boston truly is that city on a hill.
Clichés heard often in the commercial real estate community:
- Interest rates have no place to go but up.
- Who is going to pay $4.50-per-square-foot rents?
- Wait until the next wave of units is delivered.
- Valuation and yield don’t make sense.
The facts:
- Economists have been predicting interest rate increases for the past five years.
- Market vacancy has been sub-5 percent for more than five years.
- Every major apartment player owns or is currently building in Boston, averaging $1.2 billion in product for past three years.
- Boston is a premier gateway city and buyers want in.
The Investor Outlook Simplified
When cap rates for the most desired real estate class — in a gateway city, in the safest country for investment in the world — average 4.25 percent, it’s a great time to invest. The 2006 cap rates were just 100 basis points above the 10-year risk-free rate. Today they are 2.0 to 2.25 percent. Half of the deals are cash transactions. Locals can only shake their heads at the pricing and yields, but this is a flight to safety for the long term.
With regard to rates, in early September the 10-year Treasury — the bedrock of global finance and a gauge of investors’ sentiment — finished out at 2.0 percent, its lowest point since April and down from a peak of 2.47 percent at the end of June. Since the market crash seven years ago, all previous 50 basis point swings in the 10-year rate were explained in the economic literature by a host of reasons. In the end, the causes were independent events and correlated to global markets — something that the United States could not control.
So what’s the takeaway from all this? We cannot control other countries’ policymakers; we remain skeptical of other countries’ economic reports; and no one can predict the effect of the next earthquake, nuclear meltdown, oil crisis, or war. The continued flight to quality and resulting benefit to commercial real estate borrowers is attributable to concerns about a global slowdown, specifically China’s economic woes (including a surprise devaluation of the yuan), along with the continuing oil slump. In an unpredictable global marketplace, rates will likely remain low. In conjunction with the 10-year yield breaking below 2 percent, the continuing strength of the dollar will make dollar-denominated fixed-income assets even more attractive.
Boston is a No-Brainer
Developers provided with cash will develop, irrespective of global events. Boston is flush with international capital that ignores the high price of land, increasing construction costs (up 10 percent per year), and rigorous permitting. Locals struggle to comprehend the global view of Boston as inexpensive when each sale breaks previous records. Regardless of cause, this is the new reality of the market. Boston’s price per pound is a bargain compared with New York, San Francisco, London, or Tokyo — and, the fact of the matter is that while apartment buildings will keep going up, interest rates will not.
Millennials & Amenities
Great public transportation, access to some of the nation’s best colleges and universities, limitless nightlife and a unique historical vibe make Boston a magnet for millennials. In fact, it is home to the largest percentage of millennials of any city in the U.S. at 34 percent. For developers and investors, this is Boston’s best feature.
Yet, a lingering question remains: if the coming wave of millennials are given the choice of owning a five-bedroom house on the lake in a city like Charlotte, North Carolina (ranked as one of the best places to live) versus renting or owning 650 square feet overlooking the Southeast Expressway in the South End’s homerun development Ink Block, why are they staying? It’s clear — the vibrancy and economic opportunity provided by the city!
The Future Looks Bright
The reality of what’s happening in Boston is that the average renter is spending in excess of 35 percent of income to live in the city, and about 25 percent of renters spend more than 50 percent of income to live in the city. If anything, we can expect the demographic to shift to older people to fill the apartments as millennials get squeezed out. The numbers show millennials as the largest population due to universities, but they are not necessarily capable of affording the lifestyle, thus the demographic living inside the city is likely to shift.
— By Matt Marshall, Vice President, NorthMarq Capital. This article first appeared in the October 2015 issue of Northeast Real Estate Business magazine.