LACK OF CAPITAL NOT TO BLAME FOR SLOW MULTIFAMILY MARKET

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Commercial real estate transactions are harder to close today than perhaps ever before, but the reasons may not be what you would expect. During the recession of the late 1980s and early 1990s, there was a significant lack of capital that constrained transactions. Lack of capital does not appear to be the case this time around.

Real Capital Analytics reports that total commercial transactions are down by 87 percent nationally from peak closing levels in 2007. Because of the availability of agency debt from Fannie Mae and Freddie Mac, the multifamily transaction volume has been thought to be more stable. However, according to the Real Capital Analytics data, the multifamily sector is down by 85 percent nationally. In the Southeast, multifamily markets have been hit harder than at the national level. Atlanta and most tertiary markets in the Southeast have experienced an 88 percent drop in apartment transaction volume. Secondary markets like Birmingham and Memphis have experienced a greater drop at 97 percent. The market in the Southeast with the lowest drop has been Nashville, with an 82 percent drop in volume.

Apartment operations have suffered as well. Dale Henson Associates reports that street rents in Atlanta garden-apartment properties have fallen 5.5 percent in the past year. However, the use of concessions has dropped; as more properties incorporate lease rent optimization software and daily pricing strategies, they are less reliant on concessions. The impact as reported by Dale Henson Associates is a more moderate drop in realized rent of 2.4 percent. These drops have been fairly consistent across property classes A to D. Occupancy, on the other hand, has more severely impacted the lower-quality properties. In Atlanta, Class A apartment properties have increased in occupancy during the past year to 91.7 percent, while Class D properties have dropped to 83.3 percent occupied.

Transaction volume has once again caused people to question the liquidity of real estate as an investment. The drop in rental rates and weak occupancy raise concern about the housing market, and the seemingly endless increases in expense ratios cause investors to ponder the long-term viability of the entire business model of the apartment industry. So why in the world are the capital markets gearing up at a record pace to acquire real estate? There is a staggering amount of money being raised by both public REITs and private equity. According to Prequin Ltd. and Bloomberg.com, last year 50 North American private real estate funds raised $21.4 billion for real estate investment. Here in the Southeast, Bell Partners just completed raising $50 million of equity to invest in apartments.

So why is so much money being raised? The answer is in the demographics. Apartments present an attractive housing option for a younger and many times more transient population. Typically, multifamily housing is well located near employment centers and offers an affordable option for housing without a long-term commitment. The burgeoning echo-boom generation is now in the 20 to 34-year-old age bracket. This represents a huge client base for the multifamily industry. This boom bodes well for the outlook of Atlanta and other southeastern cities where the population is younger, but the problem has been that this age bracket has been hit the hardest in this recent economic downturn. As the unemployment in this age cohort returns to a historical norm, the demand for apartments will skyrocket.

Apartment construction has dropped almost everywhere. In Atlanta, Dale Henson Associates has reported that multifamily starts dropped to a mere 427 apartment units in 2009. Currently, DHA reports physical occupancy of 88.5 percent for all classes and 91.7 percent for class A. The total stock of apartments in Atlanta is roughly 400,000 apartments. Accounting for a 4 percent frictional vacancy, the current low occupancy means there are roughly 30,000 apartment units readily available for an up-tick in demand.

Property performance is down, but record amounts of capital are being raised, and there is reason to believe in an optimistic demographic outlook for apartments. Sellers are receiving record numbers of offers. The mismatch of capital being raised to transaction volume has posed serious questions from the capital markets. This is resulting in many new capital raises being cancelled or postponed. Many of the bidders on these recent sales did not actually have access to the capital they believed they were bidding for. Financing applications are met with more detailed questions than ever before. There are more groups in existence to acquire properties, and the process of determining which groups can actually perform and which groups actually have the money they think they have is more difficult than in the past.

The outlook is strong for the multifamily business and the capital markets recognize the opportunity. The challenge today is to sift through the hordes of callers and ideally match the properties with the right buyers.

— Sean P. Henry works in the Atlanta office of Apartment Realty Advisors.

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