In January, the Atlanta market was ticking like a fine Swiss watch. With leadership from its robust crew of business, education, healthcare, accommodations and leisure services industries, the economy cruised into 2020 with a full head of steam. Although moderately slower than regional peers, Atlanta’s pace of job creation was considerably faster than state and national averages, contributing to falling unemployment — the metro rate was only 3.2 percent in January, the lowest ever for the first month of the year — and strong absorption of office space in blossoming Midtown.
Construction projects large and small transformed the landscape at a formidable pace, molding urban neighborhoods in a grand style rarely seen in 21st century America. Multibillion dollar developments like Centennial Yards and the ambitious mass-transit-inspired Atlanta Beltline project promised to enhance the urban living environment while preserving Atlanta’s renowned quality of life.
No commercial real estate segment was more active than multifamily. Last year, apartment properties valued at nearly $8 billion exchanged hands, establishing a metro series record. In addition, construction of more than 17,000 units is underway — assets with stabilized value of about $2.5 billion — and another 25,000 units are planned.
Late-decade property performance was among the strongest in the country. Reis average effective rent metrics advanced 7 percent in 2018, in the top decile of the nation’s 50 largest markets, and 5 percent last year, ranking in the top quintile.
Recent trends, however, have been softer. Occupancy and lease-up rates began to weaken last spring from a combination of slower labor force growth and supply pressures. Occupancy rates of stabilized, same-store properties peaked in April on 94.46 percent, according to data collected by Yardi, slipped below 94 percent in November and declined further to 93.78 percent in February. With respect to lease-up, completed properties tenanted an average of 3.0 units per month in January and February, down materially from 5.4 in the same period of 2019.
Rent growth trajectory also turned over. Same-store rent trends decelerated from over 5 percent in winter 2019 to less than 4 percent in November and further to 3.37 percent in February.
Expected investment returns already were under pressure from rising asset prices and cap rate compression. Cap rates applied to Class A urban mid-rises dropped to as low as 4.2 percent after mid-year 2019 and were universally below 4.5 percent — levels heretofore the sole province of primary markets. Top quality garden complexes inside the Interstate 285 perimeter traded to caps only 10 or 20 basis points higher, and even B-quality suburban gardens exchanged hands on sub-5 percent yields.
Based on our previous optimistic slow GDP growth/low inflation economic forecast, RED Research models projected Atlanta compound annual rent growth of 3.6 percent over the next five years, within 10 basis points of rivals Charlotte, Dallas and Raleigh. But with supply-related occupancy losses anticipated and a cap rate structure now 10 to 20 basis points lower than its top competitors, expected annual unlevered return estimates for late 2019 investments fell in the mid-7 percent area, not quite up to result levels calculated for regional rivals.
With the advent of COVID-19, these projections are now moot. At this point one can only speculate about the impact of the pandemic on the economy and asset performance. To shed some light on possible outcomes, RED Research developed two possible paths forward, one optimistic, the other more pessimistic. The pessimistic assumption posits that absolute U.S. GDP falls 5 percent in each of the first two quarters and the federal stimulus package has no net impact on future growth. The optimistic scenario posits 2 percent and 5 percent declines in first and second quarter GDP and a 2 percent stimulus boost to third-quarter growth. Rents are held flat for the first six months of 2020.
In the pessimistic scenario, 2020 GDP and payroll employment drop 6.8 percent and 1.5 percent, respectively. Projected rent growth falls to -0.2 percent in 2020, and 2.7 percent annually over the 5-year forecast interval. The terminal cap rate soars from 5.23 percent to 6.27 percent as the strength of the post-COVID rebound and extended monetary stimulus stoke faster inflation and push term interest rates higher. Expected total returns decrease to 2.5 percent under the circumstances.
In the optimistic scenario, 2020 GDP and employment drop 3.9 percent and 0.4 percent. Atlanta rents increase 0.5 percent in 2020 and 2.3 percent over the forecast interval. The exit cap rate is 5.88 percent, generating 2.8 percent annual returns.
In any event, we are likely to see much weaker returns than were expected in January and investors may be compelled to extend holding periods to achieve hurdle IRRs.
— By Daniel J. Hogan/RED Capital Research. Hogan is ORIX Real Estate Capital’s Managing Director for Research. RED Mortgage Capital, a division of ORIX Real Estate Capital LLC, is a content partner of REBusinessOnline. The views expressed herein are those of the author and do not necessarily reflect the views for RED Capital Group or of the author’s colleagues at RED. For further analysis from RED Capital Group, click here.