Daniel Hogan
Director of Research,
RED Capital Group
Florida markets typically perform well during flush economic times and the current cycle isn’t an exception. Blessed with the fastest growing population east of the Rockies and a business-friendly tax and operating cost environment, Florida is one of the first alternatives multifamily developers and investors look to when the primary markets begin to feel crowded.
True to form, Florida experienced record investment sales volume in each of the past two years, and 2018 is shaping up to meet or exceed last year’s total. Acquisition cap rates continue to track lower, with asset prices reaching new highs.
By the same token, the supply pipeline is building and occupancy is beginning to erode at the margin. Nearly 70,000 units in 300 projects are under construction across the state and another 375 or more projects are proposed. At least 40,000 new units will be delivered this year, and vintages of similar magnitude can be expected in 2019 and 2020.
Can the Sunshine State property performance and investment returns continue to sizzle under these conditions?
Strong Job Growth in Jacksonville and Tampa Keep Apartment Markets on Even Keel
To date, Jacksonville and Tampa have exhibited the greatest resiliency among the six Florida markets that RED Capital Research (RCR) covers, maintaining occupancy in the mid-95 percent range through the summer (Reis), despite rising supply levels. Powerful job formation was the linchpin. Payroll employment in Jacksonville increased at a blistering 3.2 percent annual rate in the first nine months of 2018, matching the comparable period last year, while Tampa growth accelerated from a respectable 2.1 percent in 2017 to a robust 2.5 percent this year.
Rapid job creation fueled vigorous apartment demand. Tampa tenants absorbed nearly 1,200 vacant units during third quarter 2018 (Reis), one of the metro’s largest harvests of the decade, while Jacksonville properties leased a net total of nearly 300 — holding occupancy near 12-year highs in each case.
Likewise, rent trends went from strong to stronger. Reis reports that Jacksonville and Tampa average unit effective rent increased 4.7 percent and 4.6 percent year-on-year in third quarter, the strongest results observed in nearly two years.
Investors were active in both markets, particularly Tampa — where proceeds are poised to top $3 billion for a third consecutive year. Value-add buyers were the principal catalysts in Tampa, the most active Florida market for this type of transaction. Investors feasted on ’90s-era product at low-5 percent cap rates and 1970s and 1980s construction at mid- to high-5 percent yields, projecting 6 percent or higher post-renovation returns.
Jacksonville attracted a mix of yield-oriented and value-add investors. The former concentrated on high-gloss new construction Arlington and Southside gardens at cap rates in the 5 percent to 5.5 percent range, while the latter accumulated 20- to 30-year old Lake Shore and Orange Park properties acquired at going-in yields in the low- to mid-6 percent range.
Orlando Grows by Leaps and Bounds, but Supply Wave Looms
Throughout the expansion, Orlando has been the unchallenged Florida leader for economic and demographic growth. After a brief lull in the second half of 2017, metro payroll growth has soared in 2018, rising at a 3.5 percent annual rate in the first half and an 18-year high 4.9 percent pace in the third quarter, far and away the fastest growth recorded among larger U.S. MSAs.
Apartment demand grew accordingly, maintaining metro occupancy in the mid-95 percent range through mid-year. But conditions are unlikely to remain benign for long. A 60-basis-point sequential occupancy rate decline in third quarter 2018 provides a foretaste of what may transpire over the next 15 months. Developers will deliver more than 10,000 units over the period — a substantial wave even by this metro’s standard — threatening market equilibrium. Indeed, RCR models project that metro occupancy is likely to decline to the mid-93 percent area by year-end 2019, as a result.
Rent trends still remain among the strongest in the country, rising nearly 7.5 percent year over year in second quarter 2018, and 6.4 percent in third quarter. But rising vacancy rates and slowing personal income growth are likely to impede momentum next year, holding growth below 3.5 percent, according to RCR’s Orlando rent model.
Neither pending supply nor risk of slowing revenue growth impeded Orlando investors. Buyers acquired more than $2 billion of multifamily assets in the first half 2018 — a new six-month record by more than 30 percent — and $700 million in the third quarter, another seasonal record high.
Investors were more inclined to acquire recent construction Orlando assets, snapping up mid-rise trophies and luxury gardens at low-5 percent cap rates. Value-adds also garnered investor attention as Class B and Class C gardens traded to mid-5 percent and low-6 percent yields, respectively, a bit more generous than is available in other major Florida markets.
Southeast Florida Occupancy Declines on Rising Supply and Weak Job Growth
Performance trends were softer in Southeast Florida. Slower growth in the key tourism and construction sectors, particularly in Miami and Palm Beach, trimmed job growth to the slowest rates since 2011. Largely for this reason, space demand lost momentum, slowing to the lowest level in nearly two years. Coupled with rising supply, particularly in Broward County, occupancy rates buckled, settling to the lowest levels in seven years in each market.
Rent trends remained constructive but were considerably weaker than recent peak levels, stifled by rising rent concessions and the competitive weight of vacant inventory. Southeast Florida rents increased 3.8 percent year over year in third quarter 2018, down from 4.6 percent in the prior quarter and 5.8 percent as recently as fourth quarter 2017. Deceleration was pronounced in the Miami market where trends slowed to 3.6 percent in third quarter 2018, after rising as fast as 7.0 percent in fourth quarter 2017.
Perhaps reflecting a degree of price resistance as well as supply and growth concerns, apartment sales volume declined this year. Southeast Florida investment sale proceeds totaled about $2.4 billion through the first three quarters, down nearly 30 percent from 2017.
Value-adds accounted for the lion’s share of the volume decline as older product sales plunged 40 percent over the year. By contrast, interest in higher-quality trophies was firmer, falling only 23 percent from 2017. Indeed, bidding for available luxury assets was aggressive, sending going-in yields as low as 4.1 percent in the Miami area and the mid-4 percent range in Broward and Palm Beach counties.
Miami Offers the Highest Expected Investment Return Performance
Florida investors are targeting 5.5 to 6.0 percent internal rates of return (IRRs) on Class A and Class B acquisitions, levels readily achievable under the most probable economic scenario, according to RCR forecasting models. Among the six Florida markets that RCR covers, Miami may offer the best return prospects due its more readily digestible supply pipeline and constructive rent growth outlook. By contrast, Orlando may suffer from its own success as heavy prospective supply is likely to pressure occupancy rates and give rise to below-peer-group rent growth and investment total returns.
— This article was contributed by Dan Hogan, Managing Director of Research with RED Capital Group, which is a content partner of REBusinessOnline.com. 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.