Raleigh’s Potent Economic, Demographic Growth Rewards Multifamily Investors
Raleigh checks all the boxes: a youthful, highly educated population, top research universities, a thriving large cap research and tech sector, plus clement weather. It’s Austin with more first-rate college basketball teams and less traffic.
Despite its conspicuous lack of entry barriers, multifamily investors and developers have placed enormous bets on Raleigh’s continuing success. Since 2017, apartment properties valued at nearly $8 billion have exchanged hands and over 15,000 market-rate apartment units worth more than $2.5 billion were delivered — a commitment of capital the equivalent of roughly $11,000 for every working Triangle resident.
Competition promises to be no less taxing this year. Supply in 2020 will approach 8,000 units, easily the largest vintage in market history and an increase of 40 percent from last year.
Few players have regrets. The metro apartment and labor markets continue to perform at full throttle, and investment returns remain among the highest in the country.
There were, however, moments of doubt. Recent preliminary Bureau of Labor Statistics payroll employment and hourly wage data for the nine-month period that ended in June 2019 recorded uncharacteristically soft results. Initial reports suggested that metro payroll job formation had limped along at a 1 percent annual pace for that time period, barely one-half the rate observed nationally, and average hourly wages fell nearly 2 percent year-on-year in the second half. Such fundamentals seemed unlikely to support Raleigh’s lofty commercial real estate valuations.
However, revised data released in mid-March proved such concern baseless. After collecting more complete establishment data that included small businesses and start-ups, and recalibrating company birth and death rates as well as population growth estimates, the Bureau found that job creation had been as strong as ever. Actually, Triangle payroll employment increased on a brisk 2.4 percent year-on-year pace during the first half 2019, and was nearly as vigorous after mid-year. Moreover, wages advanced more than 2 percent.
Demand for apartment space proceeded apace. Individual property data from Yardi indicates that renters absorbed a net of about 4,900 vacant units in 2019, an increase of approximately 5 percent over 2018. Fourth quarter 2019 occupancy averaged 89.79 percent among all completed properties, including those in lease-up, an increase of more than 1 percent over the year-earlier quarter. Same-store occupancy among properties stabilized for at least a year averaged 94.78 percent, up about 5 basis points year-on-year.
Rents continued to rise at an accelerated rate. Stabilized, same-store apartment rent trends increased on a healthy 5.32 percent annual pace during the fall quarter — the fastest quarterly growth metric since 2016 — and at a 4.11 percent rate in February. The Class A segment shrugged off the effect of competition from new supply, advancing on a 4.55 percent fourth quarter 2019 trajectory and 3.58 percent in February.
Investors were well rewarded. RED Research estimates that the average metro property posted a 10 percent increase in NOI last year. Cap rates fell another 20 basis points or so, boosting look-back total returns near 19 percent, among the top three markets in the RED 50, RED Capital Research’s (RCR) peer group of the 50 largest U.S. multifamily markets.
But that was yesterday, and tomorrow looks very uncertain in light of COVID-19. So far as expected returns are concerned, RCR calculates that fourth quarter 2019 Raleigh multifamily investors would expect to earn an 8.0 percent annual unlevered total return over a 5-year hold under our “most probable” slow GDP growth, low inflation macro forecast, ranking behind Dallas, Nashville and Charlotte — the gold standards of current growth market opportunities — but ahead of Atlanta. Things look very different now.
How will the virus affect returns? No one can say for certain, but our models can provide some insight. Estimates of the impact on GDP are only wild guesses now, but it seems likely that first quarter real GDP will decline 2 percent and second quarter GDP 5 percent or more. Forcing these outcomes into the model causes the 2020 GDP forecast to plunge from 1.8 percent to -4.5 percent and size-weighted average expected 5-year returns for the RED 50 to plummet from 7.9 percent to 5.2 percent. Raleigh returns survive better than most, falling only to 6.0 percent, ranking 12th in the peer group (ahead of Dallas) and behind only Nashville in the region.
—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.