Underappreciated Multifamily Markets: Maryland Edition
Although attractive multifamily investment opportunities may still be available in gateway cities, investors increasingly are sourcing deals in secondary markets where land and asset prices are lower, cap rates a bit more generous and an unpicked gem of value-add fruit can still be found on the vine by intrepid late-cycle buyers. Parties looking to replicate past successes may not have to look too far afield as Maryland markets — overshadowed of late by Washington and Philadelphia — offer much of what they seek with perhaps a lower degree of risk.
In the last decade and particularly the last three years, the catalyst for economic growth in the Capital Area has shifted from government to high-tech services. As the tide turned, the focus of commercial real estate activity moved south toward Washington’s central core and Northern Virginia. In the process, the Maryland suburbs lost some of their star power.
The diminished status of Montgomery and Prince George’s counties wasn’t entirely a matter of perception. Suburban Maryland apartment performance materially underperformed national averages in 2017 and 2018, and the spread widened between cap rates applied to Maryland properties on one hand and District and Northern Virginia assets on the other. Same-store property rent growth decelerated to less than 1 percent in 2017 and was barely positive in the Class A segment, comparing unfavorably to 3 to 4 percent gains in most U.S. markets. Maryland cap rates went almost nowhere in 2017 and 2018, even as comparable levels in Washington and NoVA fell 30 basis points or more.
Things changed last year. After essentially flatlining for nearly three years , the Suburban Maryland economy was reanimated in 2019, generating some forward momentum late in the year from the same source supercharging D.C. — professional and technical services. At the same time, the market’s more affordable rental housing stock began to look more appealing to Washington’s cadre of millennial generation workers, who helped elevate same-store occupancy 30 to 50 basis points and pump effective rents about 3.5 percent higher, the fastest growth observed in six years. Indeed, a rising tide lifts all boats.
Although cap rates declined accordingly, Suburban Maryland assets remain compelling relative values. Class A mid-rises in Bethesda/Rockville and Prince George’s County trade to 5.0 percent and 5.4 percent yields, respectively, discounts of 40 basis points to comparable Washington assets.
Prospective returns also look constructive. RED Research’s forecasting equations suggest that metro occupancy is likely to stand firm over the next five years, while rents rise at a solid 3 percent annual rate. After generating total returns averaging about 12 percent last year, our models expect Suburban Maryland assets to post 9 percent or greater average returns into 2022, levels on par with Northern Virginia but with considerably lower NOI volatility.
Much the same can be said for Baltimore. Baltimore also found its economic stride in 2019, riding the technical services and life sciences wave to its fastest payroll growth since 2015, and constructive personal income gains. Apartment occupancy was steady near 96 percent, according to Reis, and same-store rent growth chugged along in the 2.5 to 3.0 percent range.
Future performance is likely to follow Suburban Maryland’s form. RED forecasting models project compound rent growth of about 3 percent in these precincts, too, but moderately better occupancy trends than Suburban Maryland, owing to Baltimore’s leaner development pipeline. Average institutional quality asset cap rates reside in the same 5.2 percent zip code, producing expected annual total returns in the 8.1 percent vicinity, about 40 basis points greater than the Maryland suburbs.
NOI volatility is the element that really separates the two from an investment perspective. Suburban Maryland is a low-volatility market and perennially sports a risk-adjusted return metric in the first quartile of top 50 U.S. apartment markets. Currently, it stands 13th in our rankings. But in this respect Baltimore is the low-volatility emperor, holding a strong first position among the group.
Multifamily investors looking for a safe harbor outside of the short list of primary markets will profit from kicking tires in the Free State. Income-oriented buyers looking to reduce portfolio risk in late cycle may find the perfect ride in Baltimore.
—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 on the Baltimore market from RED Capital Group, click here.