Why real estate investors should focus on apartments Featured

6:22am EDT October 4, 2010

John Leonard, first vice president and regional manager, Atlanta office, Marcus & Millichap Real Estate Investment ServicesSmart Business spoke to John Leonard, first vice president and

regional manager of the Atlanta office of Marcus & Millichap Real Estate

Investment Services, about what to expect in the national and regional

multifamily market.

Some sectors of the

commercial real estate market have shown signs of recovering. For investors

interested in returning to the market, which sector is poised to make the

greatest strides as we head into 2011?

The multifamily sector is positioned ahead of the

office, industrial and retail sectors, even though the industrial property

sector has started to recover as a result of U.S. manufacturing gains. U.S.

apartment fundamentals have strengthened this year as a result of many factors,

including the release of pent-up demand, moderate private sector job growth,

single-family home foreclosures and homeownership hurdles facing many

Americans.

U.S. apartment transactions accelerated during the

second quarter, hitting the highest level since late 2008. Increases were

driven largely by the $5 million to $10 million and $20 million to $40 million

segments, as larger private investors and REITs/institutions moved off the

sidelines. Investors have begun to accept that a wave of deeply discounted,

distressed opportunities may never materialize. At the same time, financing

constraints eased, as the agencies and life insurance companies became more

aggressive in their pursuit of high-quality deals. With a significant amount of

capital previously earmarked for distressed deals now targeting stabilized

assets, competition for deals has increased and cap rates have started to contract

for higher-quality properties. On average, cap rates dropped 10 basis points

this year to 7.3 percent, while per-unit prices rose 9 percent to $83,600.

Apartment vacancy dropped 20 basis points to 7.8

percent during the second quarter. Approximately 46,000 apartments were

absorbed, the strongest demand since late 2000. During the first six months of

the year, 10 metro areas accounted for 55 percent of the absorption recorded

nationwide; combined, these markets added 212,000 jobs, equivalent to approximately

one-quarter of all positions created in the United States during that time.

How is the U.S. apartment market performing

compared to other sectors?

During the second quarter, rents increased and

concessions declined for the second consecutive period. Asking rents rose 0.4

percent to $1,021 per month, while effective rates gained 0.6 percent to $946

per month. Concessions peaked late last year at 7.8 percent of asking rents, or

slightly more than four weeks of free rent on a one-year lease, and have since

slipped to 7.3 percent of asking rates, still well above the long-term average

of 4 percent. Despite regaining some pricing power, owners will likely wait

until 2011 to raise rents more substantially, instead focusing on attracting

tenants and filling vacant units.

Former homeowners are also moving into rental units as

a result of home foreclosures. At the same time, tight lending and high down

payment requirements preclude many renters from purchasing homes; as of

mid-2010, just 8 percent of residential mortgages originated allowed for down

payments of less than 10 percent, compared to 29 percent in 2007. The

homeownership rate has dropped considerably in recent years as a result of

these trends.

How is the Atlanta apartment market performing?

Renewed job creation and the formation of new

households will continue to stabilize the Atlanta apartment market and set the

stage for steady improvement in fundamentals in 2011. Over the remainder of

this year, renter demand will fluctuate as the private sector slowly begins to

hire workers and temporary government positions are eliminated. With job growth

remaining below pre-recession levels, rents will continue to fall, albeit at a

reduced pace from a year ago. Concessions will remain necessary to attract price-sensitive

renters and will not burn off significantly this year for most properties.

Additionally, the completion of new units will decrease from a year ago, but

lease-ups will be somewhat slow amid recovering but subdued renter demand.

Absorption of recent additions to supply will pick up next year, though, as

demand strengthens and construction slows.

Describe the multifamily investment sales market in

Atlanta. What are investors doing in Atlanta to position themselves for the

recovery?

Large, institutional-grade properties will continue to

account for much of the activity in Atlanta in the near term, while the market

for performing, stabilized assets will gain momentum gradually. Stabilized REO

properties, defined as cash-flowing assets with high occupancy, have started to

trade with greater frequency in the region as lenders step up efforts to

resolve troubled loans. Offering cap rates range from 8.5 percent to 9.5

percent and mark a reversion to pricing norms that existed before the run-up in

values in 2005 and 2006.

In addition to these properties, investors remain

highly interested in distressed, high-vacancy assets that can now be purchased

at prices often much lower than the prevailing marketwide median. Overall,

investment activity will become more normal and sustainable as an economic

recovery picks up steam and bolsters the metro area’s stature as a diverse

job-creation engine capable of significant growth for extended periods.

Numerous investors purchasing assets at their current low prices anticipate

steady returns over the five-year horizon.

Over the longer term, institutions eager to place

money will continue to look to Atlanta, where a large stock of top-quality

assets provides an outlet for capital. Properties located in the core of the metro

will garner the greatest investor attention due to relatively consistent renter

demand.

John M. Leonard is a first

vice president and regional manager of the Atlanta office of Marcus & Millichap Real Estate

Investment Services. Contact him at john.leonard@marcusmillichap.com

or (678) 808-2700.

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