The View from Institutional Capital
- Apr 26, 2013
Industry leaders gathered yesterday in Dallas for NMHC’s 2013 Apartment Strategies/Finance Conference. The program provided valuable insight into the financial and demographic drivers behind multi-family’s continued dominance in commercial real estate. The conference kicked off with a panel discussion on exactly what institutional capital is looking for when it comes to apartments.
Low long-term vacancy rates, strong rent growth over the last 10 years and a heightened demographic demand are three of the main drivers behind institutional hunger for apartments, said Michael Gately, managing director, research group, Cornerstone Real Estate Advisers.
“Apartments have recovered faster than other sectors. We continue to attract capital, and that reflects in current pricing, where core assets in major markets are bidding up more than they were pre-recession,” Gately added. “In some secondary markets we are seeing prices higher than replacement costs, which is a little bit concerning, though good news for sellers.”
Gately points out that the demand for apartments will only increase due to the unprecedented pullback in construction activity that occurred as a result of the recession. The supply constraint is only bolstered when you factor in the age of the national apartment stock, with 78 percent of units built prior to 1990, and two thirds built before 1980. New trends in urban living favor state-of-the-art assets, and chronically under-housed cities like New York, Boston and San Francisco (where 50 to 70 percent of the population rents) will have an easy time landing money for the newest Class A urban core products.
“There is always a premium for the newest and the best,” Gately said. “The obsolescence factor is something you can’t underestimate when you are on the leading wave.”
Although the market fundamentals remain more than solid for apartments, Gately added that there are near- term speed bumps in some markets that institutional capital is keeping an eye on. One example is the fact that the first wave of high-end high-rise development is already seeing some reluctance as rent growth slows down.
Mike Sobolik, regional director of research, North America at INVESCO Real Estate, added that institutional investors are looking for—and are willing to pay for—a long-term trophy hold. Long-term demographic drivers certainly suggest that multi-family will be firing on all cylinders for some time.
“Institutional capital is looking at the industry on the long term, and they want the high-quality core located assets,” Sobolik said. “But if you want the high-quality core located asset, you are going to pay up for it. That is what is driving the cap rates so low for the urban Class A assets.”
Sobolik pointed out that there are several factors contributing to demand over the next 10 years. New household growth is expected to increase by 15 million over the next decade, with 35 percent of that figure electing to rent. That’s 5.25 million new households in the rental market over the next 10 years. When it comes to young renters, in the pre-GSE period 27 percent of those between 20 and 34 years of age lived with their families. In 2011 that number was at 31 percent, a difference of 3 million people. As the job market continues to improve, some of these younger workers will move out into the apartment market, bringing up the demand closer to 6 million people over the next 10 years.
“But I believe this is a front-loaded demand story,” Sobolik adds. “Pent up demand is not going to take 10 years to see fruition. It is going to happen in the next three to five years.”
Jack Kern, chief investment research officer at Continental Realty Advisors, provided some insight into the locations and asset classes that institutional funds are looking for.
“To me there are three areas: downtown urban, inter-urban in the seven- to 10-mile range from CBDs and suburban. There is just such a shortage of high-quality urban core assets. On the inter-urban side, assets positioned near transportation and shopping hubs will continue to do relatively well. Unfortunately I have seen ultra-luxury buildings in suburban areas that just aren’t justified, as the people who would live in that sort of property want to be closer to the action.”
Kern proposes that owners and investors get familiar with real time mapping analytics to see how patterns vary from market to market, with changes in occupancy being the biggest indication for where opportunity exists. He adds that investors should look past the gateway markets for value, as pricing can be a bit more favorable.
“We want something that will work long term for the renter, which has been a good strategy for us, even in those Class B spaces in Orlando, Houston and Louisville.”
Gately agreed, and believes that capital is more readily flowing to secondary markets as institutional investors become more comfortable with the asset class and the demographics driving its strength.
“It is getting challenging to place core capital in the top tier, gateway markets,” Gately concluded. “Many of our clients are listening and relaxing with us. Sure they sign on for a strategy and they want some control. But before they give us parameters, I find more and more clients are relaxing and looking at the core-plus, value-add opportunities.”