High Leverage for Apartment Loans Troubles Moody’s

With prices so high for apartment properties, any loan based on today’s appraised values is going to look very large compared to historic prices. But multifamily CMBS loans are especially troublesome, according to Moody's Investors Service.

“The credit quality of U.S. conduit/fusion commercial mortgage-backed securities (CMBS) continues to deteriorate, with conduit loan leverage in the second quarter pushing past its 2007 peak,” reads a July report from Moody’s.

These loans may look relatively modest compared to the appraised value of the apartments properties now. But if prices were to fall, a number of these loans might be in serious trouble. Lending experts argue that problems may be mitigated by stronger loan underwriting standards overall. Also, property prices may have even more room to rise relative to the income from apartment properties, and don’t have to fall anytime soon, as interest rates creep upwards, according to some apartment experts.

“Lenders are holding to pretty good underwriting standards,” says Bill Hughes, senior vice president for Marcus & Millichap Capital Markets. For example, lenders still resist to the urge to offers loans with interest-only periods longer then a few years, unless the loan is relatively low leverage, covering less than 60 percent of the property’s appraised value.

Moody’s: Underwriting way past the peak

The average CMBS loan was equal to 117.8 percent the value of the property in the second quarter, as measured by the Moody’s loan-to-value (LTV) metric. That’s very high–largely because Moody’s LTV compares loans to historic property values, instead of the high values that properties are appraised for in today’s market. The average CMBS loan was equal to 66.4 percent on average of the underwritten value of its property over the same period, according to Moody’s.

“The appraisals on Q2 collateral fully reflect the run-up in commercial property prices to levels that top the pre-crisis peak, while our values use a through-the-cycle approach,” according to Moody’s.

Just to compare, in the third quarter of 2007 the average CMBS loan has an average Moody’s LTV of 117.5 percent on average of the underwritten value of its property over the same period. In response to rising leverage, Moody’s is getting tougher in its CMBS ratings, giving fewer bonds in every CMBS issue the coveted AAA rating because the rating agency expects losses.

“Loans sized to 70 percent of peak values likely will under-perform those sized to 70 percent of trough values, as can be seen by comparing loans from the 2007 peak with those from mid-cycle 2003,” says Tad Phillipp, Moody's director of commercial real estate research.

Sky-high prices

The issue of leverage affects the whole business of lending to apartment properties, not just the CMBS business, because it is driven by high prices for apartments.

Lenders are still avoiding some of the worst practices of the real estate boom, however. For example, lenders still require borrowers to show the expenses from a property on a trailing, 12-month basis, says Hughes. Also, borrowers typically can’t get away with forecasting rents that would justify a larger loan, even though the property has now history of earning those high rents.

“I’m not really seeing any of that,” says Hughes. That restraint makes measurements like a loan’s debt service coverage ratios much more meaningful today than it was during the last boom, when giant loans were made based on rosy projections of high rents and low expenses.

Even though apartment properties are selling at historically high prices, by at least one measure prices have room to rise even further. Apartment properties now sell at average cap rates of 5.5 percent. That’s 320 basis points higher than the yield on 10-year Treasury bonds. Just to compare, in 2006 at the height of the boom, cap rates were just 100 basis points higher, according to Institutional Property Advisors.

Cap rates are likely to get a little closer to the yield on 10-year Treasuries. “As investors seek opportunities in secondary and tertiary markets throughout 2015 and compress cap rates there, the spread nationwide to the 10-year will continue to narrow,” according to Institutional Property Advisors.

Interest rate outlook: Federal Reserve

The benchmark yield on 10-year Treasury bonds is also likely to stay relatively low for a long time. “Even the anticipated increase in the Federal Reserve’s benchmark later this year will likely have minimal short-term effect on long-term rates,” according to Institutional Property Advisors. That’s because the bond markets have expected the Fed to inch rates upwards for a very long time, and there is not much in the latest economic reports to pressure the Fed to act quickly. A strong dollar and low energy prices are helping keep inflation below the Fed’s target of 2 percent. “The Fed has the maneuvering room to adjust rates very slowly,” according to Institutional Property Advisors.

Slippery Situation: Oil’s Potential Impact on Real Estate

While it’s certainly good news for the majority of consumers, the sliding cost of oil and gas could gum up the works for some real estate owners and investors.

With crude oil prices hovering around $50 a barrel since the beginning of the year, industry watchdogs are voicing concerns about the threats to particular real estate markets and CMBS transactions.

Oversupply and weak demand have pushed crude oil down more than 55 percent from its recent peak of $107 a barrel in June 2014. For the regions and commercial assets that are fueled by the petroleum industry—including parts of Texas, Colorado and North Dakota—sustained low oil prices could lead to vacancies and reduced property incomes, several real estate observers cautioned.

That, in turn, could bring on a new wave of delinquencies on highly leveraged properties, as well as increased volatility in high-yield bonds, some said.

“What people are most worried about is exposure to real estate markets with a lot of oil-services tenants,” Trepp Senior Managing Director Manus Clancy told Mortgage Observer in mid-January, noting that so far the impacts are largely theoretical.

“Upon re-leasing, the office tenants in those spaces would look to either give up space or spend less money,” he said. “Houston seems to be ground zero for that concern.”

Mr. Clancy said the submarkets at greatest risk are the oilfield “man camps” in West and South Texas and North Dakota’s Bakken shale region, where oil workers drill for fresh supply.

“These are places where there may be a couple of limited-service hotels and multifamily properties and everyone is there just to drill,” he said. “Those will be the first places to close up and die if oil remains in the $40 to $50 range.”

Jana Partners, an activist hedge fund that once held a major investment in the recently spun-off oilfield lodgings company Civeo Corp. sold its entire $51 million stake in the Houston-based firm on Dec. 30, 2014, regulatory filings show.

The New York-based fund dumped its 12 million shares after Civeo announced plans to severely cut its 2015 spending to between $75 million and $85 million, from $260 million and $280 million in 2014, as previously reported. Civeo plans to close sites and further reduce its North American workforce.

Civeo’s stock closed at $3.14 a share on Jan. 21, down from about $25 a share in October 2014. Representatives for Jana and Civeo declined to comment.

Several other Houston-based companies that specialize in oil and oil services, including Baker Hughes and Schlumberger, have announced budget cuts and layoffs. Overall, oil company analysts have said they expect 500 to 800 U.S. drilling rigs to come out of service in 2015, the Houston Chronicle reported in late December.

Likewise, CMBS deals backed by properties with heavy oil-related tenant bases could also take a hit if oil prices remain at a sustained low for several months or more, according to Trepp and other industry sources.

“For the Houston market, the concern is that if you just took out a $100 million loan on an office property where you have three big energy tenants, your grade-A tenants may start to look like grade-B tenants,” Mr. Clancy said. “If oil prices remain low, the securitizer may wonder, ‘Will they shrink their square footage? Will they go out of business?’ he added. “Nobody can say for sure what will happen to these guys, so that’s where all eyes will be.”

One prominent B-piece buyer who spoke at CRE Financial Council’s January 2015 conference in Miami Beach said that some recently issued securitizations for non-prime Texas developments are in jeopardy with oil and gas prices down. That buyer, who could not be named due to a strict conference policy on attribution, said those CMBS loans had been originated with high loan-to-value ratios and that the properties’ projected revenue streams relied on continued oil sector growth.

Now that that growth has been stymied, the panelist said he fears the loans may be headed to special servicing in the near future. That speaker and other industry representatives at CREFC declined to go on the record with their comments.

To be sure, others see the drop in oil prices as a minor concern in the context of a stable economy and rejuvenated real estate industry.

“The geographic diversity of other assets in multi-borrower deals will mitigate oil price exposure for CMBS,” Mary MacNeill, managing director of U.S. CMBS at Fitch Ratings, told Mortgage Observer.

There are no records of a single-asset securitized loan on a property in Texas, according to Fitch. However, the loan could still bring down the cash flow of securitizations that hold other mortgages.

“Vacancies in certain markets will rise over time if oil prices stay low for a more protracted period,” said Ms. MacNeill. “Particularly for office properties in Houston or other oil-dependent markets.”

The city of 2.1 million people, which is commonly referred to as the “energy capital of the world,” houses more than 5,000 energy-related firms, according to city government data.

Among several buildings in Houston that could be exposed are two office properties: Two Westlake Park at 580 Westlake Park Boulevard, owned by Houston-based Hicks Ventures, and Two Allen Center at 1200 Smith Street, owned by Brookfield Office Properties, loan documents provided by Trepp show.

Two Westlake Park is 80 percent leased to ConocoPhillips and BP, while Two Allen Center is 52 percent leased to U.S.-based natural gas and oil producer Devon Energy Corporation. Civeo is based in nearby Three Allen Center at 333 Clay Street, also owned by Brookfield.

The Devon Energy lease does not expire until 2020, which gives the space “minimal near-term exposure,” according to a Brookfield spokesperson.

“While Houston is considered a resource market, its economy is clearly more diversified now than it was during the ’80s and ’90s,” said Paul Frazier, head of the real estate giant’s Houston region. “Furthermore, the mid-stream and down-stream sectors of the energy space are also prominent in our economy, which gives us a hedge against lower commodity prices.”

Tom Fish, co-head of real estate investment banking in JLL’s capital markets group, also said that Houston’s economy and real estate market are adaptable enough to handle a shock to the oil industry.

“I don’t expect developers and projects to be going bankrupt or for there to be a string of foreclosures because of over-leveraged debt,” said Mr. Fish, who is based in Texas’ most populous city. “The capital markets for new development are efficient enough to withstand distress in the market,” he said. “I was here during the oil downturn of the ’80s and I don’t think we’re there again.”

Still, Mr. Fish said that there are concerns about the future of office and high-end multifamily properties in Houston with crude oil prices at such a low.

“Those have been the two most active sectors of construction in our city for the past few years,” he said. “If oil prices were to stay below $50 a barrel for several years, it would take its toll, but we are a long way from reaching a point where we see a lot of defaults.”

For the time being, low oil prices create a boon for retail companies, medical facilities, technology firms, and low- to moderate-income residences, Mr. Fish said.

“We’re a consumer-driven economy,” he told Mortgage Observer. “There’s no better way to turbocharge that than to put money back into consumers’ pockets.”

Commercial mortgage delinquencies returning to prerecession levels

The delinquency rates of most types of commercial and multifamily mortgages fell in the third quarter, with multifamily loan delinquency rates back at prerecession levels, according to Mortgage Bankers Association (MBA) research.

The 30-day delinquency rate for commercial mortgage-backed securities (CMBS) loans was down 0.37 percentage points to 5.47%. The 60-day delinquency rate of commercial and multifamily loans held by life insurance companies fell 0.03 percentage points to 0.05%.

The 60-day delinquency rate for multifamily loans backed by Fannie Mae decreased to 0.09%, while the 60-day rate for Freddie Mac multifamily loans increased 0.01 percentage points to 0.03%.

The post-recession highs for Fannie Mae and Freddie Mac multifamily delinquency rates occurred around 2010. In the fourth quarter of 2010, the 60-plus day delinquency rate for Fannie Mae was 0.71%, and was 0.33% in the third quarter of 2011 for Freddie Mac.

In the fourth quarter of 2006, the Fannie Mae 60-day delinquency rate was 0.08%, and the Freddie Mac rate was 0.05%.

Some delinquency rates were still above recession-era peaks. Approximately 1.28% of loans held by the Federal Deposit Insurance Corp. and banks were delinquent 90 or more days in the third quarter. That delinquency rate peaked between 2010 and 2011 at above 4%, with the low at 0.8% around mid-2006.

CMBS 30-plus and real estate owned (REO) delinquency rates stood at just above 5% in the third quarter. The peak was in 2011 at close to 9%. Between 1997 and 2009, CMBS delinquencies were below 2%.

“Improving property fundamentals and values, as well as a strong finance market, are helping drive delinquency rates down across all investor groups,” said MBA Vice President of Commercial Real Estate Research Jamie Woodwell in a press release.

Is Houston the Next Gateway City?

Institutional investor demand for Houston commercial real estate, coupled with job growth, a less expensive cost of housing and movement of oil and energy industries into the city is leading local players to predict that the most populousmetropolis in Texas could become the next gateway market. "Houston has always been a strong market for institutional investment, but it is now viewed as a gateway city," Kevin Roberts, the southwest president at Transwestern, said. "Today, it is considered one of the top tier investment markets in the U.S."

Las yea, the city was ranked fourth in the U.S. for foreign investment and fifth globally, according to the Association of Foreign Investors in Real Estate. "This was a huge improvement since not all that long ago, Houston was not a primary investment market for foreign capital, because most foreign investors were going toward gateway markets such as Los Angeles, San Francisco, New York, Washington, D.C., and Boston," Tom Fish, executive managing director at JLL, said. "[The city has] recently been perceived as a gateway market in the eyes of foreign investors, and [it] now has a healthy amount of foreign bidders."

Consolidation of the oil and energy industries into Houston has created internationally competitive jobs that draw foreign capital to the region, Kevin Roberts, the southwest president at Transwestern, said. He explained that Houston is predicted to be the number one supplier of oil and gas in teh United States in 2015.

Because of this, there has been a rapid increase in foreign investment from Mexico as well as an in-migration trend, according to Jan Sparks, managing director of structured finance at Transwestern. "There is significant influx of wealthy Mexican nationals into Houston, predominantly in Mexico City and Monterrey. Houston offers a stabilized, safer environment for them to raise their families and conduct their business. Commuting to numerous cities in Mexico from Houston is easy and inexpensive. They can get in and out of Mexico in the same day if they desire," she said.

The city has seen in-migration from the Northeastern, Midwestern and Western parts of the U.S., Roberts said, as people seek to take advantage of low-tax business opportunities. "Our governor has been very aggressive in trying to attract people to those businesses," Fish said. "The one thing that is interesting about the oil business is that it's not just people in hard hats drilling. It also produces an enormous amount of technology jobs, and a lot of people are coming in from places like California to fill those positions."

 

Job growth in Houston, which is seeing 80,000-100,000 new jobs created each year, is close to double the national average, Fish said. This means the office sector has seen a lot of demand, Sparks said, as it has been an efficient way to place large amounts of equity for the past two years. Houston now has more office space under construction than any city in the country, according to Fish, a vast majority of which is already leased.

 

Multifamily is also one of the leading product types in Houston this year, Roberts said, with more than 17,000 multifamily units delivered in 2014 and nearly 15,000 of those units abosorbed. "Many members of Generation Y are coming in and renting these urban, multifamily units," Roberts said. "Sixty percent of Generation Y renters think that they'll move within the next five years, so they're willing to pay up for apartment units because they are renters by choice."

 

With all of the new construction, Fish said that he believes there is enough discipline in the market to limit it to the best products that are able to get capitalized. "We have had a terrific four years of double-digit rent growth, and as long as we continue to experience the job growth that we are now, I think we'll be able to absorb the units that we have coming in," he said. "Even though construction prices are going up because of the heightened labor market, I think the future of Houston looks pretty healthy. There's always a little bit of caution about what will happen in the oil industry, but I'm very optimistic."

 

Although the market in Houston has been favored among investors for a couple of years, according to Roberts, he doesn't believe Houston has seen its peak yet. "Many use baseball analogy that we're in teh middle innings of an extra innings baseball game," Roberts said. "Fundamentals in Houston and the economy's supply and demand equilibrium are very much in check, and I do believe that this current cycle will have a very nice run. I don't think we're close to the end. I think we have several years in the future to enjoy this momentum and continue to build on it."

Freddie to Fund, Securitize Small Apt. Loans

Freddie Mac, which increasingly has relied on the securitization market to fund loans its lender partners originate, has launched a program to fund small-balance multifamily mortgages in much the same way.

So far, the housing-finance agency has approved Greystone Servicing Corp., Hunt Mortgage Group and Arbor Commercial Mortgage to write loans for the program. Its aim is to have its first $100 million securitization in the market by early next year. The agency also plans to add other lenders to the program in the coming months, with the hope of having five to seven lenders in the program by the end of the year. Next year, it plans to open the program up to its Program Plus lenders - those that regularly have been writing small-balance loans.

The overall structure of its small-balance securitizations will be similar to the agency’s existing K-series transactions, in that bonds will be structured according to risk and would include a first-loss, or B-piece. It’s not clear whether the most senior bonds will also be rated.

Each transaction will be secured by loans originated, and sold to Freddie, by a single lender. And that lender would be required to retain the B-piece, which would likely amount to more than 7.5 percent of the entire transaction.

As the program evolves, transactions backed by loans originated by multiple lenders might be floated. The agency is aiming to fund loans with balances of between $1 million and $5 million

against properties that have a minimum of five units each. Loans could be sized up to 80 percent of a collateral property’s value and would require debt-service coverage ratios of at least 1.25x, or 1.2x in the country’s strongest markets. It will offer fixed-rate balloon loans as well as hybrid adjustable-rate loans, which could have terms of up to 30 years and fixed rates for their initial five, seven or 10 years. After that, the loans’ coupons are reset every six months.

While Freddie’s small-balance loans, like its larger-balance offerings, are nonrecourse, save for specific carve-outs, the agency will require originators to collect borrower FICO scores. So a borrower’s credit history, in addition to a property’s performance, will play a role in a loan’s underwriting. That’s because most smallcap properties are held by individuals as opposed to bankruptcy-remote entities, like larger properties are. “We believe our initiative will increase liquidity in the small multifamily loan space and provide stability and facilitate private capital investments in this somewhat fragmented and underserved market segment,” said David Brickman, executive vice president of Freddie’s multifamily business.

The agency estimates that roughly half of the country’s apartment units are in what could be considered small-capitalization properties. And about one-third of the multifamily mortgage market is comprised of small-balance loans.

The small-cap apartment market is highly fragmented and generally has been served by local and regional banks, which often won’t write long-term loans. In addition, because of regulatory pressures, those bank lenders often can move out of certain markets, leaving property owners with few borrowing options.

“The opportunity is ripe” for Freddie to get into the small-balance market in a bigger way, according to Nashwa Moussa, director of conventional structured transactions, who oversees the agency’s small-balance lending initiative. “We’re bringing securitization to the space,” she explained. While other lenders have securitized small-balance loans, none has developed a systematic program to regularly bring deals to market.

Living with Gen Y: Trends in Multifamily Development

All eyes are on the Millennials as a new generation of consumers whose unique mindset is impacting all industries, from housing to environment, infrastructure, media and retailing.

Anton Menlo in Menlo Park, CA. Designed by KTGY, this $120 million sustainable mixed-use community serves Gen Y professionals in the walkable, transit-oriented neighborhood of Menlo Park.

Key characteristics of Gen Y

Also known as Generation Y, Millennials are fundamentally different from their Baby Boomer fathers and mothers. For one thing, Millennials (those in their 20s and early 30s) have been forged in the Great Recession, they know the risks of adventurous investments and financial escapades, they are burdened with student loans but highly educated and place a great deal of importance on sustainability. Unlike their parents, they delay some of the rites of passage into adulthood such as purchasing a house or getting married, precisely because they want to do things right. Young people move back with their parents or dive into renting not because they abandoned the American dream, but because they appreciate flexibility and seek financial stability before pursuing homeownership.

As of 2013, it is estimated that there are approximately 86 million Millennials residing in the United States. Over the next twenty years, this demographic group is expected to grow exponentially as immigrant counterparts continue to make America their home.

Impact on multi-family design

Partly due to the Millennials’ surge, apartment demand in most markets has climbed as well. Acknowledging Gen Y’s preference for urban living, mixed-use developments and walkable environments, multifamily operators have embraced innovation and new residential design trends have emerged. Car and bike sharing services, electric vehicle charging stations, community kitchens and farms are now an integral part of apartment communities.

“Multifamily developers and designers have been inspired by high-end amenities found at resort hotels and expensive membership health clubs as well as those amenities that single-family home owners would want,” said Rohit Anand, AIA, NCARB and managing principal in the Tyson, Va. office of the award-winning national firm, KTGY Group, Inc., Architecture + Planning, in a written statement.

“These amenities include resort-inspired pools, large spaces for vegetable and fruit gardens, additional storage closets off the patio/balcony and/or in the parking garage, bicycle storage and repair, jamming/recording studio, a large fitness center with lots of windows, a Pilates/Yoga studio, and big screen TVs or even individual screens on each tread mill or stair climber. Some developers are including a training facility with personal training in their membership-quality gyms.”

One other thing that multifamily operators should not disregard when devising retention strategies is technology and Millennials’ preference for digitalized environments. The members of this cohort grew up texting and socializing on Twitter and Facebook, they acquire everything online, from groceries to insurance policies and services, and don’t mind sharing when it comes to transportation and housing. Consumer-generated media, online reviews, rankings and opinion polling are a part of their daily existence. They like to make themselves heard and expect feedback, whether at work, within their communities or in their group of friends. Understanding the Millennial mindset and what the members of this demographic expect from their place of residence will allow property managers to better position their assets and cash out on their investments.

“Understanding the wants and needs of your primary target market is critical to success. Going the extra mile to provide amenities that are unique to the marketplace will give you a real marketing advantage in the process,” observed Anand.

“Today, amenities and technology, both low tech and high tech, are being leveraged to provide apartment residents with a convenient lifestyle free from the burdens and responsibilities of home ownership,” he added. “One of the advantages of apartment living near transit in urban, walkable communities is that residents can more easily do without owning a car. Car sharing businesses like Zipcar and Buzzcar have increased in popularity. Bike sharing, first made popular on college campuses, has moved off campus as well.”

In addition to tech offerings, Gen Y-ers expect their apartments to accommodate their lifestyle needs, such as socializing, shopping and entertainment. During the selection process, chances are that prospects will place as much emphasis on location as on rental rates and unit size.

“Location is everything. What’s in the neighborhood within walking distance is the most important amenity. Where services are missing from the neighborhood, developers might incorporate ground floor retail/services to include a ‘grab & go’ convenience store, dry cleaning, nail (and hair) salon, sports pub and/or cafe. Investors are snapping up these “retail condominiums” at premium prices in high traffic, urban infill areas,” Anand explained.

One simple step to improve chances of success in attracting and retaining residents is offering a wide amenity package, to cater to all renter types. Whereas proximity to parks and recreation spaces will act as leverage when it comes to attracting outdoorsy types, pet-friendliness in a community will serve as a retention driver for pet-owners and animal lovers. You just have to know your target well and align your offerings with the prospects’ needs.

“As Gen Y loves their pets, savvy apartment developers are including grooming stations, a bark park or doggie run, and even doggie day care with pet walking services,” Anand pointed out. “Veterinary care and training might also be included.”

As to where these Gen-Y-centered apartments should be located, news organization Vocativ has compiled a list of cities where young Americans would feel more at ease in terms of job opportunities, quality of life, green, and general atmosphere.

Vocativ based their ranking on traditional data like average salary, employment rates, and the cost of rent and utilities measured against everyday factors like bike lanes for commuting, low-cost broadband and the availability of good, cheap takeout. What’s more interesting though is that they also included some quirky yet “all-important” lifestyle metrics in the study like the price of a pint of beer and an ounce of high-quality weed, as well as the level of access to live music, coffee shops and vintage clothing stores.

As it turns out, if you’re in your twenties, eco-minded, struggling to make ends meet and looking to put down roots in a city that won’t suppress your dreams, Portland, Austin, San Francisco, Seattle and Minneapolis are your best bets. See the complete ranking here.

Flowtown – Social Media Marketing Application

Multifamily Boom Slows

The multifamily industry is on an ascending path, with trendlines pointing to a steady, albeit slow, recovery of the housing market all throughout the U.S metro areas.

The construction pipeline remains active in most markets, with 1,400 properties, 316,010 units, currently under construction, according to the latest data from Pierce-Eislen. The company’s services monitor the 50+ unit apartment universe from the property level to the submarket/market level within 59 United States markets, extending in geography from the Pacific Northwest to the Mid-Atlantic.

Denver, L.A. Metro, Seattle and the Carolina Triangle lead the charts in terms of new apartment development, followed closely by Washington D.C., Northern Virginia, Urban Boston, and three of Texas’s economic hubs, North Dallas, Austin and West Houston.

Common Characteristics

Pierce-Eislen research shows that more than 90 percent of the units under construction possess two characteristics in common: the developments are located in urban environments, and they are positioned so as to serve the two, “renters-by-choice” lifestyle rental categories: wealthy empty nesters (55+), and young professional, double-income-no-kids-households.

The capital source, lender, developer, investor universe all seem to point to the same conclusion: urban, cutting-edge development, fully dressed up, with all the amenities is the one configuration that actually works in the current economic context.

On the other hand, when conducting quarterly comparisons of market data, the apartment industry conditions seem to be weakening. All four indexes of the National Multi Housing Council’s (NMHC) October Survey of Apartment Market Conditions dropped below 50 for the first time since July 2009. Market Tightness (46), Sales Volume (46), Equity Financing (39) and Debt Financing (41) all showed declining conditions from the previous quarter.

“After four years of almost continuous improvement across all indicators, apartment markets have taken a small step back,” said Mark Obrinsky, NMHC’s Vice President of Research and Chief Economist, in a statement. “Conditions cannot continue to improve indefinitely and new development is at least somewhat constrained by available capital – though more on the equity than the debt side. Even so, both the Market Tightness and Sales Volume Index are within hailing distance of the breakeven level and the Debt Financing Index rose despite some rise in interest rates. This bodes well for the apartment industry going forward.”

Key findings of the NMHC survey include:

Mixed sentiments regarding the availability of capital for new development. More than three quarters of the respondents regarded construction debt financing as widely available – 34 percent think both equity and debt financing are widely available, while 43 percent think construction loans are widely available but equity capital for new development is constrained. Only 36 percent think equity capital is widely available.

Market Tightness Index fell to 46 from 55. Conditions vary greatly from place to place, but on balance, most respondents (67 percent) said they saw no change in market tightness (higher rents and/or occupancy rates) compared with three months ago. One-fifth of respondents felt that markets were looser than three months ago, while 13 percent saw tighter markets.

The Sales Volume Index remained at 46. Almost one-third (32 percent) of respondents saw a lower number of property sales, compared with almost one-quarter (24 percent) who said sales volume was unchanged. A plurality of 44 percent regarded sales volume as unchanged.

The Equity Financing Index dipped to 39. Sixty percent viewed equity financing as unchanged – this was the tenth consecutive quarter in which the most common response was that equity finance conditions were unchanged from three months ago. By comparison, 27 percent of respondents viewed conditions as less available and only 5 percent viewed equity financing as more available.

Debt Financing Index rose 21 points to 41. Almost one quarter of respondents (22 percent) viewed conditions as better from three months ago, a sizable increase from eight percent last quarter. Forty-one percent of respondents believed now is a worse time to borrow, down from 67 percent in July.

The survey was conducted October 7-October 16 and included the responses of 64 CEOs and other senior executives of apartment-related firms nationwide.

Philadelphia Area Fourth Quarter 2013 Apartment Market Report

Economy on Sound Footing, Driving Apartment Sales

Respectable job growth and the formation of new households reduced vacancy in the Philadelphia metro over the first nine months of 2013 and is supporting a strong multifamily sector. Nearly every private-employment sector added workers during the period, though many industries still have additional hiring to do to recapture all of the positions lost during the downturn. Job opportunities in degreed fields or those requiring specialized training, such as healthcare, are available, but lower-skilled workers continue to face challenges. Specifically, deficits to former peak staffing levels in retail and wholesale trade persist and may be suppressing the performance of apartment buildings on the lower rungs of the quality scale. Economic trends are pointing upward, however, which could hasten the pace of hiring in lagging employment sectors in the quarters ahead. A recent regional survey by the Federal Reserve showed a rise in the index of new orders for goods and services and also signaled improved prospects for hiring.

Although investor demand outweighs the number of properties listed for sale, deal volume continues to surge. Nonetheless, the recent rise in long-term interest rates is motivating additional owners to place properties on the market. Generally, for owners contemplating a sale in the next year or two, the current bidding climate and the relatively modest rise in interest rates improves the probability of executing a transaction. Lenders are competing to provide acquisition loans, with leverage reaching as high as 80 percent. In many instances, local and regional banks have emerged as more competitive sources than the agencies. Cap rates are virtually unchanged from six months ago, and healthy disparities persist between first-year returns on different classes of assets. Class A properties, for example, typically trade in the low- to mid-5 percent range, while Class B properties change hands in the mid-6 to low-7 percent band. Cap rates for Class C or lower-quality properties with working-class tenancies typically start in the mid-8 percent range, though many deals settle closer to 9 percent.

2013 Annual Apartment Forecast

• Employment: Payrolls will swell by 33,000 jobs in 2013 to expand employment in the metro 1.2 percent. Growth in education and health services employment underpinned the creation of 28,700 positions in 2012.
• Construction: Projects containing 3,400 units will come online in 2013, up from 1,278 rentals last year. New stock will be placed in service in 10 of the metro’s 16 submarkets. The greatest impact is in Center City, where 1,429 new rentals will expand stock 4.6 percent.
• Vacancy: Vacancy will decline 30 basis points this year to 4.9 percent, the lowest year-end level in six years. The vacancy rate was unchanged in 2012.
• Rents: Following a 1.1 percent bump in 2012, average rents in the metro will rise 2.6 percent this year to $1,128 per month. With the projected increase, rents will have climbed 10 percent since bottoming four years earlier.

https://www.marcusmillichap.com/services/research/webreports/Philadelphia/Apartment.aspx