Apartment Renovation Ahead

Builders Put Up Luxury Apartments, Renovate the Rest

By JOE GOSE, FOR INVESTOR'S BUSINESS DAILY

 Posted 12/11/2014 05:22 PM ET

 

With apartment construction at its highest point in nearly a decade and still accelerating, commercial real estate observers remain confident that demand will continue to absorb supply for the next several quarters.

 

Some investors hoping to capture better rent growth prospects are also fixing their sights on renovating older properties that appeal to a broader population.

 

"You're dealing with pent-up demand after several years of a drop-off in construction," said Mark Obrinsky, chief economist for the Washington, D.C.-based National Multifamily Housing Council. "So we're not only building to meet annual demand but also to catch up with demand."

 

Construction Rebound

Builders completed 214,000 multifamily units in projects with five or more apartments year-to-date through October, a year-over-year increase of nearly 42%, according to the U.S. Census Bureau. Some 431,200 units were under construction at the end of the month, a jump of 28% over a year earlier.

 

Meanwhile, the average national vacancy rate of 4.2% in the third quarter represented an uptick of 10 basis points from the second quarter, according to New York-based property research firm Reis. While that uptick largely ended four years of quarterly occupancy gains, it still remained well below the 20-year average of 5.4%, Reis says.

 

Only over the last couple of months have annual apartment completions rebounded to match levels seen in the years between 1996 and 2007, Obrinsky says.

 

The burgeoning millennial population continues to prefer apartment life, he says, and renters who would have moved out to buy a home a decade ago are staying longer. Indeed, the homeownership rate of 64.4% in the third quarter was the lowest since 1995 and down from the all-time high of 69% in 2005, according to the Census Bureau.

 

However, most units under construction fall into the upscale category and include gyms, dog parks, rooftop patios, granite countertops and other high-end amenities, observers say.

 

These units largely target a third of the rental population: high-earning young professionals who want to live downtown or in an urban-type environment, says Kevin Finkel, executive vice president of Philadelphia-based Resource Real Estate, which specializes in commercial real estate investment, lending and securities. The upscale units typically fetch around $2,000 a month, on average, which reflects high land, labor and construction costs, and a developer return of about 20%, he adds.

 

Alternatively, Finkel's firm and others are renovating Class B and C suburban properties of 1980s vintage or older. They're catering to households that earn the median income in the U.S. — $52,250 in 2013 per the Census Bureau — and make up more than half of the rental population.

 

Move to The Middle

Often such renters are single parents who work more than one job and can't afford to live in upscale downtown properties — nor do they necessarily want to live there, Finkel says.

 

While developers receive tax credits to build affordable apartments for low-income renters, incentives for new construction that serves the middle market don't exist, he says.

 

"Nobody talks about the middle, and that's where the real housing crisis is," he said. "That's where we believe the strongest growth prospects are, and we see an incredible amount of demand for these units."

 

Reis notes that the Class B and C apartment properties' vacancy rate fell to an average of 3.5% in the third quarter from 4% a year earlier. In the same period, Class A apartments' average vacancy rate climbed 50 basis points to 5.2%.

 

Meanwhile, the annualized Class B rental rate climbed an average of 5% in November, a year-over-year hike of 200 basis points, according to Axiometrics, a Dallas-based apartment and student housing research firm. It says average annualized rental rate gains in Class A and C properties that month were 4.7% and 4.2%, respectively.

 

Resource Real Estate looks for 1980s garden apartment communities — low-slung projects with surface parking, generally in locations with good schools — and spends about $5 million to $10 million on improvements. It opts for new Formica countertops instead of granite, for example, but it also adds fitness facilities and other amenities. Ultimately it looks to take monthly rent from around $900 a unit to $1,200 or $1,300 a unit, Finkel says.

 

"There's a real opportunity for people that have the capital, experience and team to renovate these properties," he added. "There's growing demand but little supply."

 

Real Estate Refresh

A rising number of real estate professionals are noticing the shift. According to Emerging Trends in Real Estate 2015 — a survey of developers, investors, lenders and other real estate executives, produced by PwC and the Urban Land Institute — 35% of respondents said that apartments serving middle-income renters were attractive investments. Only 21% thought high-end apartments were.

 

A longtime suburban rehabber, Rochester, N.Y.-based Home Properties (NYSE:HME), announced last summer that it was halting development to focus full-time on renovating and repositioning Class B and C properties. The real estate investment trust launched the development strategy about eight years ago, but it didn't grow into a meaningful part of the business, says CEO Edward Pettinella.

 

The company focuses on buying older properties in close-in suburbs in nine markets primarily in the Northeast and mid-Atlantic regions. It caters to moderate-income householders — the REIT's rent averages $1,325 a month — who often want to be in good school districts but can't afford houses in the neighborhoods, he says.

 

"You have many potential tenants looking for (that) kind of living," Pettinella said.

 Read More At Investor's Business Daily: http://news.investors.com/business-inside-real-estate/121114-730165-apartment-developers-focus-on-luxury-and-renovations.htm#ixzz3LgIrCpgb

Follow us: @IBDinvestors on Twitter | InvestorsBusinessDaily on Facebook