How Will Tariffs Affect Multifamily Development?

In a post on the BMO Harris Bank site, Managing Director and Head of US Commercial Real Estate Kim Liautaud looks at how tariffs could impact multifamily development:

In the multifamily market, project underwriting has tightened across the board because capital providers are concerned that the sector is late in the cycle, according to Chris McKee, head of development at CRG, the real estate development arm of Clayco. McKee explains that while trended rents used to attract equity providers, there’s now a reluctance to underwrite projects unless they’re at flat rents. Tariffs have only exacerbated that effect.

“We’re seeing contractors start to plan for increased costs,” McKee says. “Steel and aluminum companies know the tariff increases are coming, and they’re passing the costs along to general contractors. With flat rents and construction costs on the rise, spreads have been squeezed and multifamily projects became more difficult to underwrite. Tariffs have only added to that, and that trend will likely continue for the foreseeable future.”

McKee notes that trended rents still drive multifamily developments in certain markets where availability is tight, such as Seattle, Lehigh Valley in Pennsylvania and Inland Empire in Southern California. Less constricted markets, however, require more caution. “You may get squeezed a little bit by those cost increases because you may not have the rent increases that you would get in some of the tighter submarkets,” McKee says…

When it comes to managing multifamily projects, McKee stresses focusing on fundamentals and relationships. “Look for the right opportunity in the right location,” he says. “If you have a long-standing relationship with an equity or debt provider, you can make a case for rent increases specific to a high-growth micro-market, such as Tampa or Fort Worth. It’s an advantage to have pre-existing relationships with equity lenders who trust and believe in you. So when you go to show them something, they know you’ll deliver.”

One-Off or Early Signs of a Trend?

Those of us who were around pre-Great Recession can remember a time when it was relatively commonplace for apartment communities to be converted to condos. Then the mother of all recessions happened and rental housing became the most lucrative, and safest, real estate game in town and we stopped seeing those conversions – if anything we saw condos converting to rental units.

That’s what makes the news of this move in Winston-Salem pretty interesting. From a story in the Triad Business Journal:

Winston-Salem investors Ben Bloodworth and Taylor Williams purchased the 836 Oak Street Lofts apartments in downtown Winston-Salem for $2.75 million with plans to convert the 26 apartments in the former mill facility into condos.

The purchase included 1.22 undeveloped acres adjacent to the apartments.

Bloodworth told Triad Business Journal that all current leases would be honored, and the units would be upfitted and sold as the leases expire.

Downtown Winston-Salem is experiencing a boom of new housing, retail, restaurants and entertainment with the growth of the Wake Forest Innovation Quarter, including the Bailey Power Plant, and the office renovation projects at the GMAC tower.

Downtown Winston-Salem is a particularly hot market in the Triad right now, so this might portend a larger trend across the region, but it will be interesting to see if other investors follow suit, especially in the downtown markets of the Triad’s cities.

Co-Living Not Just for Students Anymore

With the growing popularity of shared workspaces (think We-Work) it probably shouldn’t surprise anyone that shared living spaces are beginning to catch on. Of course, the student housing sector has been using this model for years, but in the market rate apartment world it hasn’t been seen until very recently. One issue is that local ordinances often prevent them, but as the affordable housing issue becomes more prevalent in virtually every city and town across the country, both housing providers and municipal leaders are looking for creative solutions and co-living looks like a good option. The Wall Street Journal recently ran an article that had some interesting data about this new housing approach:

This product, which is less than 10 years old and found primarily in large U.S. cities, represents only a tiny niche in the multibillion-dollar apartment industry. But developers are now preparing to build some of the largest new co-living properties in North America, a sign that the appeal of this type of housing could be broadening…

San Francisco-based co-living startup Starcity last week agreed to purchase a development site in downtown San Jose where it plans to build a 750-unit co-living building…

Rents at the company’s properties range from about $1,600 to $3,100 a month—not cheap but less than the average studio apartment rents in the Bay Area. Half of the rents at the new San Francisco property will be even further below market, affordable to people making as little as $35,000 a year, under new state legislation that streamlines the permitting process for projects with an affordable component.

“To tackle our affordability crisis we need both private sector solutions and public sector solutions,” said San Jose Mayor Sam Liccardo, referring to his city’s new co-living project.

 

Home Sales Slump, Rental Market Rises

Home sales have slowed in recent months and according to this article in the Wall Street Journal, the culprits contributing to the slowdown in the for-sale market are rising prices, rising mortgage rates and the Trump administration’s tax bill that reduced incentives to own homes. That could be good news for the apartment industry:

Yet other analysts argue that all the gloom hanging over housing is good news for owners of apartments, like AvalonBay Communities , which is up 7.4% over the past six months, andEquity Residential , which has added 5.7% in that time. Rental-home companies have also gained, with American Homes 4 Rent climbing 3.8%.

“Having pressure on home sales is a positive for the rental side of the industry,” David Singelyn,  American Homes chief executive, told investors recently. “It should all fare very, very well for pricing power going forward.”

Source: Wall Street Journal

In fact, we could also see room for rents to rise in the near future:

Not only is the added cost likely to keep some renting longer, $135 is about 8% of the average monthly rent collected by American Homes, suggesting that there is room for these companies to raise rents and remain less expensive than comparable homes for sale, he said.

To that end, Freddie Mac said last week that about 78% of Americans view renting as more affordable than owning, a rise of 11 percentage points since the mortgage company released similar survey data six months ago. Freddie also said the proportion of respondents who said they have no plans to buy homes also rose.

Hurricane Florence Recovery Challenged by Low Apartment Availability

The Wall Street Journal ran an article highlighting one of the challenges faced by cities like Wilmington and Fayetteville as they start the recovery process after Hurricane Florence – a tight apartment market:

Places like Wilmington and Fayetteville have fewer than 1,500 empty apartment units each, according to apartment research firm RealPage Inc.

The figure is less than half the number of vacant units in a larger center like Charleston, S.C. Houston, which was suffering from a rental glutbefore Hurricane Harvey hit last year, had some 70,000 available units just before the storm. Fewer available units in North Carolina could lead to a severe apartment crunch.

Making matters worse, much of the rental inventory in places like Wilmington and Fayetteville is in single-family homes, analysts say. This type of housing is more vulnerable to storm damage than higher-rise apartment complexes…

Cindy Clare, chief operating officer for Greensboro-based Bell Partners Inc., said it is difficult to assess the damage to the company’s four properties in the Wilmington area because all roads into the area are closed and most of the properties still don’t have electricity.

Rental Markets Cool Down in Many Large US Cities

Cities that were experiencing very strong rent growth just two or three years ago are now experiencing flat year-over-year growth and in some cases even year-over-year declines. Some of this shift can be attributed to red-hot construction volume, and some can be attributed to other factors like millennials (finally) moving into home ownership in significant numbers. From Bloomberg:

Tenants are gaining the upper hand in urban centers across the U.S. as new amenity-rich apartment buildings, constructed in response to big rent gains in previous years, are forced to fight for customers. Rents are softening most on the high end and within city limits, Terrazas said. Landlords also have been losing customers to homeownership as millennials strike out on their own, often moving to more affordable suburbs…

U.S. multifamily apartment construction for the past few years have been at levels not seen since the 1980s and rapid rent gains have also encouraged owners of single-family homes and condos to fill them with tenants. Projects opening now were conceived by developers a few years ago when rent gains in the U.S. were peaking at an annual gain of 6.6 percent, according to Zillow data.

The most expensive markets slowed first as new supply became available and tenants struggled to afford rapidly-rising lease rates. Rents in the San Francisco area jumped 19 percent in the year through July 2015. Now, they have been flat since last July. New York rents, which were up 7 percent in 2015, have been decelerating for a couple years, declining 0.4 percent in July.

The two largest metro areas in North Carolina are a part of the trend:

Source: Bloomberg

HUD Shifts Focus to Liberalization of Land Use Regs

The US Department of Housing and Urban Development recently announced that it is going to reverse some Obama-era policies related to integrating lower-income housing into wealthier neighborhoods and place more focus on promoting more affordable housing development overall.

According to an article in the Wall Street Journal, “HUD will begin holding stakeholder hearings on how to change the way it determines whether communities are enforcing the Fair Housing Act, which requires local governments to institute policies that help break down patterns of housing segregation. HUD stakeholders include nonprofit groups, academic researchers and private businesses.

But local officials in some communities said the process was costly and amounted to the federal government forcing them to put low-cost rental buildings in wealthier areas.”

So, instead of focusing its attention on the integration piece HUD will try to create incentives for local governments to liberalize land use policies and make it easier for developers to build more housing in general. From the WSJ article:

Policy makers have long puzzled over how to create incentives for cities and towns to build more housing. Local officials are often in a difficult political position because the loudest voices among their constituents tend to be those objecting to development. At the same time, federal and state governments have limited control over local zoning.

Mr. Carson (HUD Secretary Ben Carson) said the new rule would tie HUD grants, which many communities use to build roads, sewers, bridges and other infrastructure projects, to less restrictive zoning.

“I would incentivize people who really would like to get a nice juicy government grant” to take a look at their zoning codes, he said.

 

Affordable Housing’s Headwinds

You can add financing to the litany of challenges being faced by affordable housing developers. From the Wall Street Journal:

Rising interest rates are undermining efforts to build more affordable housing, creating larger funding gaps for an industry already grappling with cuts in government subsidies and rising construction costs.

This year’s climb in borrowing costs—coupled with expectations that they will keep rising—has driven down the amount of debt used to fund affordable housing deals, said Michael Novogradac, managing partner of Novogradac & Co., an accounting firm that specializes in affordable housing…

The permanent debt rate—a measure of the long-term debt projects pay to lenders—was 4.18% for a Bridge project completed in the Mission District of San Francisco in 2016. This year, a proposed development less than a mile away, with the same developer and a similar amount of debt, closed at a rate of 5.06%. The fed-funds rate rose about 1% in the interim…

Affordable housing, which constitutes about a quarter of all new apartment construction in the U.S., is already facing a number of difficulties, including a decline in government subsidies and rising construction costs.

Stuck in Place

A lot has been written about the lingering effects of the Great Recession on the housing market – we’ve done our fair share of it in this space – but something we haven’t really covered is reduced mobility of Americans that has resulted. To put it simply, Americans just don’t move as much anymore. This article at Slate helps us understand what that means:

Americans are no longer the footloose strivers of popular imagination. It’s not just about moving between states, a long-running and well-documented phenomenon that has recently leveled off. Most of the current decline is from Americans not making local moves, either. Three million fewer local moves in 2016 vs. 2006, in fact, compared with just 200,000 fewer interstate moves. Eleven percent is the lowest mobility rate on record, and as the annual report from Harvard’s Joint Center for Housing Studies shows, it’s stuck in a feedback loop with several features of the housing market.

One reason for fewer moves is that older people tend to move less. Many own their own homes and have paid them off so they don’t want to leave them. Some live in high-cost areas with mechanisms like rent control that makes moving too expensive.

Another reason is something that the apartment industry has been impacted by for years:

It’s not just your parents’ fault. After the recession, nearly 4 million single-family homes, many purchased in foreclosure auctions, became rentals. (That’s about three percent of the total U.S. housing stock.) Big-time landlords who own dozens or even hundreds of properties are a rising force in U.S. cities, and their purchases have taken a big chunk of homes off of the market. There are fewer single-family homes for sale than at any time since 1982. Adjusted for the nation’s population gains in that time, the shortage is even more severe.
There’s scarcely more slack if you’re looking for an apartment.

As you might expect, this has driven home prices through the roof. Prepare for sticker shock when you Zillow that neighborhood you’ve been picturing yourself in. But those high prices haven’t produced the housing-construction boom that your Econ 101 professor would predict. On the contrary, fewer homes are being built per capita than at almost any time in history. The Harvard report cites a few reasons for this: fewer vacant lots, land use restrictions, building material costs, and a skilled worker shortage. What’s clear is that even as America’s (very bad) sprawl model continues its slow decline, nothing has emerged to replace it. New construction in most major cities remains vastly outpaced by demand.

The result of all this? Young people, those who are historically most likely to move, are staying put. Just 24% of 20-24 year-olds moved last year, which is down from 34% in 1996. This affects renters as much as homeowners:

This mobility drop holds for renters as well as would-be owners. Except at the very high end, tenants are still under historic levels of financial stress, which may discourage them from making expensive moves, even if a better neighborhood or apartment might be out there.

More Good News for Multifamily: Spring Home Sales are Slow

Here at PTAA, we’re often asked why the apartment industry has continued to thrive despite historically low (now rising) interest rates, a strong economy and rising rents, and our answer is, “Well, there are a lot of reasons.” Many of those reasons are highlighted in this article about a lethargic spring home sales season in the US:

Instead, home sales are lackluster. That is locking many young home buyers out of the market when a good job market should give them the opportunity to purchase a first home. First-time buyers made up 31% of sales in May, down from 33% both the prior month and a year earlier, according to the National Association of Realtors. Mr. Khater said that is a missed opportunity for many millennials, who might find it hard to catch up, as prices are growing faster than incomes.

Supply is tight in part because of a lack of new-home construction caused by regulatory barriers, lack of available land, and labor and material shortages. Existing homeowners also have been reluctant to put homes on the market…

The situation could grow more challenging for buyers in the months ahead if mortgage rates continue rising. The average interest rate on a 30-year fixed-rate mortgage in May was 4.59%, up more than half a point from 4.03% in January, according to Freddie Mac.

At the same time, the median sale price for an existing home in May was $264,800, up 4.9% from a year earlier and a new all-time high, according to NAR. Prices have risen 71% from the low in January 2012…

Rising mortgage rates and home prices also help deter existing homeowners, many of whom enjoy historically low rates, from selling because the cost of purchasing a larger home is a significant jump from their current monthly payment.