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With Room to Grow, Multifamily Sector Reaches Prior Peak

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Image courtesy of Legacy Real Estate Ventures

For all the election hoopla of late, the real estate industry is one sector of our economy that can provide strong evidence of a robust return to its prior prowess, according to a recent telecast discussion titled Apartments in Sixth Year of Performance Gains: How Long Can This Cycle Run?, organized by Institutional Property Advisors earlier this month. Two of its vice presidents, Brian Murdy and John Chang, interviewed Robert Hart, president & CEO of TruAmerica Multifamily, and Gregory Pinkalla, chief operating officer of Fairfield Residential Company, about the state of the multifamily market

During the Great Recession some 8.7 million jobs were lost across the country. To date, the economy has returned all of those jobs and grew by another 50 percent to roughly 12.6 million jobs. This recovery has even outpaced the growth cycle from the 2000s, when 8.2 million jobs were added, according to John Chang, IPA’s first vice president of research services.

“People really believe that this housing market has a lot of life to it,” said Robert Hart. “It’s the demand that is driving this positive attitude about multifamily.”

The fact that housing demand keeps rising is undeniable, and the experts are not only seeing that around the Bay Area, but across the nation, as well. In the next 5 years, the US population is projected to grow by approximately 13 million people, the size of the state of Illinois, said Chang, and whether it’s singe family or multifamily, their demand for housing will keep the industry going.

The millennial generation, which today is the largest demographic cohort of roughly 70 million people, is the main driver of that demand. In addition to that the unemployment rate of that group has dipped significantly, and the millennials are contributing to paying rent as they exit their parents’ homes. “Multifamily is dominating, because 70 percent of 70 million people are renters,” said Hart.

Yet the story is multidimensional, and it doesn’t end with just the millennial generation as the only driving factor. The other is homeownership, which has decreased since the Great Recession to levels below those seen in the ’70s. “Our homeownership rates are down to around 63.7 percent, we’re staring to see first time home buyers sustaining in that 31 percent range,” said Chang.

However, the rosy statistics can also signal that the market in so many ways might be approaching a peak again, which then begs the obvious question—how long can this go on. “When things are so optimistic, you always begin to think what can go wrong,” added Greg Pinkalla, although he admitted being unable to provide credible evidence of the industry turning in the short run. On the contrary, he sees the positive effects of the country’s economic prosperity continue to fuel the multifamily industry.

“Because everything is so positive, from occupancy to rent growth, it’s not only in select markets, it’s across the United States,” he added.

As a result of this demand and household formation outpacing housing completions, deals across the industry are rare, with prices approaching prior peaks and cap rates at record lows. In California, in particular, the speakers agreed, the effects of this market were especially amplified.

“It’s very, very difficult to buy in California. Cap rates are at 4, low 4s, whether it’s core or value add. We tend to be more developers in California, rather than buyers just because of that,” said Pinkalla. “We know we can build cheaper than where deals are trading, and you’re seeing core deals trade at $500,000 to $600,000 a unit not only in Southern but in Northern California, too, and we can build at a fraction of that.”

The only sign of worry for the two developers was the exposure of certain markets to the tech industry. The fast pace of growth these companies can experience, can lead to equally fast downturns, as well. “Austin is churning out a lot of jobs, there’s a lot of supply, but it’s heavily tech dependent. That could move very quickly. In the past we’ve seen markets like San Jose, which is a much bigger Austin and much more diversified, but I remember one year where we’ve had rents increase 20 percent, the next year they’re down 20 percent. That’s a volatile market,” said Pinkalla.

“I would agree with Greg,” added Hart. “San Jose, and for different reasons San Francisco, because you have a lot of supply coming into San Jose, and you’ve seen tremendous rent growth and even class B minus or C rents, some of them are $2.50 to $3 a square foot, one bedroom apartments are renting for $2,000. If you had the least bit of interruption in the tech sector you could quickly empty out some of those buildings. Same thing in San Francisco, if you had an interruption in finance or venture capital, paying $80 or $100 a foot for office rent is going to go away pretty fast.”

But how fast is the million-dollar question. The experts agree that the market does not see very much at risk in the very near term. Both Pinkalla and Hart see A markets growing 1 to 2 percent over the next 12 months, and B and C growing 3 to 4 percent, so, by extension, they concluded, if you believe this prices will continue to go up while the cap rates continue their dive to historic lows.