CREJ - Multifamily Properties Quarterly - January 2015
One doesn’t discover new lands without consenting to lose sight of the shore,” said Andre’ Gide, Nobel Prize winner in - 1947. As we roll into 2015 in the Denver multifamily market, both long-term investment veterans and rookies alike are amazed by our astounding apartment landscape. Many investors are using the new year as a trigger to take a deep breath to contemplate their internal risk/return models. Clearly it’s not a one-dimensional challenge to determine an appropriate investment strategy when recent growth and success have been so dramatic in the multifamily arena. Consider the following summary from 2014 pertaining to our multifamily market: • On pace to close over $2 billion in transactions; • An average price per unit of $179,546 for third-quarter 2014; • A trailing 12-month rent growth of over 10 percent; • Almost 20,000 units currently under construction, with an additional 20,000 units planned; • Double the number of apartment permits from previous year to date; • Extremely high absorption of more than 2,500 units for the last two quarters; • Return of high loan-to-value and interest-only purchase money debt; • Consistent ranking from experts of Denver metro being in the top five best markets to invest; and • Solid job creation, quality of life and quality of weather patterns (especially compared with the East and West coastlines). So this begs the question, are there a few trends that are notable as we turn the corner of a new year? Let’s explore two interesting topics. Have there been any shifts in where buyers, developers and equity sources desire to buy? In the first few years after the Global Financial Crisis of 2008, investors, developers and equity alike flocked toward the core markets of Denver, namely downtown and Cherry Creek. In unstable markets, the smart money tends to seek the best locations and most stable rent environments. Frequently repeated buzz words included “urban core,” “mass transit hubs,” “upscale shopping” and “pedestrian friendly urban experience.” The upscale renter pool was displaced and discouraged with the traditional own-your-own-home model and flocked to the best rentals in the coolest locations. This resulting pool of new renters propelled savvy apartment owners to enjoy a breakthrough into the holy grail of rents: the magical and elusive $2-plus-per-foot rent barrier. The resulting jump in rents also allowed lenders to justify backing seasoned developers to start a plethora of new construction. Another factor that helped spur Denver’s apartment development was the city’s severe lack of condo/ townhome development. Fear of lawsuits due to Colorado’s construction defect law severely curtailed developers from building any housing that would include a homeowner’s association. This lack of entry-level housing to purchase, primarily condo development, did constrain the choices available for the typical renter. Apartment developers and investors started to shift toward the less exotic and exciting suburban markets in late 2013 into 2014. Partially caused by construction starts swamping the core markets, some developers feared a bubble of overbuilding. Additionally, rents started to escalate in the fringe markets and the dated properties started to look interesting for “value-add” investments. This trickle-down effect of rent growth in the suburban markets is very real: The new “A” property gets so expensive for the average renter that they move to the less popular markets. Yet, if an owner can make improvements to a dated property, he or she frequently can drive rents up. New construction lags in these less frothy submarkets, so rents go up faster than expected. An example of this is the recent survey of over 100 cities across the U.S., conducted by Apartment List, which concluded that Aurora was No. 1 nationwide in rent growth as a percentage, from October 2013 to October 2014. What’s changing in the value-add arena? Prices continue to increase for value-add transactions. Investor equity abounds and rents continue to go up, especially in corridors that are lagging in new construction. The industry definition of valueadd offerings is also expanding to include units constructed prior to 2000 (compared with a few years ago, when it was typically pre-1985 year of completion). Properties built prior to 2000 that have produced a history of sustained cash flow with few capital improvements (i.e., limited renovations to clubhouse, kitchens, outside faþade, etc.) are hot candidates to be called valueadd. Many of these existing owners have held the investment for several years and they don’t desire either to do the work or furnish the capital to implement a new vision for the property. A new buyer can invest the funds to modify the look to the exterior and interior of the units, improve the resident base, raise rents, improve management and recast expenses, and the resulting higher cash flow supplies the new owner with a solid return. One fact is clear as we sail into the new landscape of 2015, new and old investors are excited to be in Denver. With terrific job growth and in-migration of renters to the metro area, absorption of vacant units continues to astound even the tried-and-true pessimists in our industry. Steady growth in values of all ages and locations of apartment properties in the entire Denver metro apartment market will continue as long as rent growth is sustained. An analogy that speaks to this is “as the water rises all ships go up.”