CREJ - Multifamily Properties Quarterly - April 2015
It seems a little hard to imagine that we could be reading a headline like this in the future about home prices in Denver. However, f we look back 20 years, we can see that median home prices went up 2.65 times from 1994 to 2014. If you apply this same rate of appreciation to year-end 2014 median home price, you could forecast home prices to exceed $830,000 in 20 years. As is said, “Past performance is not an indicator of future outcomes,” and obviously this methodology is a bit oversimplified, but it provides an entertaining way to take a guess at what the future could hold. Apartments – A Look Back When looking at historic average apartment sales for properties with 100 units or more in those same time periods, the rate of appreciation is even more striking with the average price per unit increasing 4.35 times from 1994 to 2014. The average price per unit does not account for the age of the property, amenities, property upgrades and so forth. These factors have a bearing on values, especially if you consider the record-level pricing achieved by newer properties with incredible amenities in core locations. For example, if we look at record-setting sales in terms of the highest price per unit each year for apartments sold with 100 units or more, we can see the difference – the record sale price per unit increased by 4.86 times from 1994 to 2014. If this rate of appreciation were to occur again over the next 20 years we could see a record-breaking price per unit of over $1.9 million! That seems really hard to envision, but I recall a conversation with a client back in the early 2000s. He purchased apartments in Capitol Hill 10 years prior for $15,000 per unit, and he didn’t think that in his life they would be worth over $50,000 per unit. This client is still very much alive today and we have seen properties similar to his sell for over $125,000 per unit. Historic Returns Capitalization rates represent the rate of return an investor is expecting based on the purchase price. The percent is derived by dividing net operating income by the purchase price. A higher cap rate indicates a higher rate of return. Further, the greater the difference between the cap rates and mortgage rates indicates better investment returns after debt service. By looking at the difference between average cap rates and mortgage interest rates it would appear that leveraged buyers have a more positive spread of 1.9 percent in 2014, compared with 0.9 percent in 1994. Recession Proof? This macro view of historical values might belie the fact that the market weathered two major recessions in the last 20 years – first around 2001 with the dot-com bust, and again in 2008 with the financial markets meltdown. It might also be somewhat misleading to think that everyone who bought real estate over the last 20 years made money (because real estate always goes up in value, right?). After the fallout from the recession in 2008 we witnessed several apartment buildings become lenderowned from owners who purchased the properties between 2005-2007. Interestingly, we recently valued a property for a lender who foreclosed during the end of the recession and has been managing the asset since that time. At one point the lender was facing a significant loss. Now, based on the current restabilized operations, the property is worth significantly more than what the previous owner paid for it in 2007. We tend not to think of real estate gaining or losing value quickly but, as recent history shows, it can happen. Predictions We remain very bullish on the nearterm apartment market due the positive make up of a growing generation of millennial and empty-nester renters, lack of for-sale housing options, strong in-migration to Colorado and a steadily growing employment market. However, forecasting what the real estate market will do in the near term is always difficult. Will a European debt crisis stymie the market? Will interest rates increase rapidly? When will the next “black swan” event occur? These game-changing events that tend to send demand from renters and apartment investors to the sidelines usually occur suddenly and without much warning. Those who can avoid selling into these markets likely will enjoy the long-term upside similar to what we have seen over the last 20 years. We know that in the current market with record-high rents, low borrowing costs and strong investor demand, it is an excellent time to be a seller and an owner. Looking into the past over the long term paints a pretty good picture of steady overall apartment appreciation. With our biased love of Denver and all that Colorado has to offer, we remain very positive on this market for the long term. Here’s to seeing a record priceper-unit sale in 2034 of $1.9 million! In the meantime, enjoy these record rent increases and record profits. And to those waiting to buy in the next cycle, please let me know when it will be coming.