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Monday, 05 June 2017

The Multifamily Sector: A Tale of Two Classes

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 Commercial Real Estate Direct Staff Report

Luxury apartments have been the darlings of the multifamily sector's building boom since the Great Recession. However, a number of shifting dynamics are putting pressure on the asset class, while mid-range class-B properties remain underserved by developers and investors, despite strong fundamentals. Workforce housing, often categorized as class-C, is facing even tighter supply issues.

New apartment supply is expected to peak this year with some 320,000 units scheduled for delivery, up 5.3 percent from last year, according to Marcus & Millichap. Most of the supply is in the luxury urban class, and for good reason. Construction costs across the board have steadily increased, by 37 percent during the 10 years since 2006, according to the IHS PEG Engineering and Construction Index. The higher cost needs to be offset by high rental income in order to make housing construction profitable.

Meanwhile, lesser-quality properties, those that might be considered class-B or -C, have seen little in the way of new construction.

Last year, class-B/C units outnumbered class-A units by about 1 million. That's despite just about zero growth in volume over the past seven years. During that time, the country's class-A inventory has grown by some 17 percent.

                Inventory of Apartment Units


"Of the approximately 320,000 units that are expected to be built this year, the class-B/C component is projected to be approximately 50,000 units," said Scott Lawlor of Waypoint Residential, a real estate investment firm with more than 22,000 multifamily and student-housing units across the South, Southeast and Midwest markets. "However, with a similar number of units of older mid-range stock likely to be renovated to class-A status, the net result would be only a negligible increase in overall affordable-housing supply," he explains.

Class-A properties typically are less than 10 years old, offer a slew of luxury amenities, like fitness centers, swimming pools and pet spas, and feature the finest interior finishes. They are usually professionally managed and in prime locations.

Tenants of class-A properties are renters by choice. They have the wealth or income to be discretionary about their housing choices. Millennials—people born between the early 1980s and 2004—and Baby Boomers—people born between 1946 and 1964—are the biggest targets for these newer communities. Many are attracted to the flexibility that renting affords.

Class-B/C Properties Are Aging, Offer Opportunity

Class-B properties, meanwhile, are between 10 and 20 years old, offer some amenities and have little deferred maintenance. For investors, they are typically value-add opportunities because unit and common-area improvements can result in higher rents. Class-C properties are between 20 and 30 years old and often come with original building systems and finishes. As a result, they typically have substantial amounts of deferred maintenance.

Tenants in class-B and -C units are generally renters by necessity. They tend to be grey-or-blue collar professionals, such as teachers and policemen, with steady, but moderate income. A lack of accumulated wealth may prohibit home ownership.

While there is no standard definition of workforce housing, it usually is considered housing for tenants who make too much money to qualify for traditional housing subsidies, but not enough to afford local market-rate homes.

The Urban Land Institute describes workforce housing as properties that target households making between 60 and 120 percent of an area's median income (AMI). Affordable housing, meanwhile, is targeted to tenants that make 60 percent of AMI or less. There are a number of federal and local programs to subsidize rent and building costs for those projects.

"Very little (new workforce projects are being developed) and in many markets, none at all," explained Greg Campbell, senior managing director of acquisitions and dispositions at TruAmerica Multifamily. The Los Angeles company was founded in 2013 with a focus on affordable high-quality rental homes that it could reposition and renovate. Workforce housing projects "don't pencil out well for developers, and unless we see costs decrease, or municipalities offer stronger incentives, we aren't likely to see this change," he explained.

National apartment rents across all asset classes grew by 0.1 percent on a trailing three-month basis in March compared with February, according to Yardi Matrix. Gains were led solely by the renter-by-necessity asset class, which grew 0.2 percent during that time period, while 'lifestyle' rent growth was flat. Trailing 12-month rents show an even wider gap between the two groups, with rents at renter-by-necessity properties growing by 4.9 percent over the prior year and those at lifestyle properties rising by only 3.1 percent.

"Suburban class-B markets are underserved, with occupancy rates in the 97-99 percent range," Campbell noted.

That begs the question, is the class-A multifamily market overbuilt? Not necessarily.

There Is a Need for More Apartments

While there are pockets of what arguably could be viewed as over-development, "household formation in the U.S. is increasing so quickly, that it's creating a housing shortage," Campbell said.

The number of renter households increased by 9.3 million in the 10 years through 2015, according to the Census Bureau, while the number of owner-occupied households decreased by 2.1 million.

The top markets for new supply are Dallas, with 25,093 units; Houston, with 15,450; Washington, D.C., with 13,686; Seattle, with 12,351; and Denver, with 12,080, according to Yardi Matrix. Nonetheless, each of the markets, except for Houston, is expected to see at least nominal growth in rents this year.

Rent growth nationally has slowed and that trend is expected to continue. Last year, for instance, asking rents grew by only 3.7 percent, according to Reis Inc. That's in contrast to the 5.8 percent growth rate in 2015. The New York research company expects a further softening this year, with rents growing by 2.7 percent.

"Gone are the projections of 5, 6 and 7 percent annual growth," Campbell said.

Millennials, Baby Boomers Want to Rent

Demand for all apartment asset classes is expected to remain strong through 2024, primarily because the number of millennials between 20 and 34 years old, the prime renter ages, will reach nearly 70 million, or 20 percent of the country's total population.

Baby Boomers are getting in on the rental action, too. The number of renters 65 years or older will more than double by 2030, to 12.2 million, according to research by the Urban Institute.

Freddie Mac, meanwhile, last year found that 71 percent of people aged 55 and older planned to rent their next homes.

Unfortunately, nearly a quarter of Baby Boomers have no retirement savings, according to the Insured Retirement Institute, and about half of retirees are living off of their Social Security benefits. The average social security payment in January 2017, according to the Social Security Administration, was about $1,317, while the national median rent was $1,234/month, according to GOBankingRates.

Perhaps that's all working to pour cool water on the sector. In March, prices paid for apartment properties actually declined, by 0.48 percent, marking only the second time that had happened since 2009. They're still 52.2 percent higher than they were during their previous peak, in 2007, according to the Moody's/RCA Commercial Property Price Indices.

Comments? E-mail Jen Loukedis or call her at (267) 247-0112, Ext. 212.


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Additional Info

  • Syndicate to Realpoint: No
  • Sector: Multifamily
  • Subject: Property Acquisitions (ACQ), Research (RES)
  • Private: No
Read 3436 times Last modified on Monday, 05 June 2017

Data Digest







Top Bookrunners Domestic, Private-Label CMBS - 2017
Investment Bank #Deals Vol$mln MktShr%
Goldman Sachs 17.59 11,819.34 13.68
JPMorgan Securities 14.52 10,968.11 12.70
Citigroup 12.04 10,012.71 11.59
Wells Fargo Securities 14.02 9,936.06 11.50
Deutsche Bank 12.55 9,879.74 11.44




cppichart FP



CMBS 2.0 Spreads


Top CMBS Loan Contributors - 2017
Lender #Loans Vol$mln MktShr%
Goldman Sachs 146.89 11,719.34 13.63
JPMorgan Chase Bank 117.68 10,114.14 11.76
Deutsche Bank 198.48 9,689.97 11.27
Morgan Stanley 166.18 8,539.78 9.93
Citigroup 199.05 8,088.24 9.41





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