A bout with the economy.

Author:Riggs, Kenneth P., JR.
Position:Cover Report: Commercial - Cover Story
 
FREE EXCERPT

Record homeownership fueled by low mortgage rates has dealt a blow to the apartment market. Rising unemployment has delivered another punch, but multifamily has proven its resilience before and will do so again.

The multifamily market is being hit with a one-two punch that is leaving investors and lenders searching for a corner in which to rest and take stock of a changed environment. Like most property types, apartments are suffering from a weakened economy. However, this recessionary period has put apartments in a different position than they were in during previous recessions.

Interest rates are at 40-year lows, turning would-be renters into homebuyers. In addition, buyers and sellers disagree about where apartments are situated in the real estate cycle. As a result, bid/ask spreads have continued to widen, leading to minimal transaction activity. Until either the economy picks up or apartment assets are repriced, buyers and sellers will remain in different corners.

Investors are discouraged from selling while occupancies are relatively low, and since many investors have solid equity positions and financed apartments at relatively low interest rates, they are choosing to wait until the economy revives rather than lower their asking prices now.

With expectations that home financing rates will continue to remain low--particularly for the short-term-what investment opportunities lie ahead for apartments? Although this is a more challenging environment than apartments have faced recently, there are opportunities for multifamily investment.

Hitting below the belt

Believed to be one of the most recession-proof of all investment property types, the multifamily sector is now feeling the ripple effect of the downturn in the economy. Waning demand in the face of low interest rates and practicality of homeownership, along with oversupply in many areas due to the construction boom of the late 1990s, have softened the normally strong apartment market.

One of the most significant factors affecting oversupply is the development of luxury units, which are the least desirable during economic downturns and when home purchasing may be the preference. Concessions, infrequent in the apartment industry during the late 1990s, are now common. Up to a couple months of free rent on a 12-month lease and other incentives are becoming standard for apartments to remain competitive.

Thin profit margins have deterred some developers, but because appropriately zoned land for apartments is hard to come by and the market generally responds quickly to economic recovery, many have purchased available land in order to have locations available to develop when the economy improves. According to the Real Estate Research Corporation's (RERC's) research, (see Figure 1) overbuilding risk increased during the last few quarters but as of first-quarter 2002 overbuilding risk finally began to subside.

Rental growth on the ropes

During past recessions, job loss caused many people to postpone home purchases until they derived a certain amount of comfort with economic conditions. This allowed apartments to remain a strong investment choice throughout the recession. However, with interest rates as low as they are now and the current economic downturn being more business-driven than...

To continue reading

FREE SIGN UP