Analysts See Demand for Multifamily Strengthening Through 2011


Landlords Expected to Benefit from “Catch 22″ for Renters; Many are Unable to Qualify for a Mortgage Even as Single-Family Home Prices Tumble

The outlook for the multifamily sector is stabilizing, with vacancies that peaked in late 2009 continuing to decline as demand slowly grows and the new supply pipeline all but shut off. That’s the conclusion of a recent Fitch Rating report, drawing extensively from CoStar Group data and presented during a recent webinar on the varying degrees of recovery in U.S. commercial and residential real estate sectors.

Private-sector job growth has led to positive net absorption for multifamily properties, with supply constrained markets such as Washington, D.C./Northern Virginia, San Jose and Boston ranking among the best in the country, while markets bombarded by the weak economy and single-family housing collapse such as Florida, Las Vegas, Detroit, Norfolk, and Memphis faring the worst, according to Adam Fox, senior director, U.S. CMBS.

Citing statistics from CoStar subsidiary PPR, Fitch Managing Director Steven Marks said vacancy declined to 8.1% in the second quarter from a historic high of 8.4% in fourth-quarter 2009. Vacancies will continue to decline over the next year, fueled by job growth, new household formation and limited supply driving renter demand in the near term. That will result in rising rent revenue and net operating income for apartment owners.

“The effects of a stabilizing economy combined with an advantageous supply-demand dynamic are expected to benefit multifamily fundamentals,” Marks said. “Over a longer time frame, favorable demographics, relatively limited supply growth and tighter lending conditions in the single-family housing market should support fundamentals in the multifamily sector.”

That said, “Ultimately, we believe a recovery will require job growth in order to be sustainable; but rents are rising in the meantime.”

Solid liquidity driven by access to both public market debt and equity and a continuing flow of mortgage debt capital from government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac also bolsters Fitch’s view of the sector, Marks said.

Fitch expects a below-average construction pipeline to churn out little supply for the rest of 2010, and even less in 2011, for two main reasons: most developers can’t achieve economical pro forma returns on projects, and developers are having ongoing difficulty obtaining construction financing from traditional capital sources, namely banks, Marks said.

Given the weak amount of new apartment space, even a modest improvement in job growth will strengthen demand and absorption, though there will be a lag. The current improvement in demand has very little to do with job growth and more to do with new households, with many single people and young marrieds who were doubling or tripling up with friends and family decoupling to enter the ranks of renters.

Single-family housing affordability has improved somewhat over the last few quarters, theoretically reducing demand for rentals on the margins. However, given the amount of equity that home buyers need to get a mortgage — combined with tighter underwriting and limited confidence that prices will stop falling anytime soon — increased affordability may not significantly impair apartment demand going forward, Marks said.

In the 10 most expensive U.S. markets to buy a home, apartment owners generally have had above average pricing power over the past three years, as indicated by stronger rent growth relative to the national average, Marks said, pointing to CoStar data on historical and forecasted changes in rentals rates.

More volatile markets like New York and the San Francisco Bay Area experienced weaker performance in 2009 compared to the broader market due to severe job losses. Going forward, apartment landlords will not be able to increase rents aggressively in several of these large markets, and properties are expected to generate only slightly above-average rent growth compared to the nation over next five years.

In contrast, landlords have had less pricing power in the 10 least affordable housing markets, with demographics and higher home ownership rates working against apartment owners in such Midwest markets as Indianapolis, Detroit, Cleveland, Cincinnati and Pittsburgh.

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