Written by John Sebree
Investors should be keen on apartment assets due to strong fundamentals, opportunities for both buyers and sellers, and an abundance of capital, advises John Sebree of Marcus & Millichap.
The 2019 investment outlook is off to a bright start. The underlying metrics supporting the apartment market entering the new year remain healthy. Employers ended last year on a high note, lifting annual job growth to 2.6 million positions and extending the positive monthly addition streak to 99, the longest in the post-war era. Payroll growth should continue to create new households, including a sizable share of renter households due to elevated home prices.
Assuming the current expansion surpasses the previous record in the third quarter, investors will be employing diversification strategies favored in a mature economy. In primary markets spreads are tight, providing buyers little margin for a downturn in operations. In secondary and tertiary markets, buyers may pursue higher yields. Meanwhile, cap rates in tertiary metros can be 150 basis points higher than in primary markets, significantly lifting the attractiveness of the area. Investors are also realizing cap rate spreads by going into the neighborhoods that showed little growth 10-15 years ago and are now becoming desirable locations.
AMPLE CAPITAL FOR CONSERVATIVE DEALS
During the last quarter of 2018, contentious midterm elections, volatile equities markets and a poorly received interest rate hike tested the strength of the U.S. economy. Adding to local headwinds, ongoing trade negotiations between the world’s two largest economies, the potential for no-deal Brexit and weakness in Latin America added to the market’s uncertainty. Nonetheless, investors should be keen on apartment assets due to strong fundamentals, opportunities for both buyers and sellers and an abundance of capital.
Although the Fed could tap the brakes on interest rate hikes early this year, tightening monetary policy should raise the cost of capital in 2019. For the first time since the end of 2017, the Fed is walking a tightrope regarding monetary policy. Early in the fourth quarter of 2018, Jerome Powell considered rates “a long way” from neutral. By early January of this year, however, the chairman declared the Fed is being “patient.” The aggressiveness of Fed action aside, liquidity is prevalent within the apartment sector and loans benchmarked to debt-service-coverage of 1.2x. Due to the wide range in cap rates between primary and tertiary markets, loan-to-value ratios can vary between 50 and 75 percent. Regardless, abundant capital is available for apartment deals that meet conservative underwriting standards.
Apartment owners that are within five years of a disposition will consider advancing their plans to redistribute their portfolios. Should a recession occur in the next few years as many predict, there could be limited opportunities for owners that hold onto their properties too long. Additionally, there is ample capital searching for apartment properties, creating a solid environment for sellers. Overall, the apartment investment market will remain healthy this year as capital purses apartment properties outside of core locations.