Will Apartments Be Worth More in 2018?
By Les Shaver
This is the second article in Chief Executive Outlook, our series predicting industry trends in 2018.
Executives expect apartments to maintain their value into the year ahead, but at a certain point cap rates will go up.
Since 2012, apartment cap rates have fallen precipitously—from the mid 7 percent-range to the mid 6s. If you look at trophy assets in major cities, the drop off is even more stark with cap rates hovering at around 5 percent in Q3 2017.
With pricing at that peak for more than half a decade, it is logical to wonder if 2018 is the year values finally go down.
“If you look at our model, we have been underwriting that there is going to be a modest cap rate increase every year for the past three or four years,” Ansel says. “We have been wrong every year.”
Right now, Gables CEO Sue Ansel says there is nothing that indicates a cap rate rise in 2018.
“If you look at recent transactions, such as the Greystar acquisition of Monogram or some individual property sales, I feel pretty good about the valuations,” Ansel says. “Our current valuations are pretty solid based on those data points.”
MAA CEO Eric Bolton agrees, attributing strong value to the prevalence of financing options for apartments and unyielding investor interest in apartments.
“Compared to other commercial real estate, apartment real estate looks very compelling,” he says. “It is comparable to some broader positive trends that we see in industrial real estate as e-commerce continues to expand and grow.”
Jeffery Lowry, COO for Madera Residential, is not in the Class A space, and yet sees growth potential in his value-add Texas deals.
“For our company's business model, and what we’re doing, we see next year as a viable productive year,” Lowry says. “We are looking at acquisitions into next year at a very healthy pace.”
That said, Lowry admits that an influx of competition is driving up asset purchase prices. Greg Mutz, Chairman and CEO of AMLI Residential agrees that this phenomenon is happening nationwide. For instance, in some markets, stick-built apartments are priced at replacement costs. He attributes it to a lack of Class A core product in that particular submarket.
“Capital is pursing yield in every asset class and it is no different in real estate,” Mutz says. “If there is a perceived sense that you get more yield buying a B [community] and putting in $10,000 to $15,000 per door in renovation capital and you can turn a low 4-percent cap rate into a low 5-percent cap rate, you are going to chase that.”
The pricing of value-add deals has led some observers to believe the market is in a bubble. But even if values decline, executives do not expect the bloodbaths seen during past downturns, partially because buyers are now putting a lot more equity in their deals. For instance, Trammell Crow Residential, which CEO Ken Valach says “came out [of the recession] scarred, but fine,” was putting in 25 percent into its development deals more than a decade ago. Now, it is contributing approximately 40 percent, which will help it weather future storms.
“At some point, we’re going to have an economic downturn and values will go down,” he says.
If past cycles are a guide, a dip in values, will mean a buying opportunity for some.
“Certain metros or submarkets could see declines in areas that have been overly affected by new deliveries, which could actually be a buying opportunity for investors who have longer term investment horizons,” says Bell Partners’ President Lili Dunn, who thinks overall investor interest will keep valuations flat, if not drive them up a bit.
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