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Pet fees are up while late fees are down.
As the COVID-19 pandemic continues to cast a long shadow over the rental housing industry, ancillary revenue would seem to be a low priority. In previous years, collecting ancillary fees was an important — though legally fraught — concern. But now, with job losses mounting around the country, many apartment operators are simply focused on collecting rent on time.
For example, Haven Realty Capital, based in El Segundo, Calif., is sacrificing the flow of one ancillary revenue stream in exchange for trying to keep its residents in place. “Month-to-month premiums were waived to allow flexibility for residents who had lease expirations during the pandemic months,” says Sudha M. Reddy, Managing Principal of Haven.
In a recession, apartment operators are justifiably focused on just “keeping heads in beds.” Operators may even need to think twice about imposing ancillary fees.
But in the longer term, the COVID-19 lockdown may present new revenue opportunities, if residents receive financial relief and the unemployment situation stabilizes. If trends such as teleworking become commonplace, the COVID-19 lockdown could change the way residents use energy and bandwidth and give operators the chance to consider residents’ high-speed connections to the outside world.
Not Pressing the Issue
The general rule for multifamily ancillary revenue is about 5 percent of total income, but many of the fees are also accompanied by attendant costs. In the short term, Max Sharkansky, Managing Partner of Trion Properties, based in West Hollywood, Calif., is more concerned about on-time rent payments.
“We [could] charge higher pet rates and higher lease-break fees, but we’re just not pressing that issue because it’s tough out there,” Sharkansky says. “We’re signing leases, we’re doing fine, our collections are in the mid-90s. But we’re also in a 12 percent unemployment market, so I don’t know if this is an optimal time to start increasing our fees.”
As the amenity wars heated up during the past decade, ancillary revenue took a back seat to services, such as dog walking. But as the recession lingers, those services are also in jeopardy.
“It’s so hard to compete on what has become a commodity,” says Brian Zrimsek, Industry Principal of the tech firm MRI Software, based in Solon, Ohio. “The apartment can only be so big; the pool can only be so grand. So we found operators moving to adding services, dog-walking services, laundry pickup services and yoga classes — amenities as a service. But when a recession comes, that’s the first thing to go.”
This strategy is a throwback to the 2008 housing market collapse. “In 2008 they lowered prices and increased terms to lock people in,” says Zrimsek. “They’d rather have sure but thin revenue. In good times, it’s okay to have a little nickel-and-diming for things. We’re also seeing concessions come back. It would not surprise me if things that people charge for in the best of times they change their mind on now.”
Sorry, You’re Late
Early in the pandemic, municipalities, states and the federal government moved to curtail evictions and late fees to help keep residents in their homes. Now, six months into the crisis, what were once seen as temporary measures are being extended in many parts of the country as the apartment business takes the hit.
At Haven Realty Capital, late fees have traditionally been a large revenue stream, followed by pet rent and admin fees. “[But] late-fee revenue has dropped to zero since April,” Reddy says. “The moratorium on late fees has also eliminated the incentive to pay on time, resulting in a delay in our collections at some of the properties.”
It’s the same story at Trion Properties, as Sharkansky simultaneously eyes what’s happening in collections and the state legislature. “We’re in California, and not allowed to charge late fees,” he says. “In California, it’s open-ended. It’s a function of when they remove the emergency order. In Oregon, it was set to expire but was then extended to Sept. 30. We still get the majority of our rents in the first week [of the month], but the next 20 to 25 percent are paying in the following three weeks.”
As many residents have been hunkered down for months now, apartment operators are seeing an increase in their energy and data consumption. Even before the pandemic, says Todd Richman, Senior Vice President at Morgan Properties, based in King of Prussia, Pa., marketing contracts with cable providers and Internet providers did well for his company.
Richman is predicting that addiction to Netflix and Zoom dependence is going to raise the income from fees. “I would assume that once we see the numbers, we might have higher income from these services,” he says. “With people working from home, they may have had to upgrade to a better Internet service, they may have ordered more services. It’s possible it’s remained the same. But I’m expecting Internet penetrations to be higher than they’ve ever been.”
Laundry rooms are another small but reliable revenue source for Morgan, and Richman is expecting to see an uptick — again, because people are spending more time at home.
Trion’s Sharkansky also is bullish on laundry. Trash collection, water usage, pest control and sewage fees are also looking up. “Ratio utility billing [RUBS] is huge,” he says. “Although I don’t know if you can qualify that as ancillary income; it’s more of an expense reimbursement, but it’s on the income side of the P&L.”
Doggy Day Care
The pandemic has been a huge boon for pet adoption, according to a number of sources. The consensus is that people who had been putting off getting a dog or cat because they didn’t spend enough time at home suddenly have no excuse.
In April, Kitty Block, CEO of the Humane Society, told the Chicago Tribune, “I think it’s a combination of reasons. We’re going through a global pandemic, and its anxiety-provoking and it’s isolating. Those who are fortunate enough to work remotely are doing it from home, so people have the time now and the desire to open up their homes to a pet, to give that animal a chance.”
The trend is confirmed by the numbers Trion Properties is seeing. “In April, May and June we had an uptick in pet fees,” Sharkansky says. “Looking at year-over-year for June, portfolio-wide, we did about $9,400, and last year [it] was around $7,000, so we’re seeing a 34 percent increase.”
But even enforcing pet fees will likely get some pushback from residents, demonstrating, once again, that at this point in time, fees are a touchy issue
“I don’t know that the first thing a resident does when they get a pet is call the office and let us know,” says Richman of Morgan Properties. “We’re trying not to be intrusive to residents about being in their apartments. We’re not doing walk-throughs of each apartment; it would be very hard to do that.”
Scott Sowers is a freelance writer.
Owners and operators of affordable housing communities have a lot to worry about.
As the COVID-19 pandemic persists, managers of affordable housing communities are straining to protect their residents. They clean obsessively. They have set up hotlines to share information and have established networks of volunteers to check on vulnerable residents.
At the same time, many managers have to worry about an increasing number of residents being unable to pay their rents. Millions of Americans have lost their jobs and not all affordable housing residents receive rental subsidies to make up for lost income. Also, the rents and rental subsidies at many affordable housing communities are tabulated based on the average rents and incomes in their area. A prolonged recession would cut into those rents and incomes.
Protecting Residents Comes First
The top priority for affordable housing community managers is to keep residents and staff safe from COVID-19—especially at communities where a large number of the residents are elderly or vulnerable.
“The greatest challenge has been keeping our residents and staff safe,” says Michelle Norris, Executive Vice President of External Affairs and Strategic Partnerships for National Church Residences (NCR), based in Columbus, Ohio. NCR’s communities house more than 42,000 low-income seniors in 25 states, including many of the states hit hardest by the coronavirus, such as Florida, Georgia, Michigan, New York and Texas.
Companies like NCR carefully disinfect the shared spaces still open at their communities such as lobbies, elevators and stairwells, although amenity spaces like gymnasiums and community rooms often remain closed. Managers follow standards set by the federal Centers for Disease Control and Prevention (CDC), along with state and local guidance. These common areas are even more difficult to clean than usual, because they have been getting more traffic. Managers also have to manage more trash and recycling.
“People have been at home much more—practically 24/7 given that they are not going to work, school or events,” says Milton Pratt Jr., Executive Vice President at the Michaels Development Co., based in Camden, N.J. Aside from more cleaning and trash pickup, it means more wear and tear on the common areas.
On the other hand, maintenance crews at Michaels and other communities have done a lot less in-apartment work since the start of the pandemic to help limit the spread of the virus. “Regular maintenance has been curtailed,” says Pratt. “The focus is on emergency maintenance, since we [aren’t] entering homes unless absolutely necessary.”
Communication Is Key
During the pandemic, communicating with residents about repairs or other issues has often been difficult. At many communities the leasing office has been closed. NCR created its own coronavirus hotline to provide information on the crisis to its 26,300 residents and staff.
“Everyone was really scared,” says Norris. It was important to make sure the field team knew what to do, he adds.
NCR has a clear policy if one of its residents tests positive for COVID. “We alert residents to positive cases in the building—not the names, to protect the privacy of residents,” says Norris. Using the hotline, “we track all of our positives through their journey.”
NCR community managers also created networks among residents in which the seniors check-up on one another. “We have set up quite a bit of the old-fashioned ‘I’m OK, you’re OK,’” Norris says. NCR had previously worked to create strong relationships with the seniors at its communities. “It’s already built into the DNA of the buildings,” she adds. “If you did not have a culture of this, it can be hard to get residents to rally.”
Volunteers of America (VOA), based in Alexandria, Va., developed its own rapid- response team to communicate with residents about the coronavirus. The system has been “quite effective in preventing and dealing with positive cases as they crop up,” says Patrick Sheridan, VOA Executive Vice President for Housing.
Managers of affordable housing communities also rely on partnerships with service providers to help care for residents. For example, Michaels Development has partnered with nonprofit support services organization Better Tomorrows at its communities for families and seniors. “They have been focused on food delivery and wellness services,” says Pratt. “They’ve been adapting to continue these services while minimizing contact with individual residents. They [also] adapted their youth summer programs to outside and virtual activities.”
Early in the pandemic, there was a shortage of the N95 masks needed by health care workers. To solve the problem, NCR made its own fabric masks for its staff, each marked with the company logo. “We had a culture of mask wearing way before it was cool,” says Norris. “Volunteers also offered to make masks for residents. People kept making them and offering them to our seniors.”
Bendix Anderson is a freelance writer.
COVID-19 has buried apartment operators under a mountain of deliveries.
It’s a problem that just won’t go away for multifamily housing operators: Figuring out how to handle all the packages that come to an apartment building has long been a time-consuming challenge for staff at multifamily apartment communities, only exacerbated by the rise of e-commerce in the last two decades.
Then COVID-19 struck.
With more residents spending more time at home during the pandemic, and fewer venturing out to the store for basic supplies, operators have been faced with a flood of packages that has made every week feel like the holiday rush, turning every day into Parcel Armageddon.
The volume of packages Gates Hudson has been receiving onsite is increasing, says Aaron Almanza, Regional Vice President for the Fairfax, Va.-based company, which operates 22,000 apartments. “At one of our larger properties, with 912 units, we had to add a second full-time concierge whose sole duty is to help with packages.”
Almanza isn’t alone.
“Having packages delivered directly to the leasing offices is no longer a viable option due to the volumes we’re receiving,” says Scott Gilpatrick, Vice President of Operations at Atlanta, Ga.-based Carroll which operates30,000 apartments. “We’ve been repurposing amenity spaces as package rooms.”
And at Chicago-based LaSalle Investment Management, an operator of 17,000 apartments, Senior Vice President Kelly Soljacich says the pandemic and its resulting surge in e-commerce have collided head-on.
“COVID-19 has created a real challenge to keep up with an increasing amount of online purchases during stay-at-home orders,” she says. “We have been seeing double and triple the amount of packages normally received in the summer months.”
Indeed, according to the U.S. Postal Service, package volume increased 50 percent in the second quarter compared with second quarter 2019. At United Parcel Service (UPS), the increase was a smaller 21 percent, but shipments to homes — the most expensive and challenging type of delivery for carriers — was up 65 percent. And both UPS and FedEx announced surcharges this summer for major shippers to help accommodate the crush of packages.
For apartment operators, finding ways to handle the never-ending stream of deliveries has been a shotgun approach:
Package lockers help, but are expensive and eventually face their own volume, space, size and use constraints.
Dedicated package rooms have been making a comeback at apartment communities, but they eat up space, need 24/7 access and pose the risk, amid COVID-19, of bringing residents too close together as they get their stuff.
White-gloved service by staff who receive packages for residents and then deliver them to individual doors has worked at some companies, but can increase costs or pull staff away from other tasks.
Third-party package drop-off services, which receive parcels at an off-property location and deliver them to residents when they’re home, have become increasingly popular, but carry with them a per-door fee for operators. Apartment execs must decide whether to pass it on to residents during a period of declining rent amounts and increased collection hurdles.
“The pandemic has taken an already-confusing situation with packages and just made it more challenging,” says Tim Kramer, Vice President and Director of Operations at Chicago-based Draper and Kramer, which oversees more than 8,000 apartments. “Honestly, we haven’t settled on a single universal solution to package handling, because properties can be so different in what residents are asking for and what we have room for.”
Exterior Package Lockers
For David Lynd, CEO of San Antonio, Texas-based Lynd, which operates 20,000-plus apartments, the packages piling up at his communities also were a problem long before COVID-19 came along. “The offices at a lot of our properties were just starting to look like industrial warehouses because the number of packages was getting so ridiculous,” he says. “They come all day, every day.”
To deal with the onslaught, Lynd decided to outfit his portfolio, which includes assets built anywhere from the 1970s through the 2000s, with package lockers. His challenge was putting the lockers in an area where staff would not have to be present to give residents access.
“The premise with lockers is, you want them to be available to residents 24/7,” Lynd says. “If you have to get into the office area to access the package lockers, what’s the point?”
That ruled out areas behind locked doors, and because many of his communities are garden style, lobbies weren’t always an option either. Where Lynd could install them in an internal common area that allowed round-the-clock access, he did. But where that space wasn’t available, he chose exterior-rated lockers that could stand up to the elements while giving residents access to their packages any time of the day or night.
“We armed all of our communities with package lockers,” Lynd says. “We picked a central location where residents already go, whether it’s the mail kiosk or another area where residents already naturally congregate, and that’s where we put them.”
They didn’t come cheap. Lynd says his interior lockers cost around $22,000, while exterior-rated units ran between $33,000 and $35,000. Although that amounted to a significant capital expense, the good part was it didn’t eat as heavily into Lynd’s recurring operations budget, which should help him realize more value over time.
But beyond the dollars and sense, Lynd says the lockers basically amount to table stakes, given the current situation in the multifamily housing environment, where operations budgets have increased and rent collection has become more challenging amid COVID-19.
“The coin has rotated,” Lynd says. “Now it’s a race to keep tenants. So while I can’t necessarily quantify a true value-add cost, what I can say is properties that have these lockers are the ones that typically experience higher occupancy and a better renewal rate. And going into the market right now, that’s what you’re looking for.”
But for others who have turned to lockers in the past, the units have come with challenges of their own.
For example, while an erstwhile general rule has been that an apartment community should receive about 20 to 25 percent of its apartment count in packages on a daily basis, operators say that metric is now woefully low.
“So if you had a 400-unit community with a capacity to handle 100 packages a day, that was plenty,” says Tim Peterson, Chief Operating Officer at Boca Raton, Fla.-based Altman Companies, which counts 8,000 apartments in operation or under development. “Now, we’re planning a capacity of one to one.”
From his perspective, lockers come with an inherent scaling issue because of the exponential rise in online ordering, both before and since the pandemic began.
“When the idea came out a decade ago, package lockers seemed like such an elegant solution,” says Peterson. “But the explosion of e-commerce means they have essentially become obsolete in a five-year timespan. We’ve come to the conclusion that you really just can’t build enough lockers. It becomes too unwieldy.”
Other problems operators report with lockers is residents not picking up their packages on a timely basis, leaving no room for other packages, which are then left out in the open. That has led some operators to charge daily storage fees for repeat offenders, to the chagrin of residents.
“Once it gets full and people’s packages can’t go into the locker, residents get upset,” Kramer says. “So you’ve basically taken something that should be an amenity and turned it into a detractor.”
Even when there is ample space for incoming parcels, delivery people often don’t sort packages for individual lockers because it adds time onto their already-busy schedules.
“The issue that we’ve found surrounding lockers is that they are really dependent on the delivery people buying in and using them 100 percent of the time,” says Almanza at Gates Hudson. “Delivery personnel will sometimes walk into the fobbed package room with all the lockers right there, and they’ll still just toss the packages on the ground and walk off. That creates a situation where anyone with access can walk in at any time and leave with a package that isn’t theirs.”
Smart Package Rooms: New Twist on an Old-School Approach
Issues with package lockers have led some operators to go back to running package rooms for deliveries, which typically take up less space and, when managed correctly, can avoid a rush of residents all trying to get their packages at once.
At the Altman Companies, Peterson has converted storage spaces that would normally get rented to residents into ad hoc package rooms and hired temporary workers to help residents with their packages. “Longer term, we’re moving from the package locker solution to a package room solution with restricted access and cameras where residents use their fobs to get in,” he says. “So if somebody picks up the wrong package or somebody’s package is not there, we can use a combination of the access logs and the video to figure out where [it] ended up.”
But while so-called smart package rooms have advantages, some point out that they inevitably bring residents into closer contact with one another — an ongoing problem as long as COVID reigns.
"When it comes to self-service package rooms, which are typically small, how do you ensure only one resident goes in at a time?” says Kramer. “If the package room gets full, or if there are issues getting into the room and residents can’t access it, it still requires contact with staff.”
White-Glove or Do-It-Yourself?
To deal with that situation, Draper and Kramer has piloted white-glove, to-the-door package service at some of its communities, while running centralized, staffed package rooms at others, with staggered times for residents to pick up their packages.
“The white-glove package delivery is really only practical at smaller properties,” says Kramer. “At our larger properties, we have centralized package receiving, and we’ve been experimenting with designated pickup times.”
For Mark Segal, Senior Vice President at Glencoe, Ill.-based Optima, which operates luxury high-rise apartment buildings in Chicago and Arizona, taking a white-glove approach has been a labor-intensive, but effective, way of getting packages to residents’ doors. Staffers drop packages outside individual doors on a daily basis.
First, team members, wearing masks and gloves, place the package outside of the apartment home, Segal says. “We [later] do a sweep through the hallways of the community, and if the package isn’t picked up as of a certain time of day by the resident and brought into their home, we return [it to] our storage system.” It’s both a service and an amenity, he adds.
Segal says the system keeps residents from congregating around crowded locker rooms, coming into contact with one another and having to touch other people’s packages. While the service involves staff time and effort, Segal says he’s also realized other benefits from it.
“Beyond the service itself, we have more regular interaction in different areas of the community by our team members,” Segal says. “So they’re experiencing what’s going on, and if they notice anything that could be touched up, for example, along the way, they let the team know. It’s helping us with overall maintenance of the community, because you have more eyes on what’s happening.”
Third-Party Package Delivery Services
Others in the apartment industry, after years of grappling with rising piles of packages at their communities, are now deciding to get out of the package business altogether. Instead, they’re contracting with third-party providers who receive packages offsite, and then interact with residents via an app to schedule a drop-off when they’re home.
“At that point, it becomes nothing more than a pizza delivery,” says Kramer, who has been evaluating these services. “You wouldn’t have it delivered when you’re not home, so there’s no need for us, as the managers, to even get involved in the package- handling process.”
For Larry Goodman, Chief Operating Officer at Addison, Texas-based Pinnacle, which operates 160,000 apartments, third-party services have been a rare bright spot in the situation operator face today.
“COVID has pushed operators to look at alternative delivery options that remove the staff from the equation,” Goodman says. “Looking at those services has really helped during this new time we are living in.”
Still, those services typically come with a price tag of $10 to $15 per door per month, which results in another quandary for operators: Passing that charge onto residents at a time when rentals are decreasing, or eating it themselves as an operating expense to keep their communities full.
While neither approach comes without its own pain points, on balance, operators say taking themselves out of the package delivery stream is a scalable solution for an ever-growing challenge.
“Many operators have tried to solve the challenges with package locker systems, package concierges or self-service package rooms,” says Toni Reeves, Executive Director at Charleston, S.C.-based Greystar, the largest apartment operator in the United States, with approximately 660,000 apartments and student housing beds. “With all these options, our onsite teams are still handling packages, [which takes] up at least two to three hours a day at any given property. Using a third-party vendor gets us out of the package business.”
For example, Greystar piloted a third-party vendor delivery program at a 490-apartment community in Dallas in 2017. To date, the service has delivered more than 11,000 packages at the building, attaining a 99.2 percent on-time delivery rate while saving more than 1,420 hours of staff time.
“Just achieving one of those metrics alone would make it compelling,” Reeves says. “All three together mean it’s an easy decision.”
That’s at least one way to tackle a problem that by all accounts will only continue to grow in the months and years to come.
Joe Bousquin is a freelance writer.
Managing the entirety of the employee lifecycle should include protocols for the offboarding process.
Terms like “onboarding” and even “pre-boarding” have made their way to the forefront of focus for many businesses as the war for top talent continues for many organizations. But one topic heard about less often is that of offboarding.
The idea of a business making a great first impression, setting the stage for the entirety of a prospective employee’s tenure, is critically important. But what if the impact an organization makes when an employee departs was just as powerful?
Offboarding is the last opportunity your organization has to show employees value. Former employees are destined to be a part of your organization’s word-of-mouth marketing. How they perceive your company, especially in their final days, will be shared with their friends, family and even strangers on the internet. Following is guidance on how to make a significant impact during a staff member’s final days of employment.
Communicate the Change. Employees want to feel valued; preparing to leave a company is no different. It is important for the company to announce when an employee has given notice and thank the exiting employee for contributions made during their tenure.
Create a Checklist. It is critical to ensure that the exiting employee receives clear instruction concerning expectations prior to departure. A checklist of expectations should cover standard items like return of keys, transition of job duties and removing access to company systems. Other items such as the cessation of benefits ending and receipt of last paycheck also should be addressed.
Celebrate the Employee. When a departing employee gives notice, there will be emotions that, left unchecked or unacknowledged, will dampen the overall employee experience. While not convenient for all parties, the exiting employee has made their choice for reasons of their own and careful consideration should be given to ensure that this decision does not sway your opinion regarding their work ethic or the quality of work produced during their time with the company. Instead, the employee should be celebrated for their accomplishments and progress achieved. This may be social time spent together with the team or sending a thoughtfully crafted, handwritten card. Whatever the budget allows, make the time to send a message with impact.
Conduct an Exit Interview. It is insufficient to treat an exit interview as an item to be crossed off a to-do list; rather, focus on the information shared within the interview and dedicating effort to understanding how it can applied to improve the organization (further information below). Determine whether the company has the resources to conduct the interview in person or on a survey. Offering both options to exiting employees may increase the percentage of interviews completed.
Analyze Turnover. It is not enough to just gather feedback from departing employees via exit interviews, instead, the information gained should be applied to identifying enhancements and changes to company programs, where applicable.
There will be employees who leave for reasons outside of the organization’s control, such as moving out of state, graduating college, a life-changing event such as marriage, having children or death, or simply a change in career. These are unpreventable of course, but the real strategic understanding can be learned from employees leaving for reasons like compensation, poor leadership and lack of growth potential. It is up to the organization to leverage that information to identify where improvements can be made.
Offboarding Is Critical to Future Success
As your final opportunity to show exiting employees how much they are valued, make sure to put a strategic offboarding program in place, understanding that it will evolve over time as feedback is received. Removing negative energy and administrative burden from your offboarding process will allow you to review its effectiveness and help you put the employee at the center of the experience, to the great benefit of the organization.
Consider offboarding as risk mitigation for the organizational reputation, in that first impressions are important, but so are final impressions. Everyone suffers from recency bias, in that we instinctively bestow greater importance on recent events (offboarding) rather than past ones (onboarding). Additionally, everyone generally gives more credence to word-of-mouth recommendations. When considering both in conjunction, a departing employee with a positive offboarding experience is more likely to speak highly of the organization than they would otherwise be inclined to absent strategic offboarding efforts.
Stephanie Anderson is NAA’s Industry Operations Manager, and can be reached at [email protected].
January and February drove volume before March problems arose.
January and February started off as strong months for apartment transactions. Overall, the first quarter was flat from Q1 2019 with stable prices. “The economic crisis brought on by the new coronavirus, however, is moving faster than quarterly figures can measure,” RCA wrote in its Q1 report.
Then came March and the full-blown arrival of COVID-19. Deal volume fell below $10 billion in the month, according to RCA. In studying first quarters from 2001 to 2019, RCA found that, on average, March represented 36% of all quarterly deal volume. In 2020, March represented only 25% of quarterly deal volume with a sharp slowdown at the end of the month, according to RCA.
In fact, without two entity-level transactions involving Steadfast Apartment REIT, March would have looked even worse. RCA sales entity-level transaction were down 12% year-over-year, but slumped 38% in March.
Garden-style apartment sales were flat in Q1, but mid- and high-rise sales fell 7% YOY. However, in March both segments saw sales fall more than 10%.
As the economy took a sharp, historic turn downward, 10-year Treasuries hit record lows. While investors may have hopes that low rates will push cap rates even lower, RCA warns that they shouldn’t get too excited. It noted that the relationship between cap rates and treasuries “widened and narrowed based on changing expectations for growth and appetites for risk.”
Right now, the spread between the 10-Year and cap rates is at 450 basis points. The average since 2001 is 315 basis points.
“Conditions needed to shrink this spread just are not in place,” RCA wrote. “If investors suddenly expected more growth in the economy and subsequent stronger growth in property income, many would be willing to accept a narrower spread to the risk-free rate to capture some of this growth.”
In the last downturn, demand for apartments from former homeowners helped narrow spreads. This time, questions about rent payments, along with rent control threats, could potentially push spreads further apart, according to RCA.
“In response to the GFC [great financial crisis], apartment cap rates across the U.S. climbed 130 bps,” RCA wrote. “Doing some scenario analysis that generates a cap rate 100 to 150 bps higher than the current 5.5% is not outside of the range of possibility given these historic moves.”
Single-asset sales continue to increase as investors chase yield and safety in a potential recession.
In September 2018, Greystar closed its $4.6 billion purchase of student housing REIT EdR. This year’s third quarter didn’t see a comparable transaction, which is a big reason why deal volume fell 7 percent year over year (YOY), according to the most recent Real Capital Analytics (RCA) US Capital Trends apartment report.
Despite the decline in sales volume and the fact that only one entity-level transaction closed in the quarter (Cortland’s $1.2 billion purchase of Pure Multi-Family REIT), RCA still sees a healthy apartment-transaction market ahead.
For one thing, single-asset sales are growing. In the third quarter of 2019, deal activity rose 8 percent YOY in the segment. “Single-asset sales are up as recession fears are stoking further investor demand for investments in the apartment sector,” RCA said in the report.
With a potential recession coming, investors want to find properties where capital expenses won’t be as challenged in a downturn, according to RCA. Citing the National Council of Real Estate Investment Fiduciaries (NCREIF) data, RCA says the apartment sector has the lowest ratio of capital expenses costs relative to other commercial sectors.
Regardless of buyers’ motivation, apartment executives are still seeing strong interest in their assets. James A. Bloomingdale, Senior Vice President and Head of Acquisitions for JRK Investors, says transaction volume is holding steady YOY. “There’s a lot of money chasing deals,” he says. “Rates are staying low, and we’re seeing a lot of deals getting done.”
Johnny Gregorio, Senior Associate, Eagle Rock Advisors, sees a lot of competition for deals in the Northeast and Mid-Atlantic. “There’s a lot of capital in the market ready to be deployed in value-add deals, and you see that reflected in purchase prices,” he says.
The data back up Gregorio’s observations about apartment costs. Apartment prices rose 7.7 percent YOY in September, according to the RCA CPPI (Commercial Property Price Indices). While that’s slower than the 11.4 percent pace set in September 2018, it’s stronger than that for all other property sectors.
In this low-return environment, investors are chasing yield. Right now, value-add apartments serve this need. “It’s a very challenging environment to acquire any properties that have a value-add component—all the upside is already priced in,” says Robb Bollhoffer, a Managing Principal and Director of Acquisitions at 29th Street Capital (29SC).
With so much interest in value-add, 29SC has changed its strategy. “Transaction volume has definitely decreased for 29SC on the acquisition side but has picked up on the disposition side,” Bollhoffer says.
Bollhoffer detects excess leverage in the market, which he says feels similar to 2007, which is also driving his decision to sell.
“On the properties we’re selling, there’s a common theme of bridge debt; then, preferred equity and mezzanine; and, then, a small amount of equity,” Bollhoffer says. “Now is a great time to upgrade the vintage of our portfolio.”
As it sells older assets, 29SC sees more opportunity to develop core-plus properties. “We’ve opened a development business unit in Sacramento [Calif.], since this market is underserved on the supply side, and our cost basis will still be below some of the older-vintage assets that are trading in the market,” he says.
A respected industry analyst says those who succeed in picking, buying, financing and managing properties during a downturn will be set up to thrive when the economy improves.
While no one knows when the next recession will arrive, Ryan Severino, Chief Economist at JLL and an adjunct professor at Columbia and New York universities, is seeing signs that a downturn is getting closer.
“Growth will decline from ’18 to ’19 and ’19 to ’20, and we’re going to have to see if things hit the fan in 2021,” Severino said at NAA’s Maximize Conference, Sept. 23–24, in Atlanta.
Indeed, he’s already seeing some trouble on the horizon. “Objectively, [interest] rates are still low by historical standards,” Severino says. “Yet, investment is starting to pull back.”
When the recession does come, Severino thinks global political instability or unwise policy decisions will likely be the cause.
“We’ve entered a place where policy is starting to become a very big part of this economic outlook,” Severino says. “Most recessions are caused by policy errors.”
Specifically, Severino points to the trade war as a potential cause of the next recession. “[The trade war] isn’t doing very good things,” Severino says. “Trade is the linchpin on which a lot of this stuff hinges right now.”
In addition, political and economic tensions around the globe could spark a problem. “There’s no shortage of political risk in the world today, especially [regarding] policy,” Severino says.
When the next downturn does come, Severino isn’t sure there will be the political will to increase spending. “Spending is a lever that the government pulls to get the economy going. I’m not sure how many people are going to want to pull that lever next time,” he says.
The apartment industry is fairly well-positioned for the next downturn, though Severino does have some concerns about supply.
“Supply will start ramping up again,” Severino says. “If the economy goes into a recession, absorption may be more difficult with more supply.”
While supply could cause problems in the Class A space, other locations and asset classes could thrive. Severino thinks suburbs to primary markets are poised to do well as millennials leave the urban core. He also likes older product. “I like B and lower product in a recession,” Severino says. “The demand there is incredibly stable, and supply has gone down.”
As a sector, Severino says, the apartment industry has some advantages going into a downturn. “There’s still a lot of demand out there, especially with for-sale housing being so expensive,” he says.
Even in a sector positioned to weather the downturn, there will be winners and losers. When the recession comes, the skill will be the most important factor in determining success, according to Severino. “Companies will rely on skill—picking, buying, financing and managing properties—to succeed,” Severino says.
The good news is that those who succeed in the worst of times are often set up for success when the economy improves. “The most successful people I know in real estate made their way in times of trouble,” Severino says.
As supply fills up some major cities, secondary and tertiary markets are thriving.
As cap rates have fallen in the major metros over the past decade and more money has moved into the apartment sector, investors have begun looking to markets they wouldn’t have considered in the past.
“We have groups of investors who want to invest in secondary markets, and now they’re even looking at tertiary markets,” said Alexandra Jackiw, CAPS, COO at Hayes Gibson Property Services at the session “Does (Market) Size Really Matter?” at Apartmentalize this past June in Denver.
But these markets come with risk compared with larger cities. “Tier-one markets have great economic diversity and less exposure,” says Alan King, Managing Director and President, Property Operations, at Berkshire Residential Investments.
Many smaller markets often rely on one employer. If that company downsizes or closes shop, the ramifications can be felt throughout the area.
“One of my former employers bought a 324-unit property in Peoria [Ill.],” Jackiw says. “The day we took over, Caterpillar announced a reduction in workforce. We had 60 apartments occupied with their employees.”
But even with those cautionary tales, Jackiw sees why investors are clamoring for apartments in secondary and tertiary markets. “Secondary markets are less prone to big shifts [when the economy turns] than primary markets,” she says.
Secondary markets are also usually less prone to having huge amounts of supply. In contrast, King cites concessions of two and a half to three and a half months in Houston and South Florida.
“I’ve seen a lot of new construction in high-profile submarkets,” King says. “The absorption has been tough in some of them, such as Houston and Charlotte. In the worst of these [places], concessions have impacted the A-minus and B-plus markets.”
As that supply hits some large markets, a lot of smaller markets are posting staggering rent increases.
“In 2018, national rent growth was 3.3 percent,” Jackiw says. “The secondary markets had astronomical rent growth.” In Midland–Odessa, Texas, for example, rents rose 21 percent in 2018, according to Jackiw.
That market isn’t alone. “The secondary markets across Texas are doing well,” says Hugh Cobb, a Partner and one of the Owners of Alpha Barnes Real Estate Services
If these markets continue to thrive, developers will find their way in. Alpha Barnes recently opened a project in Frisco, Texas—roughly 30 miles north of Dallas—that’s renting 40 units a month.
“Building Class A products that are well located in small markets is a very strong business model,” King says.
When going into smaller markets, Cobb says investors and developers need to be on the lookout for permanent job drivers, such as Walmart distribution centers, prisons and colleges and universities.
But there are also hazards awaiting developers in these markets. “Secondary markets see developers with deep pockets as a way to add streetlights and other things,” Jackiw says.
Despite the concessions, there’s still a lot to like about big markets. “The tier-one markets are getting population growth,” says Jordan Brooks, Analytics Specialist at ALN Apartment Data. “The others are stabilizing or declining.”
The main reason for this is jobs. “Tier-one markets have diverse job drivers,” King says.
King adds that outside of some high-profile problems in markets such as Houston, Dallas and Charlotte, absorption has been strong in most large markets.
“In our revenue management system, we saw the best four-month lift through May that we’ve seen in any four months since 2013,” King says.
Apartment deal volume set a record in the first half of 2019, but rent control poses valuation issues moving forward.
Driven by strong growth in secondary markets, apartment deal volume posted record highs and topped total commercial property sales growth statistics for the first half of 2019, according to Real Capital Analytics (RCA).
In all, $80.5 billion of apartments sold in the first half of 2019, beating the previous first-quarter record set in 2016. More than half of that volume, $43.2 billion, occurred in Q2, which posted a 19 percent year-over-year (YOY) increase and 7.3-percent YOY price change.
“Record highs this late in the economic expansion are all the more meaningful given how the market achieved this level of sales activity,” RCA said in its “US Capital Trends” report. “Back in 2016, the combination of portfolio and entity-level sales were [the foundation] behind 29 percent of all deal volume in the first half of the year. In 2019, only 23-percent of sales volume was tied up in megadeals.”
Only 2 percent of 2019 sales were entity-level deals (sales of entire companies), compared to 4 percent in 2016. Sales of individual assets, which RCA calls the “bedrock” of the market, struggled in Q1, but rose in Q2.
“It [the interest in single assets] is people making a decision one building at a time that, given all the other investment options; apartments are the place to be,” says Jim Costello, Senior Vice President at RCA.
The RCA CPPI, which tracks apartment value, increased 7.3 percent in Q2, compared to 11 percent a year earlier. Partially driving down prices was the performance in the six major metros: Boston, New York, Washington, Los Angeles, San Francisco and Seattle. The RCA CPPI only rose 4.5 percent YOY in those markets, versus an 8.3 percent gain in secondary and tertiary markets.
Cap rates averaged 5 percent in the six major metros in Q2, which is a 20-basis point increase from a year ago, according to RCA. “The increased deal volume in Q219, along with the cap rate movement, suggests that owners have capitulated a bit on price expectations,” RCA said in the report.
RCA determined that cap rates were up in 11 out of the 15 submarkets that are within the six major metros but increased in only 15 out of 43 remaining markets in the non-major metros.
“People are looking at some of these [six major] metros and making the decision that, given rent control and a host of other factors, they are just stepping back from their [return] expectations,” Costello says. “There is a little bit of uncertainty around what’s going to happen to the rents and apartment income of these markets.”
Dallas led the way in deal volume for the first half of the year, followed by Phoenix, Los Angeles, Atlanta and Houston. Manhattan, which had held the top position for years, fell to No. 8 on the list.
“Again, cap rates are extremely low and a change in rent control regulations have chilled investor optimism [in New York],” RCA wrote in the report.
New rules cap cash for rehabs, guts underlying asset values.
One-third of the apartments that make up New York City’s residential real estate market—valued at more than $2.6 trillion as a whole and worth as much as the gross domestic product of the United Kingdom—just lost 20 percent of their value.
That’s the consensus of apartment market watchers who are trying to quantify the fallout from New York’s recently passed rent control measures, which dramatically limit the dollars owners can spend on renovations at rent-regulated buildings, and thus how much they can increase rents to enhance the value of their assets.
“The law disincentivizes owners from making improvements at their properties because they can no longer recoup those costs through increased rents,” says Robert Dremluk, a real estate attorney and Partner at law firm Culhane Meadows.
That, in turn, is pummeling the valuations of properties caught in the crosshairs of the new rules.
While it will take time for transactions to emerge and actual price discovery to occur in the market, “you’re looking at devaluation of at least 20 percent, or more,” says Paul Mullaney, Senior Loan Originator at New York-based Pembrook Capital, which provides bridge financing to multifamily rehab projects. “Cap rates are going to rise from the 3’s to the 5’s. That’s an enormous value erosion.” (In rental housing arithmetic, when capitalization rates go up, prices go down.)
That stark downward revaluation is happening now because rent control puts one of this industry’s most successful and fundamental investment strategies – value-add rehabilitation – in its crosshairs.
With value-add rehab, buyers seek underperforming buildings with deferred maintenance where rents are currently low. They buy those buildings, make improvements, and then raise rents to reflect the higher quality living standard they’ve built into the apartments. It’s a foundational strategy for rental housing improvement that’s now been eliminated for New York’s 1 million rent-regulated apartments.
Scenarios such as this could play out nationally in any markets that pass rent control legislation.
“Owners who bought rent-regulated buildings that had low rents and the potential to raise them by making improvements don’t have the incentive to add value anymore,” says Jamie Heiberger Harrison, a real estate attorney and President of real estate law firm Heiberger & Associates. “There’s just no more room to grow.”
No More Improvements in Stuy Town
One major institutional apartment owner already announced it won’t be making any but the most-needed fixes at Stuyvesant Town and Peter Cooper Village apartment community. An iconic landmark of affordable housing in Manhattan originally championed by New York power broker Robert Moses and built after World War II to house returning GIs, the 11,000-unit community was purchased by the Blackstone Group in 2015 for $5.3 billion dollars.
But according to Crain’s New York, Blackstone is now halting any improvements it had planned to make at the community. “In light of the recent legislation, we are in the process of evaluating capital investments at Stuy Town,” a Blackstone spokesperson told Crain’s.
It’s also not the only example of plans to improve the city’s housing stock that has been cut at the knees by Albany’s rent control package.
“We have clients who were already under contract when rent control passed and who are now going back to try to renegotiate those deals, because the original numbers just don’t make sense anymore,” says Mullaney.
Squeezing Investors Out of New York
Together, the new limits put a squeeze on two interrelated measures of rental housing worth – net operating income and net asset value – at rent-regulated buildings. The result is a real estate environment that just two months ago would have been unimaginable in New York: Real estate investors reportedly leaving the Big Apple for locales like Cleveland to put cash to work.
“Investors who would typically be buying and developing properties in the New York metropolitan area are looking to Texas, Florida, Cleveland and other markets to put their money into residential properties there,” Dremluk says. “They’re abandoning the New York market because they don’t think they can make money here anymore.”
What Rent Control Does
The changes, passed in June, limit how much owners of rent-regulated apartments – or approximately 1 million of the 3 million total units in New York – can invest and recoup for improvements at their buildings.
Previously, upon vacancy of a unit, owners could make improvements and then increase the rent by as much as 20 percent. If that pushed the rent over a certain threshold, the apartment could then be de-regulated, and return to being classified as a market-rate unit.
But the new rules eliminate that provision, as well as the 20 percent vacancy bonus, while limiting how much owners can spend on improving individual units to just $15,000 over 15 years.
Previously, there wasn’t a cash limit on upgrades, and owners could raise rents by 1/40th of the cost of improvements in buildings with less than 35 units, and 1/60th in building over 35 apartments. Those ratios now change to 1/168 and 1/180, respectively, under the new rules.
“You can do paint and carpets for $15,000 in New York,” Mullaney says. “It doesn’t buy a lot.”
For major capital improvements that affect an entire building – such as common area renovations, a new roof or central air conditioning system – owners previously were allowed to increase rents by as much as 6 percent per year for all residents to recoup added costs. But that type of increase is now capped at just 2 percent per year.
For owners who want to forgo running rental housing altogether and convert their building to a co-op or condo, the new rules made that significantly harder, too: Owners will now need 51 percent of residents to sign off on a proposed conversion, versus 15 percent under old rules.
“Having worked on many of those transactions during the last 20 years, that is an extremely high threshold,” Mullaney says. “If you need 51 percent of tenants, you’re basically not going to see any more co-op or condo conversions in New York.”
Bronx and Harlem: The Ghost of the 1970s
The result, say apartment financiers and dealmakers, is likely to be a calcified deal market – Bloomberg is already reporting sales at a standstill -- where owners of rent-regulated buildings stop investing in anything but the most basic and immediate maintenance needs required by law, such as health and safety issues, leaking pipes or clogged drains.
“The unintended consequences of this means the quality of the apartments is going to decline due to deferred maintenance or a lack of incentive to improve them,” Dremluk says. “These buildings are going to get worse.”
The final outcome, many say, could be a return to 1970s-era images of hollowed-out buildings in disrepair, especially in the Outer Burroughs – the very circumstances that led to prior reforms to allow owners to make improvements to buildings and raise rents in the first place. “The Bronx was finally getting better, and now it’s going to fall apart,” says Heiberger Harrison.
Adds Dremluk, “We may go back to what Harlem looked like 20 years ago.”
Forcing Owners to Sell
Aside from owners pulling back on improvements at their properties, the changes could also have some drastic effects on deals that have already been done.
For instance, in a typical rehab deal, a borrower might be able to secure as much as 65 percent to 70 percent of an asset’s value to buy it and make improvements.
Those loans are typically made by short-term bridge lenders, who hold the note at a higher rate until the improvements are done, usually two to three years. Then, when owners raise rents and increase the value of the asset, they can seek permanent re-financing on the building at a lower interest rate and lower loan-to-value (LTV) ratio based on the new, higher valuation of the property.
But with that mechanism now effectively dismantled by rent control, many owners who recently went into rehab deals are now sitting on short-term debt that will eventually need to be paid off. Whether they’ll be able to secure longer-term financing without getting a boost in asset value from improvements is anyone’s guess.
“For portfolios that were acquired using short-term, floating rate debt, my feeling is they may have a very hard time refinancing or getting out whole, without forcing the owner to sell,” says David Eyzenberg, President of New York-based investment bank Eyzenberg & Company, and a finance professor at New York University’s Stern School of Business.
Indeed, market jitters over existing loans already played out when rent control was first announced in June. Immediately after the new rules were adopted in Albany, several community banks that lend to apartment companies saw their stocks take a hit. The reason why, observers explain, is because the basic premise behind the existing loans on banks’ books had effectively been erased overnight when values on underlying assets tanked.
“The senior lender who was at 65 percent leverage may find themselves at 85 percent to 90 percent leverage when these deals trade,” Eyzenberg says. “They’ll make it out, but at a similar or worse LTV than they signed up for. That’s why the banks take a hit. There’s now a heavy preponderance of these loans where there’s no clear view of how you’re going to exit in a better position than you are in today.”
That means, just like the owners who took out the loans, the banks who made them may have a hard time finding another, long-term lender to replace them in the deal stack. Much like single-family homeowners who were unable to re-finance subprime teaser mortgages when housing collapsed in 2008, rental housing owners of these assets could now be in the same spot.
Cash Buyers, Less Lending
Going forward, that means banks are likely to lend less, based on an asset’s existing cash flow, or only at rates that won’t be sustainable for apartment owners.
“Instead of being able to get a 70 percent loan to value, you’ll only be able to get a 50 percent cost to loan,” says Mullaney. “There just won’t be any cash flow there to underwrite.”
That means owners – if they enter into new deals – will need to make up the difference with so-called “hard” money at higher rates.
“If you are used to borrowing 70 percent of your costs at 3 percent interest, now you can only borrow 50 percent of your costs at that rate,” Mullaney says. “You’ll now pay 9 to 12 percent for the financing that covers the portion of the loan from 50 percent to 70 percent of LTV. Your blended rate is going to go up significantly.”
The outcome of those deals would likely be cash buyers taking out assets at depressed values, and then simply managing the existing cash flow, without making any improvements to the property.
“Cash-rich companies will come in and scoop it up at 60 percent of the value of the building, and say take it or leave it,” says Dremluk. “It turns the process of valuation into a situation where you have a focus on just the cash yield of the property. The business will turn into just managing occupancy.”
Beyond New York City, the real concern now is that other cities in New York State will adopt similar rules, which is an option under the new law from Albany. Owners groups are currently fighting the new regulation in court.
“They left the window open that this can creep into other markets where it’s not currently enacted,” Eyzenberg says. “This could spread.”