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Seven Big Issues for 2018: Apartment Executives Weigh In

Apartment Executives 7 Big Issues
January 2018

Even after more than half a decade of enjoying strong growth and robust fundamentals, apartment executives still have a lot going for them as they begin 2018.

“There are some very favorable demographic trends that will continue to support stable growing demand for apartment housing, so we will continue to have a lot of good underlying fundamentals for our industry that give me cause for optimism,” Eric Bolton, CEO, MAA, says.

Those strong industry trends are boosted by favorable macroeconomic factors. 

“Monetary policy is pretty stable and predictable,” says Greg Mutz, Chairman and CEO of AMLI Residential. “There is still an abundance of capital, searching for quality and yield. Growth rates are ticking up. The national economy seems solid and steady.”

Despite these seemingly strong indicators, the apartment industry’s executives harbor many worries, whether they stem from market factors, government overreach, disruptive technologies, scarce labor or frothy apartment valuations. The view of 2018 is not all negative: New technology, an ever-evolving offering of amenities and a new marriage of office and apartments will showcase the industry’s potential this year. 

Following are the thoughts of a wide range of executives from companies of different sizes and areas of the country. They have identified seven critical issues that will define the apartment market for 2018.

1. The Labor Crunch

With 99,393 apartments, Eric Bolton, CEO of MAA, began 2017 as the largest apartment owner in the country. Even as the head of a large public company, he knows success is not ultimately determined by how well a deal is financed or built.

“The most important variable driving success onsite is the quality of the people who are working on the frontlines, providing service to our residents,” Bolton says. “If you do not get the onsite staff right, good performance will be challenged.”

Entering 2018, with the unemployment rate at 4.1 percent and expected to drop further, finding and keeping people who can take MAA’s systems, processes and tools and drive value for investors at the site level is a loomingchallenge for Bolton.

“In this environment, where unemployment rates have continued to come down and new apartment construction has picked up, and you have a lot of developers reaching out trying to staff these properties, they are naturally going to go to some of the bigger companies that have more robust employee training programs and try to poach their employees,” Bolton says.

“One of my areas of significant focus going into next year is to continue to think about the things that we are doing to motivate and reward our onsite associates for doing a great job.”

Bolton is not alone.

Jay Hiemenz, President and COO of Alliance Residential Company, says “talent and training” are his biggest onsite concerns in 2018. The issue is more acute in high-delivery markets.

“There have been 90,000 units built since 2012 in Houston,” Ken Valach, CEO of Trammell Crow Residential (TCR), says. “That is 300 new apartment communities with 300 new staffs and property managers. Finding the people, training them and getting 

them up to speed is a real challenge.”                         

In this real estate cycle, superstar managers who specialize in lease-ups are so much sought that they can practically name their own salaries.

“The bench is not 10-deep for high-quality community managers,” Mutz says. “Companies are bidding up the salaries and comps for really good community managers and the top maintenance guys. In addition, most service technicians can leave for a job in the construction industry, which usually pays more, even though it is more of a boom or bust job.”

Gables CEO Sue Ansel says the search for top-notch onsite staffers is uniquely difficult.

Adds Camden CEO Ric Campo, “Wage pressure in maintenance positions and shortage of construction workers is biggest onsite challenge.”

Ultimately, a tighter market for labor in any property management position adds expenses.

“Out of controllable operating expenses, payroll comprise about 50 percent,” says Valach, who relies on third-party managers to run TCR’s communities. “No matter what you put in the pro forma, you have to pay up to get the best people.”

2. Picking the Right Technology

Advancements in business intelligence, artificial intelligence, back office technology, home automation, package storage and many other innovations are giving apartment operators more and better options. It also leaves them with the quandary of choice.

“There are so many new and interesting technologies that are available,” Ansel says. “The biggest challenge is to select the one or two solutions that will have the greatest effect on what you are doing with the least amount of disruption, because managing platform changes can be costly.”

Gables is nothing if not ambitious. The Atlanta-based firm is piloting many enterprises backed by new technology, including property management software, learning solutions, sustainability initiatives, associate recognition and resident rewards programs.

But what really intrigues Ansel are technologies in development, such as blockchain technology, which she thinks could revolutionize back office functions.

For Campo and Bolton, technologies offering remote access to apartments could be a differentiator for their portfolios.

“We are increasingly thinking about home automation and how technologies can allow renters to take greater control of their home when they are not there,” Bolton says. “It could be through apps on their phones that allow them to lock and unlock doors, or turn on and turn off lights, set the temperature and monitor their home. 

Operators additionally see these technologies as a way to cut energy usage. But it is possible to go too far. With tech giants such as Amazon, Apple and Google offering competing smart-home products, AMLI is carefully letting peers take the lead.

“The technology is changing so fast,” Mutz says. “We don’t want to hard-wire for a lot of stuff that will be obsolete in two or three years.”

The apartment industry is aiming to be more progressive with its design and construction methods. Emerging design trends include flexible floor plans with movable walls, which allow apartment owners to turn one-bedroom homes into a two-bedroom model, depending on market demand.

In construction, modular systems such as creating kitchen and bath areas offsite and installing them as one piece, can reduce time and costs and in turn, make rents more affordable.

“If you can change the speed at which you deliver something or change the cost to build it, affordability will improve,” Ansel says.

3. Coexistence with Airbnb

In 2017, Airbnb frequently found itself in the headlines. Whether it was litigation with Aimco or launching its own, new community in Orlando, the short-term rental provider was a steady disruptor.

Airbnb has come to some agreements with apartment operators such as Veritas Investments in San Francisco and Virtu Investment in Denver, which allow its residents to list their apartments on the website; however, not all executives welcome Airbnb’s business model.

“We do not want Airbnb in our buildings,” Mutz says. “We are worried about [short-term guests] changing the culture and dynamic of the property and the amenities. We are a strong ‘No’ on Airbnb. If our residents are caught listing their apartments on that site, their lease is terminated.”

Others see the potential for the home-sharing service.

“I believe Airbnb will become part of the rental housing industry, but not until they can address the liability side of the equation, do a better job with qualifying and screening guests, have a legally binding relationship with the occupant and have its occupants better adhere to community rules,” Hiemenz says.

Ansel says management can take steps to maintain peaceful coexistence. For example, some put decibel meters into apartments to measure whether noise reaches inappropriate levels.

“I know folks who are doing things such as allocating one floor of a community to Airbnb [to help create a buffer],” says Ansel. “I think people will find a happy medium at some point.”

In high-cost markets, communities that allow Airbnb could have a competitive edge in luring residents who want the chance to earn extra income by subletting their apartments.

“We have to be open-minded because short-term rentals are becoming more popular,” Valach says. “As a firm, we need to figure out how to make it work.”

Bolton says the Airbnb model is here to stay.

“It’s likely it will be accepted over time,” Bolton says. “It will be more prolific in the bigger coastal markets that tend to attract more tourism and more of a short-term resident profile. Given our footprint, we do not expect to see a significant amount of demand for that sort of rental need.”

4. Amenities War Intensifies

The amenities war heated up in 2017. And with blow-dry bars in Dallas communities (TCR) and art and recording studios in California properties (Camden), there doesn’t appear to be a ceasefire in sight.

Valach says greater amenities cater to residents who “want to be by themselves with others.” Better defined, they are residents who want the privacy of a one-bedroom home, but the perk of having the flexibility to socialize within their community.

“We find that the number of renters wanting an ability to get out of their apartment and socialize more with their neighbors is increasing,” he says. “We are doing all we can to try to encourage that type of behavior. We see venues being designed to encourage residents to socialize.”

The demand for socialization can be greater among residents who work from home. To meet that need, Gables is focusing on more cross-functional areas, such as a Denver development where it installed a combination bike room-coffee bar.

Ansel says Gables also is converting spaces such as its movie rooms into more flexible space that can be used for meetings, work areas and gaming areas.

It’s even better if those areas are positioned outside. Alliance recently installed an outdoor kitchen with a Neapolitan wood fire pizza oven in one of its Orange County, Calif., communities.

“This is a first-of-its-kind amenity in the area,” Hiemenz says.

Beyond providing venues for relaxation, expect to see apartment operators continue to offer amenities that cater to residents’ hobbies and, of course, pets.

“The big focus is on dogs—dog washes and dog parks,” Valach says. “One Houston community had an extra acre of land so we turned it into a fabulous dog park.”

AMLI targets hobbyists (and commuters) with bike storage and repair areas in its urban locations. It is creating “maker” rooms, which are studios and workshops where residents can come together to create (or make) DIY projects.

“Where there is a preponderance of Millennial renters, the maker room is popular,” Mutz says. “Golf simulators seem to be popular in certain markets, but not everywhere.”

Ansel says movie rooms and wine storage areas have lost their appeal.

“It may be because in high-end communities we are putting wine fridges in units so there is no reason to use the common area to store wine,” she says. “Tanning beds and tennis courts and token fitness centers also have become outdated.”

Outside of the “tennis-crazy” Atlanta area, Bolton says tennis courts are becoming obsolete.

“For the most part, you see that amenity going away, particularly for urban set ups,” he says. “We are trying to repurpose some of these areas into more special settings, such as coffee bars, for more people to come together.”

5. A Model in Office (and Home) Sharing?

WeWork is a company that provides shared workspace, community and services for entrepreneurs, freelancers, startups, small businesses and large enterprises. The apartment industry is taking notice.

“The WeWork model is something that has a real future,” Bolton says. “There is demand for it and a need for it. It is up to the apartment industry to adopt that model and philosophy and bring it into our communities.”

With working space as a popular amenity for work-from-home Millennial residents, apartment owners see the potential to carve their own WeWork space on a smaller scale.

“We are trying to create a WeWork environment by offering business centers and more elaborate work areas that feature strong Wi-Fi connectivity and that provide coffee and refreshments for the residents,” Bolton says. “These venues have work stations that are portioned off to create that type of environment.”

AMLI is incorporating four or five single office spaces in some of its communities. The company leases them to residents who may need them for workspace or meetings. Mutz says these spaces have appeal in communities with approximately 300 apartments or more.

“[Nonetheless], we don’t want to get into the office space business,” he says. “It is an amenity. It is not a big money driver, and there is expense keeping the space clean and rented.”

Valach has spoken with companies that are building mixed apartment-office sharing communities in Houston.

“It is like a WeLive where residents get priority to use the space, but non-residents also may access it,” he says.

In some cases, WeWork is pairing its office space with WeLive, co-living buildings. With shared amenities such as a chef’s kitchen, laundry room, arcade and yoga studio, these developments have been described as dorms for adults.

Bolton is skeptical of the WeLive model.

“The WeLive model has a tougher future,” Bolton says. “At the end of the day, people would prefer more privacy than not. The only way the WeLive model takes is if you can create opportunities in expensive housing markets where you can offer a location that combines shared living space and offer it at a price that is much less than what they would otherwise have to pay to be in that area.”

Ansel and Valach agree that WeLive can work best in pricey New York and San Francisco metros.

6. Will Values Ever Fall?

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, 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.”

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 prices. Mutz 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 oin 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, TCR, which 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 some sort of new economic cycle, 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.

7. Volatility in the Year Ahead

With single-family housing beginning to tick up in some of his markets, rising construction costs and a tighter labor market, Mutz predicts 2018 will be more challenging than at any time over the past seven years. Nonetheless, he is optimistic about growth in the over-fiftyfive crowd’s interest in renting.

“We have been on a long run,” Mutz says. “Basically, the best run of my entire career. We are projecting that our same-store results will rebound a bit in 2018 over 2017 but clearly will be less than the strong increases in the 2012-2016 years. Our margins on development are coming back to Earth. 2018 is going to be a more challenging year. If you are trying to put together a strategic plan, you need to think longer and harder to generate attractive growth and margins.”

Others see apartment demand moderating in the coming years.

“I think the biggest issues are how the economy performs, job growth levels and rising interest rates in a slowing rent-growth environment,” Campo says.

Rising construction costs, especially in a slow rent-growth environment, can cloud the picture. If costs are rising at 1 percent per month, as Valach says they have in California, it makes new deals harder to pencil out.

“How can we guarantee construction costs if we have a two-to-five-year entitlement?” Valach says. 

New supply, a common worry among owners over the past few years, and finding new deals concerns Dunn.

“The increasing amount of investment capital that has been attracted to the space is putting pressure on securing opportunities,” she says. 

Increasing prices are another worry.

“Pricing is very frothy, investor capital is plentiful—particularly on the value-add space,” Hiemenz says. “You have to be careful to select projects that you really believe can achieve your renovated rents, and that the capital deployed is really accretive to your return.”

Beyond the typical ebbs and flows of a peak (or past peak, depending on who you talk to) apartmentmarket, is a less controllable issue—the situation in Washington.

“The dysfunction in Washington is a concern,” Bolton says. “To the extent that we start to get a lot of disappointing news out of D.C. and a lot of the actions that we are hoping for don’t occur, you could see the business community and the broader economic engine pull back a little bit.”

Lowry shares Valach’s and Bolton’s concerns about Washington, and also casts his eyes on local governments.

“The continual intrusion and interference of regulatory groups and the rise of local municipalities and state governments interfering with business operations with new laws worries me,” Lowry says.

Need an example? Look to California, where the effort to repeal Costa-Hawkins, which prohibits rent control on post-1994 apartment communities, is gaining steam.

“If it gets on the ballot and passes, which cities will then enact rent control and how it will look?” Valach says.

Beyond, slowing rents, jacked-up construction and acquisition prices and meddlesome local governments, is there anything else to be concerned about? Valach certainly thinks so.

“I worry about the unknown,” Valach says. “Some say it could be student debt and car loans and others say the Fed has to tighten monetarily. Our strategy is to develop the best risk adjusted projects we can find. Long term, that strategy has worked well.”

Les Shaver, Senior Manager of Content for NAA.