While fundamentals could continue to deteriorate, apartment executives see investment opportunities.
Everyone knew that the apartment industry’s 10-year run of growth would end. What no one could have predicted was that a global pandemic would thwart the unprecedented streak of rent growth.
As COVID’s lockdowns closed retailers, restaurants, movie theaters, airlines, bars and many other businesses across the country, the layoffs, pay cuts and furloughs piled up. Owners and operators helped to bridge the gap through payment plans, waiving of fees and other creative strategies while government assistance in the form of The Coronavirus Aid, Relief, and Economic Security (CARES) Act offered Americans a desperately needed income supplement to pay for rent and other essential items.
But those funds didn’t last forever.
For the most part, the apartment industry has held up. But there were some signs that segments of the market began to struggle as the year came to a close.
Moody’s Analytics REIS says national asking and effective rents had fallen by 1.8% and 1.9%, respectively, in the third quarter. That is the largest quarterly decline since 1999 when the company began publishing quarterly data.
As apartment executives turn the page from a dreadful 2020, they are hopeful that 2021 will be better, even if the U.S. is mired in a recession.
“Apartment renting tends to be stronger in downturns,” says Diane Batayeh, CEO of Southfield, Mich.-based Village Green.
It’s hard to know precisely how occupancies will shake out in 2021. But, for those apartment firms that aren’t facing financial stress, 2021 could be a year of opportunity. They might be able to find more acquisitions and development opportunities than they’ve had in previous years. As the pandemic has driven the adoption of onsite technological upgrades, many executives expect to continue looking for ways to make their communities more efficient.
Early on, 2020 looked like another in a string of healthy years for the apartment sector.
“Coming into the start of 2020 and through the first quarter, it looked to be a strong year of growth across the portfolio,” says Sue Ansel, President and CEO of Atlanta-based Gables Residential.
But the COVID stay-at-home orders hit during peak leasing season, traditionally when the industry has the greatest pricing power. “As a result of this and the various regulations put in place to address the pandemic, there was a strong downward impact on leasing and sales activities,” Ansel says.
After problems in the spring, Ansel says the Gables portfolio hit normal seasonal levels of activities and is approximately 95% to 96% leased, and 94% occupied, similar to 2019’s numbers. But because of the pandemic’s early impact on sales, net operating incomes (NOI) will be well less than anticipated for the year.
“There is likely more pricing power in suburban submarkets than urban submarkets in general, but like all things, it is market-specific,” Ansel says.
In his portfolio, David Schwartz, Chairman and CEO at Chicago-based Waterton, says that vacancies have moved up a bit and rent growth is “elusive.”
“It’s a typical recessionary environment with soft demand,” says Schwartz. “But this recession is very market dependent. Some of these Sun Belt suburban markets are performing quite well. In the urban gateway markets, rents are going down with higher vacancy levels and lots of concessions. Collections and delinquencies are also more exacerbated.”
Pinnacle’s collections have been off slightly during the pandemic, but there haven’t been dramatic problems, according to Rick Graf, President of Dallas-based Pinnacle and 2021 National Apartment Association (NAA) Chairman of the Board. Its occupancies have held steady. [Editor's note: Pinncle has rebranded as Cushman & Wakefield, with Graf serving as President of Multifamily.]
“I think the impact has not been as significant [as people expected], but the unknown is: What are the long-term implications?” Graf says. “I get a daily report of delinquency on every property. Every month seems to be the same or a little better than the month before.”
While the pandemic hit some metros harder than others, and ongoing unemployment challenges, especially those in the service and hospitality industries, are having different impacts across apartment classes, Pinnacle hasn’t experienced significant issues with rent payments, according to Graf. “If people aren’t able to pay and they’re COVID impacted, we’ve been working with them,” Graf says.
Los Angeles-based TruAmerica Multifamily generally owns Class B workforce housing in first-ring suburbs in high-growth metros around the country. Noah E. Hochman, Co-Chief Investment Officer and Head of Capital Markets for the firm, says that it collected around 97% of its billable rent earlier in the pandemic. During the past couple of months, it has dropped a couple of basis points. Still, he says there has been rent growth in some Class B low-rise apartment communities.
However, there is a divergence depending on the state. In red states, with more liberal reopening policies, TruAmerica sees better collections and even some rent growth. In blue states, it’s a different story.
“In markets like Seattle and Portland, because of the regulatory risks that exist with some of the extensions of eviction moratoriums or the inability to raise rents on renewals, we see more deterioration of the fundamentals,” Hochman says.
Schwartz doesn’t expect a massive improvement in rents in the year ahead.
“I think 2021 will look a lot like 2020 on fundamentals,” Schwartz says. “We don’t expect material improvement until vaccines are in place. Maybe toward the third or fourth quarters, we will see a more normalized economy and more demand, particularly in these urban markets.”
Investment Opportunities Ahead
Despite questions about apartment fundamentals in 2021, many apartment investors are active and confident in the long-term.
“I think most investors see the COVID disruption as temporary,” Hochman says. “Most people believe there will be a vaccine, and we’ll get back to normal at some point, whether it’s six months or 12 months from now. The bottom line in multifamily is, COVID or not, the fundamentals won’t change. There has been a housing shortage and we have an affordability issue. That doesn’t go away because of COVID.”
TruAmerica has backed up that confidence by continuing to be an active buyer during the pandemic and is on target to reach its investment goals for the year, with the majority of the purchases made since the pandemic began. When COVID hit, transactions ground to a halt and prices fell 5% to 10%. After the capital markets stabilized, cap rates returned to pre-COVID levels, according to Hochman.
“We started seeing over the summer that the capital markets calmed down, and Freddie Mac and Fannie Mae, in particular, really stepped up to provide the liquidity in the market,” Hochman says. “With interest rates at historic lows, people were able to borrow in the 2% range.”
Interest rates should remain low in 2021, encouraging investors to make deals, even if NOI is sluggish.
“Pricing in the market for acquisitions currently seems to be quite strong,” Ansel says. “We have several communities in the market for potential disposition and so far are seeing pre-COVID pricing in spite of declines in NOIs. The impact of the low cost of debt seems to be creating an aggressive buyer pool.”
Waterton expects to be an active buyer if the pricing is right. “This is a downturn, and usually, downturns result in a good vintage of investments,” Schwartz says. “So we expect to make acquisitions as we continue through the downturn.”
These investment opportunities often arrive in the form of distressed investments. The jury is still out on how much distress the apartment industry will experience during the COVID crisis.
Pinnacle is taking over some projects that have moved into special servicing. Graf sees specific properties running into issues.
“We’ve taken on a couple of receiverships in the last month or two,” Graf says. “Most of those have been connected with a mixed-use situation where the commercial piece of it is struggling,” Graf says. “The multifamily piece is not struggling as much, but they’re connected.”
While Hochman says prices have settled in suburban markets, it’s a different story in the city. Buyers and sellers have differing ideas of what an apartment community is worth.
“In some of these urban gateway markets, there have been very few post-COVID transactions,” Schwartz says. “I would suspect it’s due to a large bid-ask spread. So I think we’ll see more of that price discovery next year, which will help the investment environment for groups like ourselves.”
Schwartz thinks Sun Belt suburban markets like Charlotte, Raleigh and Atlanta offer opportunity. “I think those could be reasonably performing markets where there’s not the distress, but it’s a good investment,” he says.
As Gables puts some assets on the market, it is finding opportunities to refill its development pipeline, which could mean more construction in 2021. Ansel expects that when these projects deliver the “markets should be in a period of strong recovery.”
“While debt is at historically low rates, construction financing has become more difficult to place,” Ansel says. “And while equity is still available, pricing and terms have increased in reaction to perceived increased risks. These uncertainties have created opportunities for some development projects to come back to market.”
COVID hasn’t just accelerated the trend of people moving out of cities. It has also hastened the adoption of technology.
“Our [owners] have been more than willing to invest in new technologies or accelerate that, whereas before they might’ve been a little slower to do that in the past,” Graf says. “I think COVID has moved the technology curve ahead in our business by at least five to maybe seven years.”
Graf was experimenting in New York City and some other major metros before COVID. “Instantly, we went full tilt boogie on virtual tours,” he said.
Schwartz saw the same momentum.
“The trend of virtual leasing is something that started pre-COVID,” Schwartz says. “COVID accelerated it, and a lot of companies, like ourselves, made significant investments and will continue to make that a better, more streamlined process and beneficial to our customers.”
Waterton also looked at other technologies before the pandemic hit, like destination-based elevators that don’t require touch. These could grow more popular in the future.
As residents have worked from home during the pandemic, they’ve used more bandwidth and put more stress on maintenance. Expect that to continue in the year ahead.
“There are a couple of technology tools that we’re adopting that enable us to boost bandwidth without a significant investment,” Graf says. “The reality is that long-term, more people will be working from home and spending more time in their apartment. So, therefore, maintenance needs, technology needs and social interaction needs have changed.”
Schwartz says Waterton will continue to make technological and innovation investments to make its properties more efficient.
“The smart apartment technology is really interesting,” Schwartz says. “Some of that includes automated lock systems. Some of that is also incorporated with more energy efficiency, like thermostats and leak detection.”
Still, there are limits to technology. While 2020 has shown that virtual leasing and apps have a place, a property cannot run without people.
“I still am a strong believer that you cannot replace human touchpoints,” Batayeh says.
Les Shaver is a freelance writer.