While insufficient returns pushed down sales in 2017, apartment prices remained healthy.
Apartment sales volume declined in 2017, marking the first year where sales backtracked since 2009, according to a new report from Real Capital Analytics (RCA).
The scope is different this time. In 2009, sales volume fell 58 percent year over year, a result of the Great Recession. In 2017, they only declined 7 percent.
Despite the decline, which was most dramatic within the largest markets, the sky is not falling, writes RCA.
“A decline in deal volume is not the same as a market collapse,” RCA writes in its report. “Prices can continue to rise even as volume falls as investors are still interested in the sector, but the volume trends suggest that they are becoming more selective.”
RCA says the pullback in volume is most likely being driven by price sensitivity among purchasers, who would like to buy, but who can’t find deals providing an appropriate amount of yield at this point in the cycle.
Even for buyers who could find the necessary yield, transactions were difficult. Newcomer Blackfin went from zero to nearly 2,000 units during the last quarters of 2017, but returns were not easy to find.
“We were able to get lucky and find five very interesting deals that were mostly off-market,” says Blackfin Co-Founder and Managing Partner Doug Root, who invests in the Mid-Atlantic, from Carolina to Boston. “It was very difficult for us to meet our return requirements on the deals that were heavily marketed.”
REITs such as Equity Residential and Essex Property Trust led the acquisition parade coming out of the 2009 recession. During the past couple of years, however their acquisitions have fallen because their stock price is trading at a discount compared to the value of their portfolios.
“It is a mixed bag within the REIT sector, as AvalonBay and MAA [which bought Post Properties and Colonial Properties Trust during the past five years] have been pretty quiet this year after a more active 2016, while Camden and Equity Residential came back to the acquisition market in 2017, after doing little [Equity] to nothing [Camden] on acquisitions in 2016,” says Conor Wagner a Residential Analyst with Green Street Advisors.
Single-Asset Sales Trends
RCA says this selectiveness from buyers manifested itself in the growth of single-asset sales in non-major metro areas. In those markets, cap rates were 150 basis points higher in Q4 2017 than in the six major metro areas — Boston, New York, Washington, Southern California, Northern California and Seattle. Except for some notable transactions, such as Greystar’s September purchase of Monogram Residential Trust, large-portfolio deals fell in 2017, even in smaller markets.
“We will simply see [fewer] companies using their capital to go after large portfolios and then slicing those portfolios up to create better opportunities through some of the individual properties they acquired,” Costello says. “Without downward pressure on cap rates, it will be harder to accomplish those types of deals.”
RCA did indicate that the 2017 sales decline was sharpest early in the year. Observers attributed the dip to market volatility after the 2016 election.
“Q1 was the slowest quarter for deal-making that we have seen in more than eight years,” Root says.
Overall, apartment transactions fell 16 percent in the first half of 2016 compared to the first half of 2016, but edged up 1 percent in the second half of 2017 compared to the second half of 2016.
The sales volume of individual assets also recovered throughout the year. After falling 10 percent year-over-year in Q1, they improved to 6 percent by Q4.
“This growth of single-asset sales could signal a bit of a plateau,” Costello says. “[Sales volume] does not need to continue all the way up or all the way down. We might be settling into a new normal for annual volume for the sector.”
A Look Ahead to 2018
Wagner does not see major changes from the REITs in the year ahead.
“We will get 2018 acquisition guidance from the REITs [in late January] when they announce their Q4 earnings, but with the group trading at an average net asset value discount of more than 10 percent, we would expect them at this point to be less active in 2018 than in 2017,” he says. “If they get a more favorable cost of capital, we could see more activity from them.”
As volume declined, values remained robust. According to RCA’s CPPI metric, prices for apartments grew at a 10.6 percent year-over-year clip in Q4 2017 after slipping earlier in the year.
“From a technical point of view, I see cap rates rising,” Costello says. “I think more deals will be seen in secondary markets and in locales that are generally less expensive. I would expect prices to continue to grow, although at the recent modest pace and not the high pace of recent years.”
While Green Street does not predict cap rates, Wagner continues to like the underlying fundamentals of the apartment sector.
“Given the amount of capital that is moving into the sector, the bias seems to be for cap rates to be flat to down as of now,” Wagner says.