Multifamily

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SUMMARY  

As we enter into 2019, multifamily demand continues to be robust as we follow a record-breaking year for sales volume. Now 10 years into the national economic expansion and eight years into Oklahoma City’s apartment expansion, the question becomes how long will the expansion continue.  The Federal Reserve has been addressing potential inflationary pressure created by wage gains and increased trade protectionism with raises of short-term interest rates and quantitative tightening. The efforts, however, have run into the stubbornly low 10-year Treasury that has not responded to the Fed’s prodding. Yet there have been no alarming signs of inflation and unemployment claims continue to stay at record lows. So low that there have been challenges in the employment sector on the management side of housing. Although down in January, consumer confidence remains high, and new home construction coupled with rising home values all provide positive indicators on our overall economic health. The US Homeownership rate increased slightly from the 2017 level of 63.9% to 64.4% as of the third quarter 2018. The shortage of single-family homes, particularly starter homes for first time buyers, is likely to prevent large increases in the homeownership rate over the next few years and continues to drive strong demand in the rental market. Oklahoma City’s population continues to grow, albeit not at the same pace as our neighbors in Dallas, with a net gain of just over 10,500 between 2017 to 2018. Of the 511,242 metro households in 2018, approximately 24% were age 20-34, which is considered the prime renter, with a higher level of education and additional disposable income. This age group is expected to continue to expand in the urban core, mainly attracted by the various revitalization efforts from the city, county and state. With a combination of $2 billion in public investments in quality-of-life projects, combined with infrastructure investments of $2.4 billion and private investments of another $4 billion, Oklahoma City has reason to be excited about it’s ability to retain young talent.

Debt financing for apartment assets remains widely available, with sourcing led by Fannie Mae and Freddie Mac in addition to a wide array of local, regional and national banks and insurance companies. Loan-to-value (LTV) ratios have tightened, with maximum leverage typically in the 55 to 75 percent range depending on the borrower, asset and location. Fannie Mae has limited their exposure to Oklahoma and require all loans to be on a pre-review status prior to approval, which ultimately will limit the LTV on most transactions unless with preferred borrowers. Lenders have been reluctant to lend on future revenue growth through value-add efforts, resulting in increased use of short-term mezzanine debt and bridge loans until improvements deliver the planned returns.

Apartment sales volume have reached historic levels  should carry into 2019 as new capital enters the multifamily investment market. Recently passed tax reform, included the creation of opportunity zones, create the potential to draw new capital into multifamily assets. This influx of capital could offset any slowing of sales from the maturing growth cycle and add to the already-strong base of investors in the multifamily transaction market. Clearly the expansion must come to an end at some point, but with this type of legislation and tax reform, this could give the market a second wind.

Oklahoma City experienced another solid year in terms of multifamily rental growth and 2018 occupancy was virtually unchanged from the end of 2017. We surveyed 74,490 market rate units across 341 properties and arrived at an average renal rate of $0.90 per square foot per month for the Oklahoma City Metro Area. This was a 2.27% increase over the previous year, bringing the five-year historical rent growth average to 2.38%. Although it’s always good to see positive rent growth, this is below the historical average Oklahoma City has experienced since Price Edwards & Company started tracking the market in 1989, 2.85%; however, it does mark the 21st year of consecutive positive rent growth.. In addition to positive rent growth, 2018 experienced an overall decline in concessions of 18% to a current market average concession of 1.7%.

The biggest gainer overall on rent per foot was the efficiency units climbing to $1.15 per square foot from $1.11 which accounts for a 3.6% bump year-over-year. Followed by three-bedroom units at $0.82 per foot, a 2.5% increase from the previous year. One and two bed units leased for an average of $0.95 and $0.83 per foot respectively, an increase of 1.06% and 1.22% annually.

Overall Class A rents reached new levels at $1.21 per foot across the metro area.  Class B and C properties had an average per foot rental rate of $0.99 and $0.79 respectively.

Over the course of 2018 the market absorbed a total of 1,199 units yielding a market average occupancy of 90% at year end.

 

New Construction

New construction in Oklahoma City has been a large part of the discussion for the last several years; however, going into 2019, new deliveries have declined for the second year in a row. With only 1,199 units coming online in 2018 and even less scheduled to open in 2019, (1,024 units currently); the question becomes how many of the roughly 2,500 units in the planning stages will come out of the ground. Lenders have become more cautious to lend on ground-up construction; even coveted HUD loans have become more allusive in this changing market. Other sources have started to step up and provide liquidity; however, when you have rising construction costs and lower debt to cost ratio, developers may deliver lower returns to their investors. It’s likely that a boost in rent growth will be needed to spur any more serious construction activity, otherwise the development pipeline is likely to continue tapering off.

While average rents trended upward in 2018 (1.64% for Class A assets), tightening is expected this year as development slows and absorption takes renters off the market. Although hardly on a downward trajectory, overall confidence in the multifamily market for 2019 is best described as cautiously optimistic. Newly constructed properties have reported a slowdown in leasing activity combined with a slight increase in concession activity. While construction activity slows, the question is whether the slowdown is just a taper off after a peak in deliveries or is there a larger fundamental problem.

New construction in 2018 was a mixture of luxury urban housing, suburban market rate housing and student housing. Cross Neighborhood Apartments was delivered in Norman this fall adding 412 units to the already saturated Norman student housing market. This student housing community is located directly adjacent to campus, and in a great location to potentially weather the storm that is likely to hit Norman’s student housing over the next couple years. Back in the urban core, Steelyard completed and opened their Phase II adding an additional 97 units to the only for rent property inside the Bricktown Entertainment district. Reported at 89% occupancy, the property’s location appears to be a success particularly with the younger millennial demographic.

One other property worthy of note is the 286-unit Crown Lone Oak Apartments in far north Oklahoma City. Located right off the expansion of Portland avenue, Crown Lone Oak was built to take advantage of an urban style property with the suburban location due to its close proximate to numerous jobs in the Quail Springs area.

There are a few projects still under construction with two getting the most attention. First is the $200 million renovation of the historic First National building, once a crown jewel of Oklahoma City’s urban core. Local developer Gary Brooks and partner Charlie Nicholas have taken on this large iconic project.  These are expected to be top of the market luxury apartments with rents to match.  On the west end of downtown is West Village. In a partnership with local family investment company, Hall Capital, local developers are building a high-end urban apartment project that plays off the nearby hotel, restaurant and concert venues.  

 

Sales Summary

Strong investor interest in the multifamily sector has led to an extended peak in multifamily sales activity. Pricing continued to appreciate through 2018, although only slightly on a year-over-year basis. The overall price-per-unit increased 1.1% to a current average price per unit of $50,174, or 19.5% above the five-year average. Touting a record-breaking year, overall transaction volume consisting of 25 units and more reached a record $463 million, 21% over 2017. The 57 transactions consisted of 9,230 units, which is second only to 2007’s peak of 9,791 units. The overall occupancy of the transacted properties was 90%; and the average increases to 96% when removing distressed transactions. The average rent across all properties transacted was $0.77 per square foot, with an average concession of 1.7% at the time of closing.

Overall transaction activity was up across all asset classes with Class A transactions totaling $84.5 million for 2018. The three Class A transactions had an average price per unit of $121,847, which was down 37% from the previous year.  The average in 2018 is a better indication of the overall average as 2017 included the Metropolitan, a downtown new construction luxury product.  One notable transaction was Millennium OU which is a 196 unit, or 698 bed student housing property in the Norman sub-market. Although student properties are leased and sold on a per bedroom metric, for the purposed of uniformity, it was calculated on a per unit basis in this report. Millennium OU sold in mid-2018 for $25.2 million, which was likely less than its construction cost. The lower than expected sales price is likely an indication of the overall health of the student housing market in Norman due to the oversupply of luxury housing on or very close to campus.

Class B assets are often the least frequently traded asset of any of the classes due to the fact there are fewer of these properties in the market. Due to the construction ages and market cycles, Class B assets make up only 18% of the overall properties in the market. In 2018, there were a total of 6 transactions consisting of 1,287 units making up a total sales volume of $113 million, a 30% increase in volume from the previous year. This averaged a price per unit of $87,906 which was up 15% from the previous years average. Of the Class B transactions, there was one that should be noted called Commons on Oak Tree which sold for $17 million in the third quarter but was considered a non-arm’s length transaction. Another notable transaction was Pebble Creek in Mustang. Due to limitations on new construction as well as strong operating fundamentals, the Mustang sub-market is considered a highly desirable area with very little transaction activity. Pebble Creek traded for $19.75 million, or $102,864 per unit.  

As is the case every year, the most active asset class was Class C apartments with a record year transaction volume of $262 million. This was a 21% increase over the previous year. The 6,945 units had an average price per unit of $38,847. One of the largest Class C transactions of the year was the Highlands, which consists of two properties that have been owned and operated as one for many years. Weidner Properties acquired The Highlands early in 2018 and instituted a large-scale renovation.  

Class D assets had minimal activity with 3 properties transacting for a total of $3.3 million which averaged $10,929 per unit. Class D properties are those which are shut down or are virtually shut down and often either in the process of foreclosure or involve some type of major disrepair. One interesting Class D transaction was Highland Park, a 160-unit community that traded for only $4,828 per unit. The price per unit may be a surprise, but the complete vacancy and extensive renovation needed to cure helps explain the price. Highland Park is already on the market again, albeit at a premium to what it was previously traded for.

As multifamily yields have compressed, an increasing portion of capital acquiring larger assets has migrated to secondary and tertiary markets looking for a higher yield. This has had a direct impact on Oklahoma City as evidenced by the volume of apartments priced over the $15 million mark increasing to $285 million, representing 12 transactions, second highest only to 2015. This increase is a combination of flight to quality as well as investors reaching into smaller markets to make up for the reduced yield available in primary markets.  

Multifamily cap rates have remained relatively stable on a macro level, with yields in primary markets flattening while secondary and tertiary market cap rates have continued to trickle lower. Rising interest rates, however, have tightened the spread between cap rates and lending rates, reducing investors’ ability to generate positive leverage. Though this trend could put some upward pressure on yields, elevated capital flows into apartments will likely mitigate the upward pressure. Overall Oklahoma City cap rates have increased slightly to 6.8%, which is up 30 basis points (bps) from 2017. Cap rates on Class B assets decreased by 16 basis points to 6.07% as 2018 had one of its strongest years for that class of apartments.  Class A and C apartments traded at an average cap rate of 5.7% and 7.25% respectively. These cap rates are indicative of trailing NOI, not projected or after renovation cap rates.

 

Forecast

Multifamily housing continues to remain a desirable investment for institutional investors, large investment funds, public and private REITs and private operators. The market has continued its strong pace achieving close to 3% effective rent growth for the past thirty years and is expected to continue on that trajectory for the near future. The mature economic expansion will remain supportive of the apartment investment market in 2019, though buyers’ and sellers’ expectations will likely need to adjust to a rising interest rate climate. Stock market volatility and prospects of a flattening yield curve will weigh on sentiment, but the underlying performance of apartments remain positive. Furthermore, strong demographic momentum combined with the shift away from ownership supports a long-run positive outlook should counterbalance market volatility.

While primary markets such as Los Angeles, Dallas, and New York will continue to see the largest dollar investment, secondary and tertiary markets are becoming more popular to the larger investors in their pursuit of higher yields. Many such investors have already expanded their search into Oklahoma and similar metro areas, increasing the market liquidity and boosting overall values. However, one of the main complaints echoed by many investors new to Oklahoma is the inability to increase rents on a pound per pound basis compared to other markets. With the benefits of the low cost of living, also comes a ceiling on rent increases. Whereas in markets similar to Dallas/Ft Worth, a standard five-thousand-dollar interior upgrade can often yield an instant $200 or more per month rental premium, the Oklahoma City market will not support this level of rental increase. This requires buyers to be savvier and not just invest based on pure projections, but to rely more on fundamental economics. Creative owners are looking for ways to not only increase revenue from renovation and rent increases, but also by boosting their NOI from supplemental income and effective cost management.

The biggest factor going forward for multifamily investors is their access to fresh deals and, likewise, the ability to finance with debt levels that can sustain returns needed to satisfy investors. Value-add deals are much more complicated with more risk involved for less upside.

We remain optimistic throughout 2019, but believe it is increasingly important to underwrite to current values. As households continue to form, much of the renter demand will center on apartments that serve the traditional workforce: Class B and C properties. In downtown, the first to feel the pain in any downturn will be the luxury Class A rental market. The good thing about apartments, people always need a place to live.

Forecast Bullets

  • Strong demand drivers supporting long-term yield models will counterbalance much of today’s market volatility, encouraging investors to look beyond any short-term turbulence.
  • As new households are formed next year, much of the rental demand will center on apartments that serve traditional workforce: Class B & C properties.
  • While transaction volumes reach record levels, rising interest rates will cause upward pressure on cap rates, which in turn will keep the overall price per unit relatively in check
  • Agency lending (Fannie & Freddie) to remain active well into 2019 as FHFA leaves lending caps unchanged at $35 billion for each enterprise.
  • As investors await finalizedfrom the Department of the Treasury and the IRS regarding opportunity zones, the hunt is on for assets and investment opportunities in the designated areas that present the strongest upside potential. Investors are lining up to pour billions into Opportunity Zone Funds according to Real Capital Analytics, stating there are more than $6 trillion in unrealized capital gains eligible to be deployed into opportunity zones.
  • With robust jobs growth continuing to increase at a healthy pace, and the unemployment rate at a 50-year low, Fed officials will likely continue their course of action and gradually boost short term interest rates.
  • Investors will move to markets like Oklahoma (secondary and tertiary) for solid risk-adjusted returns.

 

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