SEPTEMBER 29, 2017 | BY CARRIE ROSSENFELD
Developers should build in markets that will absorb new construction pipelines adequately because, in some markets, rents are now softening as supply is exceeding demand, Buchanan Street Partners’ Tim Ballard tells GlobeSt.com.
NEWPORT BEACH, CA—Apartment developers should make sure to build in markets that will absorb new construction pipelines adequately because, in some markets, rents are now softening as supply is exceeding demand, Buchanan Street Partners’ president Tim Ballard tells GlobeSt.com. Investors looking to maximize ROI in real estate have historically considered financing multifamily developments, but Buchanan Street Partners has seen various shifts that investors must consider prior to making a deal, Ballard says.
Buchanan recently began a $50-million age-restricted, multifamily development in the Greater Salt Lake City area. The property, once complete, will meet provide upscale amenities, pleasing views and access to retail and public transportation. In addition, Buchanan Street has activated a programmatic effort to expand the company’s multifamily investment portfolio by investing $500 million in multifamily projects in three years.
We spoke with Ballard regarding the multifamily market, how he views its current state and strategies for other investors.
GlobeSt.com: How would you characterize the current state of the multifamily market, and what are your predictions for 2018?
Ballard: The multifamily market is starting to show signs of weakness in some of the major markets, but continues to attract massive capital flows. The last few years have brought a flood of new multifamily construction projects. As a result, the sector is likely to see a softening of rent growth in markets that have high deliveries. Despite increased vacancies in some of the primary markets, there are many secondary markets that continue to demonstrate strong fundamentals.
GlobeSt.com: What tips do you have for choosing the right multifamily developments for your investment?
Ballard: Make sure you build in markets that will adequately absorb new construction pipelines. Many of the gateway-city markets, like San Francisco and New York City, have seen significant new development. Rents are now softening as supply is exceeding demand. Conversely, while some secondary markets have seen less new development, we are still seeing strong population and job growth in cities like Salt Lake and Denver and are attracted to those markets.
There has been a lot of talk about Millennials never wanting to buy a home and creating product to serve their predicted demand. This has resulted in significant development of smaller units in urban environments that cater to this population. We believe there is a risk that too much of this product is being delivered. Furthermore, like every generation before them, Millennials will ultimately want to purchase homes in good school districts for their families. Many of the urban developments don’t have the benefit of desirable school districts or the environment that families will likely seek. We are also seeing a growing contingent of older renters by choice that are seeking higher-quality finishes and amenities. This has created an opportunity in improving the current apartment stock since many assets, even as new as 10 years old, do not reflect the preferences of these renters.
GlobeSt.com: How can investors increase ROI on multifamily transactions?
Ballard: Multifamily developments can be profitable investments, but there are several things investors must keep in mind. Assuming you get the big things right—location, quality asset and strong local market fundamentals that are consistent with your underwriting—it then becomes all about execution of the little things. Factors that come to mind are unit finishes and amenities consistent with tenant demand, technology integration that benefits tenants (i.e., package management, smart thermostats, security, etc.). As an example, energy-efficient upgrades not only reduce operating costs but also result in significant financial savings when using agency debt. Package management is a great example of changing needs. Today’s tenants receive many package deliveries—much more so than just three years ago. Many communities don’t have adequate ways of managing the influx of deliveries. Leasing offices are often closed when tenants get home from work or packages are delivered to front doors, resulting in an increase of theft. There are vendors like Parcel Pending that have developed innovative solutions to this growing problem.
GlobeSt.com: What are some common mistakes you see multifamily investors make?
Ballard: It’s easy to make mistakes with any investment, but there are a handful of things that are very important to get right. Is there too much capital in your target market? If so, you often see investors making unrealistic growth assumptions and “playing with the numbers” to make a proforma appear attractive on paper. Will cap rates hold? In some of the major markets where cap rates have dropped into the 4%-or-less range, a 1% increase would result in a 25% lower residual value, potentially crushing your returns.
Make sure you adequately underwrite capital costs. Often investors assume that a standard $250-per-unit capital reserve is adequate when in reality it costs far more to keep your property in good condition as well as to remain competitive.
Rents don’t always grow. The normal proforma I see has 3% to 5% rent growth forever. We are late in the cycle with a lot of new construction. I am sure that we will see periods of time over the next decade where you see a flattening of rents on a good day with a decline of rents likely in many markets during periods of economic contraction.