Q4 2017 Commercial Housing Trends
The housing market continues to move solidly in some respects and less desirably in others. It’s an interesting environment – investors may need to decide which factors should weigh more heavily in their investment decisions.
Might This Be a Longer-Than-Usual Cycle?
This business cycle has been one of the longer ones in U.S. history, and investors cannot be blamed for thinking that we are now in a “mature phase” of the current cycle. But cycles have been lengthening over the past half-century, and little in the U.S. macroeconomic data suggests overheating, the primary symptom of trouble ahead for a cycle.
A major factor seeing the real estate cycle extending even further into the future is the difficulty of securing construction financing. This is effectively keeping the oversupply — that is typical of a late cycle — from thus far emerging this time around. An international investment executive notes that bank regulators and new risk rules have enforced discipline on lending, a primary factor in the development slowdown.
That’s not to say that risks don’t still remain. The volume of available capital that is seeking “core properties” has pushed pricing past prior peaks in many markets. And American house prices have bounced back since the financial crisis and are above their long-term average relative to rents.
Some Declines Are Occurring — Yet Generally, Pricing is Holding Stable
After two years of record-setting volumes and $580.0 billion in transactions over the last five years, the pace of investment activity has slowed. Multifamily investment sales saw $30.5 billion of activity in the second quarter of 2017. While this figure rebounded in comparison to the $24.8 billion figure recorded for the first quarter, year-to-date volumes are 22.3 percent off the pace of 2016’s record-setting activity. A nearly 60.0 percent decline in high-rise transactions seems to be driving the volume declines.
In spite of these declines, overall pricing for multifamily apartment complexes continues to appreciate — as shown through Real Capital Analytics’ apartment property price index. The headline multifamily index has increased 8.6 percent year-over-year as of May. Non-major markets are currently driving appreciation, as the six major gateway markets (New York, San Francisco, Washington, DC, Los Angeles, Chicago and Boston) have only appreciated 7.1 percent in the past year. However, the decline of overall activity through the first six months of the year has placed pressure on pricing on select assets.
Transactions May Increasingly Focus on Suburban Opportunities
In the multifamily sector, near-term risk is somewhat elevated given the current environment of peaking rents, cresting development and asset pricing at or near previous cycle peaks in markets. As a result, some investors are adjusting their approaches with a shift toward suburban and other markets with lesser exposure to high levels of construction. The shift has caused garden-style apartment transactions to surge to represent 70.6 percent of overall activity year-to-date. And despite improving fundamentals, these garden-style multifamily assets are still trading at a relatively wide pricing discount to cap rates seen for mid- or high-rise properties, as indicated in the below chart.
The United States remains a largely suburban nation. In America’s 50 largest (and most urbanized) metropolitan areas, suburbs account for 79 percent of the population, 78 percent of households, 32 percent of land area, and—despite popular and media perception—75 percent of 25- to 35-year-olds. And from 2000 to 2015, suburban areas accounted for 91 percent of population growth and 84 percent of household growth in the top 50 U.S. metro areas.
Rental Units May Still be an Attractive Place to Be
Many observers believe that the current trends toward a “sharing” economy and millenials’ apparent de-emphasis on home ownership will continue to drive demand for rental units. PwC estimates that over half of the estimated 12.5 million net new households to be created over the next decade will rent, including people who have never owned a home as well as those who will switch from owning to renting as they age. PwC further believes that homeownership will continue to decline, with the national rate anticipated to be 60.8 percent by 2025, the lowest point since the 1950s.
And Preferred Equity Still Seems a Good Way to Play
The lower loan amounts seen in the market following the Great Recession have opened up opportunities in the middle of the capital stack. Between lenders keeping loan-to-value ratios low, and real estate companies seeking to manage the capital they put at risk, there is a need for either subordinated debt or preferred equity to fill out transaction financing.
Preferred equity seems to be the desired choice. Property lenders generally dislike subordinated loans with another lien on the property, and in times of trouble capital providers themselves sometimes don’t want to end up being members of a creditors’ committee and subordinate to a senior lender. Market participants like RealtyShares who focus on such preferred equity investments are thus often viewed as a “problem solver” in the middle of the capital stack.
Note that all of the investments offered by RealtyShares are private offerings, exempt from registration with the SEC, and the disclosures are less detailed than would be expected from a registered public offering. Ongoing disclosure requirements are negligible. The investments are also illiquid, with undetermined holding periods and no real preset liquidity terms. These offerings are also only available to accredited investors, so the illiquid nature of any investment is heightened – further emphasizing the differences of these securities compared to registered, publicly-traded securities.