by Ronald G. Johnsey, President and KC Sanjay, Senior Real Estate Economist, Axiometrics, Inc.

On Wednesday, April 25th, the U.S. Census Bureau posted its March residential permitting numbers. At the national level, annual multifamily (MF) permitting is up by 47.3% from the comparable period a year ago. While this is largely a statistical increase from the market bottom, it is indicative of the drive by developers and investors to take advantage of the strong recovery in apartment market fundamentals since January 2010.

After the drop off in apartment market fundamentals in the second half of last year, we had been wondering if the apartment market would bounce back this year. Based upon our January through March results, the market is rebounding strongly–effective rental rates are up 1.81%, about the same as this period last year. Additionally, the increase in effective rental rates from February to March of 0.89% is the strongest of any single month over the past four years. The occupancy rate is up by 33 basis points (bp) from February to March, with occupancy at almost 94.0%. These numbers confirm our forecast for a strong 2012, with effective rental rates rising by 5.35%.

Where is the MF permitting concentrated? The top ten MSA’s for MF permitting for the trailing twelve-months ending March 2012 are: New York (11,336 units), Houston (10,616 units), Dallas (8,902 units), Los Angeles (7,445 units), Washington DC (6,252 units), Austin (6,067 units), Seattle (5,399 units), Atlanta (3,396 units) and Chicago (3,383 units). The bulk of the supply is being delivered into the urban core of these markets. Some of the top MF permitting places on a trailing twelve-month basis through March 2012 are the City of Houston (7,038 units); Los Angeles City (5,952 units); the City of Seattle (3,609 units); the City of Austin (3,587 units); the City of Washington, DC (3,123 units); the Borough of Manhattan, NY (3,062 units); and the City of Dallas (2,942 units). There is a graph below comparing the annual rate of MF permitting as of March 2012 to each market’s average long-term level of MF permitting from 1990-2011.

MF Permitting Continues to Increase Strongly in March

In the U.S. over the trailing twelve months ending in March 2012, annual multifamily (MF) permitting was up 47.3% (63,475 units) to 197,696 units and single-family (SF) permitting was up by 2.2 percent (9,233 units) to 429,511 units, over the comparable period a year ago. The long-term-average for annual MF permitting is about 290,515 units, with the peak occurring in 2005 at 389,300 units, and the trough in 2009 at 121,125 units. We are about 32 percent below the long-term annual average.

Annual job growth for the U.S. increased by 1.5 percent from March 2011 to March 2012. This is higher than the comparable period a year ago when job growth was 1.1 percent.

With positive job growth in March 2012, the job growth to MF permitting ratio for the U.S. has increased slightly, from 14.3 in March 2011 to 14.4 in March 2012. The ratio is based upon current period job growth (March 2012) divided by MF units permitted a year ago (trailing twelve months ending March 2011). We watch this ratio closely because the more jobs created per MF unit delivered the higher effective rent growth goes. The long-term average ratio when job growth is positive is 5.0. We are now 2.9 times that level and the apartment market fundamentals are really strong.

The median price for a single-family home (existing homes only) sold in the U.S. decreased by -4.0 percent from 4Q10 to 4Q11. From the third quarter of 2005, when the median home price was $227,600, to 4Q11 when the median home price was $163,500, the median price for an existing home has fallen by more than -28.0%. In the markets where home prices have fallen the most, effective rental rates will be under further pressure to fall in order to maintain their equilibrium with home prices. Home ownership is now more affordable in these markets than renting; however, most home purchases today require at least a 20 percent down payment making it difficult for renters to take advantage of the lower home prices and low interest rates; especially those renters with college tuition and credit card debt.

Table 1 below shows the MF permitting trends by metropolitan area (“MSA”). Though I was skeptical of these permits turning into starts because of the difficult construction financing environment, due to the robust apartment market outlook, developers and investors are finding ways to get the financing approved. With the economy improving and the apartment market in an expansion phase, these permits are more likely to be delivered beginning in late 2012 or 2013.

Table 1. Multifamily Permitting Trends at March 2012

Despite the uptick in the MF permits during March 2012 compared to the same period last year, the majority of the markets remain below their long-term average from 1990-2011 as shown in the graph below.

Source: Axiometrics, U. S. Bureau of the Census

Based on 4,256 permit issuing places, Table 2 below ranks the top 40 places. See the link in the News & Updates section in the top right corner to download the Excel file with this information for all the permitting issuing places.

Table 2. MF Permitting by Permit Issuing Place at March 2012

Source: Axiometrics, U.S. Bureau of the Census

By Ron Johnsey, President, and KC Sanjay, Senior Real Estate Economist

U. S. Job Growth Slows to 120,000 Jobs (SA) in March

For the U.S., annual job growth, not seasonally adjusted, was 1.5 percent and 1.9 million jobs, or
162,400 jobs per month, in March (p) 2012.  In March 2011, the numbers were 1.1 percent and 1.48 million jobs, or 123,083 jobs per month.  See table 1 below for the results for some major markets.

On a seasonally adjusted basis, nonfarm payroll employment rose by 120,000 in March, and the unemployment rate, at 8.2 percent, changed little from February 2012.  However, this was well below the average over the prior three months of 246,000 jobs per month.  Since reaching a low in February 2010, payroll employment has risen by 3.6 million.

In March, employment rose in manufacturing and food services and drinking places by about 37,000 each, and in health care by 26,000.  Retail-trade employment declined by 34,000.  It seems that the seasonal hiring that occurred during Christmas in the retail sector is finally reversing itself since merchandising and retail stores lost jobs, while building materials and garden-supply stores and health- and personal-care stores gained jobs but not enough to offset the loss.  Professional and business services added 31,000 jobs, mainly in services to buildings and dwellings, which increased by 23,000 jobs. Commercial banks are hiring again (11,000 jobs), but temp employment remained flat. Though there was a huge loss during 2011 in government employment, so far in 2012 the sector remains stagnant.

The number of unemployed persons, at 12.7 million, remains elevated and is little changed from last month.  The staggering number is that, out of those unemployed, 5.3 million persons have been unemployed for nearly seven months, a record.  Further, among those employed, 7.7 million people are working part time even though they want a full-time job.

The employment-population ratio is at 58.5%, and the participation rate is at 63.8%, both near record lows, and little changed from February 2012.

Table 1. Annual Rates of Job Growth by Market (MSA)

Not Seasonally adjusted
Source: Bureau of Labor Statistics

Permitting
For the U.S., privately-owned housing units authorized by building permit in March were at a seasonally adjusted annual rate of 747,000. This is 4.5 percent above the revised February rate of 715,000, and is 30.1 percent above the March 2011 estimate of 574,000. Single-family authorizations in March were 462,000; this is 3.5 percent below the revised February figure of 479,000. Authorizations of units in multifamily buildings were 262,000 in March, which is 24.2 percent above February 2012 and 57.8 percent above the March 2011 level. (Note: The U.S. Census Bureau publishes the national results before the market results. The market results should be out on April 25, 2012, and you will receive a report on them at that time)

The multifamily permitting trends for the same markets as above for February (the latest data) are shown below.

Table 2. Annual Multifamily Permitting Trends
Source: US Census Bureau

Chandan Economics president Sam Chandan gives his outlook for the housing market.

Is There A Possibility Of A Bubble Developing In The For-Rent Apartment Housing Market?

by KC Sanjay, Senior Real Estate Economist, and Ron Johnsey, President, Axiometrics, Inc.

Generally, I do not see a bubble in the for-rent apartment housing market at this time but it is on the horizon with its arrival dependent upon the relationships between supply and demand and interest and cap rates for each apartment market.  This is really nothing new; this is a cyclical business after all.  The strong apartment market fundamentals over the past two years when coupled with low interest and cap rates has resulted in values improving substantially from the trough.

This Is A Good Thing…

While this has aided operators, investors, and lenders in recouping most of their losses from the downturn, it has also stimulated interest in the asset class, resulting in apartment prices being bid up for existing properties and making development more financially attractive.  This is a good thing.  However, this success over time often results in excess supply financed with higher levels of low interest-rate debt so when supply eventually exceeds demand and interest and cap rates inevitably rise, the value of the projects fall to as much as the debt or lower, potentially creating significant losses for the stakeholders if they have to sell or refinance a property.  In order to diminish this outcome, the stakeholders are banking on strong revenue growth, particularly in the early years of the holding period, and similar going-in and going-out cap rates.  This outcome can be mitigated.

I think a good part of the interest and cap rate risk can be constrained by the borrowers and lenders if they do the following:  1. Limit mortgage loans to 75% to 80% loan-to-cost and/or loan-to-value ratios to create a cushion when the down turn occurs.  2. Require debt service coverage ratios of at least 1.20 times to increase the borrower’s likelihood of making the mortgage payments when revenues decline.  3. Minimize the number of projects financed with interest-only loans; require loans to amortize, further reducing leverage.  4. Make loans with longer maturities at these lower interest rates to ride out the trough.  5. Work with experienced and financially strong borrowers.  6. Calculate property values using going-out cap rates based upon reasonable estimates of the risk premium and forward 10-year bond yield.  7.  Diversify loans by borrower, geography (markets and submarkets), and product to limit risk.  8. Base revenue growth upon forecasts taking into account that supply will eventually exceed demand, resulting in slower revenue growth and lower occupancy rates.

What’s Coming…

We expect the U. S. apartment market to remain strong until 2014 when supply exceeds demand, slowing down rent growth to 4.0% in 2014 and 3.0% in 2015 from a peak of 5.5% in 2012.  This is still good rent growth, especially considering occupancy peaks at 95.3% in 2013 and declines to 93.8% in 2015.  These results will depend upon the relationship between supply and demand and the renter’s wage growth.  If supply peaks at about 276,000 units in 2014, about 23% below the peak deliveries of about 355,000 units in 2007, and absorption is 114,00 units, occupancy falls to a still robust 94.7%.  With moderate job growth in 2014 and 2015 of about 290,000 jobs per month or 2.5% a year and continued strong renter household formation in the prime renter age cohort of over 350,00 per year on average, I believe the apartment market has the potential to deal with the coming rise in interest and cap rates and potential over supply.

Additionally, as the economy picks up, wage growth should as well, enabling renters to better pay the higher rental rates.  At the last peak, median wage and salaries grew at 3.6% in 2007 and 3.9% in 2008 before falling to around 1.1% in 2010 and 1.2% in 2011, according to the Bureau of Labor Statistics (BLS). However, in markets with large increases in rental rates, average annual pay has grown rapidly as well.  For example in Santa Clara County, the home of San Jose, average annual pay was up by 11.3% in 2010, the latest data published by the BLS, while rents increased also by 11.3% on average.  In the District of Columbia, average annual pay increased by 3.5% in 2010 and rents by 7.8%.  While there is a greater disparity between wage and rent growth in this market than in Santa Clara County, keep in mind that the 7.8% increase in effective rents is equal to a $113 per month or $1,359 a year versus an increase in annual pay of $2,717 or $226 per month, almost twice the increase in rents.

The chart above ranks the top markets by the difference between the value lost during the last trough and the gain since the recovery (on the bottom axis), according to NCREIF, against the cumulative forecasted revenue growth from 2012 through 2114 (on the left axis).  It shows that the asset bubble risk varies by market and is largely dependent upon our future forecasts of revenue growth, which have to be accurate to keep the bubble from bursting.  Except for New York, which results are impacted by the drop in value of the massively large Stuyvesant Town –Peter Cooper Village, the results are not surprising: the markets that have mostly recovered their values have experienced strong revenue growth since the trough and are forecasted to have the highest revenue growth over the next three years (the upper right quadrant).

And One More Thing…

For the markets near or already at their peak value, such as San Francisco, the Washington DC metro area, Denver, and San Diego, investors in these markets are relying more on higher revenue growth over their holding period to achieve their return requirement, which may be more difficult to achieve.  The markets located in the upper left quadrant are the ones where the values have not recovered back to their peak yet and are forecasted to have high revenue growth over the next three years before getting back to their peak and , hence, may not be in an asset bubble situation over this period.  In the lower right quadrant are the markets where values have mostly recovered to their peak but the future revenue growth is not strong.  The markets in this quadrant, Miami, Chicago, and Boston, maybe candidates for the asset bubble to burst.

Dr. Sam Chandan is President and Chief Economist of Chandan Economics and an adjunct professor at the Wharton School of the University of Pennsylvania. A noted economist and active commentator on issues of national and global economic significance, Dr Chandan is amongst the commercial real estate industry’s leading voices in relation to capital and credit markets and the dynamic relationship between the economy, regulation, and market performance. http://www.Chandan.com

Buying into Rental?: Tracking the Multifamily Real Estate Market

September 2011

Brian Bailey: Welcome to the Federal Reserve Bank of Atlanta’s Perspectives on Real Estate podcast series. I’m Brian Bailey with the Federal Reserve Bank of Atlanta. Today, we’re talking with Ron Johnsey, president of Axiometrics.

Ron has over 25 years of experience in the development, financing, marketing, and property management of commercial and residential properties. In 1994, he founded Axiometrics to measure the performance of the apartment sector. Axiometrics tracks over 14,000 properties on a monthly basis in over 300 U.S. markets.

Taking advantage of Ron’s extensive experience and specialized perspective, this podcast will explore the state of multifamily real estate through discussing trends, challenges, and opportunities facing the apartment sector.

Ron, thank you for joining me today.

Ron Johnsey: Brian, I’m glad to be here.

Bailey: Please give us an overview of the current conditions impacting the multifamily real estate market.

Johnsey: Well, the multifamily real estate market is performing at the highest level I have seen in over 15 years that I’ve been in this business. The primary driver for demand for apartments is job growth, and even though job growth has been anemic, and in some markets it’s even declining, at the national level, we’re seeing about 1.3 million jobs being created since at least July 2010 to July 2011. So, we’re getting a little bit of help from job growth.

But, the other thing going on is that we’re seeing renter household formation at record levels—it’s over 1.4 million based on the census’s latest numbers. And this is occurring because we see the homeownership rate declining from 69 percent to 66 percent today. And there is less interest in owning homes because the buyer sentiment is just not there. The renters that would move out to buy homes, they see the home prices declining, they see that they have to have higher down payments, better FICO scores, and so on, and all of this is working to create more renter demand for conventional market-rate apartments.

Now, demographically, you also know that there is the “echo boomer” generation. They are starting to enter the prime renting age cohort of 24 to 34 years of age, so that’s helping. We know that the job growth in this age cohort is well above the national average—it’s maybe around 3 percent. We also see that there’s a low unemployment rate for college graduates, and so all of those things are helping create really strong demand.

Now, the other thing that is really significant as well is that there’s very little supply. If we look at supply over the past three years—and I’m going to count 2009, 2010, and then 2011 year-to-date through July—we were averaging about 140,000 multifamily units permitted. That is almost a record low. If you go to 2009, I think, it would be a record low. So, historically, we supplied well over, let’s say, 400,000 historically, and the long-term trend, and the most recent—it may be in the 300,000 range—but this is a huge difference in supply that basically make the apartment market really tight. And then at the property level, we are also seeing that turnover rates—in other words, move-outs to homeownership—are at historically low levels. Typically, you have 20 percent of your turnover rate attributable to first-time homebuyers. We’re seeing that more in the 11 percent range. So renters are staying put, they’re not traveling, and that’s resulting in really strong apartment fundamentals.

Bailey: Over the last 15 years, multifamily occupancy rates have averaged approximately 94 percent. The occupancy for quarter 2 of 2011 was 94 percent. In your opinion, Ron, with an occupancy rate that by historical standards might be considered average, should we be concerned with an effective rent growth rate that is higher than normal?

Johnsey: No, I really don’t because I think the apartment market will take care of itself, and what I mean by that is that renters will opt to control their housing costs. In other words, if you’re a renter and you’re paying a thousand bucks a month and they increase your rent to $1,100, what that renter will do is say, “OK, I can’t afford this increase, so I’m going to go find another floor plan that is priced about the same.” So it means that they may move down the food chain, so they may move from an “A” property to a “B+”, and then someone in a “B” may move down to a “B-”. The other things that can happen with these increases, and that would also result in a more stable occupancy rate, is that renters will start to double up again. In the decline, we saw renters that were worried about their jobs find roommates to lower their housing costs. Well, that effect can take place, again, as these rents are escalating at these great rates. So renters will then double up; they can move back home; they might even start renting single-family homes—you get three roommates, you rent a three-bedroom house, and you really lower your housing costs.

Bailey: You touched earlier on the single-family rental market, and the increases in that. Can you tell us, how much impact is the home foreclosure crisis having on demand for apartments? Is the foreclosure crisis/lack of credit issue artificially inflating demand for multifamily product?

Johnsey: I think it’s causing the homeownership rate to drop, and renting is benefiting from that because we are seeing more renter household formation. It basically just helps the apartment market because it makes homeownership less attractive. Renters are less likely to buy a home when there is foreclosure because they are concerned about prices. Who wants to go buy a home, but then see its value go down?

But, let me just say one other thing, too, is that renter housing has always been a way station to single-family homeownership. You cannot, in my opinion—you know, the typical apartment is not designed for raising a family. So if you want to raise a family you are probably going to move into a single-family home, and I just don’t see that changing. So I think that’s why the homeownership rate will probably “revert to the mean,” as they say, maybe around 65 percent, and we might see the turnover rate in apartments (move-out to first-time homeownership) increase back to its historical level. But, you know, the foreclosures make buyer sentiment that much more difficult.

Bailey: You touched on this earlier. We’ve seen an uptick in the number of permits pulled recently on projects. What trends are you seeing on the multifamily supply side right now?

Johnsey: Well, as I said earlier, it is at historically low levels. If the U.S. is maybe 140,000 units on average, and the long-term average is probably in the 340,000 range, so it is very low at this particular point in time. However, because we’re having such strong apartment market fundamentals, we’re starting to see the permitting activity pick up, and even though it’s picking up percentage-wise, it’s sort of a statistical recovery, you might call it. In other words, if you go from 1,000 units per minute to 2,000, well that’s a 100 percent increase. We’re seeing that effect going on right now. And there are markets like Dallas, where, from a year ago, July permitting is up 200 percent, Seattle is up 150 percent, Austin is 249 percent, Miami is 173 percent. But you can look at Tampa—Tampa is still down 1.3 percent, Charlotte’s down 30 percent, but, you know, Raleigh’s up 100 percent. So, it really depends by market. San Jose is an exception—it’s already exceeded its peak in terms of permitting. But, again, that market has some really strong apartment market fundamentals. It is the strongest apartment market in the United States right now.

Bailey: Given that the multifamily sector has been the healthiest sector in commercial real estate for some time, and that it has been able to readily attract investors and financing, do you have concerns that the sector may deteriorate or experience over-supply in the future?

Johnsey: Yes, I do. But, you know, this is a cyclical industry. Again, the strong apartment fundamentals will eventually generate oversupply. I think it’s just hard to break old habits. It’s hard to see, you know, what’s going on. A developer will go into a market, find a site, and build on it, and he’ll look around and say, “Well, I’ve got the best site. I have the best product. I got great financing. I’ll capture more of the market share.” And you sort of have this idea that just takes hold. And then you have to add the—when you talk about oversupply, it relates really to, what is the demand versus the supply? And I really don’t see oversupply hitting until maybe 2015 or 2016. But, again, it really depends on, what is the job growth at that point in time? We will have, again, close to record levels of deliveries in those years. Will we have the job growth? And we’re forecasting something like 2.5 percent job growth at the national level. And so, will that occur? If that doesn’t occur, then we would have, obviously a correction. But, looking out at our forecast into 2016, we do see the impact of that excess supply starting to hit. It is going to happen. But, again, the severity of it is going to depend on what the demand for it is. Are we going to get robust job growth? Right now, we are benefiting from record renter household formation, but once the single-family market gets back in swing, then we’ll see more production, we’ll see home prices going up, and that will feed more single-family production. And, right now, we’re seeing prices of multifamily products escalating, and that’s contributing to supply as well.

So, all those forces are going to come together. We have a great opportunity over the next three to four years in the apartment industry. But you get into those 2014, 2015, 2016 years, there’s a lot of—let’s call it “shocks”— that could happen also that could change these outcomes.

Bailey: Ron, thank you for joining us today.

Johnsey: I really appreciate it.

Bailey: This concludes our podcast with Ron Johnsey, president of Axiometrics. For more podcasts on this topic and others, please visit the Atlanta Fed’s website at www.frbatlanta.org.

Article from REBusinessOnline.com

A newly released report from Axiometrics Inc. shows that during the last three months of 2011, national effective rental rates for the apartment sector declined by 1.05 percent. This compares to a decline of just 0.59 percent over the same period in 2010.

However, because effective rents had grown so much during the previous eight months of 2011, and because units at the upper end of the market are nearing capacity, pricing power for apartment owners remains strong. Consequently, rents should continue their upward trajectory nationally in 2012, the Dallas-based apartment data provider predicts.

Axiometrics, which measures the performance of the apartment sector every month by surveying more than 18,000 properties and 4.8 million units, projects effective rent growth in 2012 to reach 5.50 percent.

“The apartment market’s strength is being driven by demand from modest job growth, strong renter household formation, and low supply,” said Ron Johnsey, president of Axiometrics Inc., in a news release.

“These factors will make 2012 a strong year, better than both 2010 and 2011, at least from the owner and landlord perspective,” continued Johnsey. “Residents in most markets will begin to move more to control their housing costs, such that people in Class A properties will begin to migrate to Class B properties to keep their monthly rent constant.”

Trends in effective rents

Nationally, effective rents in 2011 increased by 4.1 percent, down slightly from a 4.4 percent rise in 2010. The difference occurred mostly in the last three months of the year. Broken out by property class, Class A properties ended the fourth quarter of 2011 with annual effective rent growth of 5.3 percent, Class B properties with a rate of 4.2 percent, and Class C with a rate of 3.8 percent.

However, since their trough in the third quarter of 2008, rents for Class A, B, and C properties have all increased such that they are now higher than their prior peak in the third quarter of 2008. From December 2009 to December 2011, the level of effective rent increased from $929 to $1,011, or almost a 9 percent increase over two years for all classes of properties.

Occupancy rate trends

The national occupancy rate finished 2011 at 93.5 percent, up 40 basis points from 93.1 percent the prior year, according to Axiometrics. Again, differences exist according to property class. Specifically, Class A properties have averaged 95.3 percent occupancy, which is the industry benchmark for full capacity, since the second quarter of 2010.

The tight occupancy in Class A properties has filtered down to Class B properties, which are now at 94.3 percent. As a result, Axiometrics expects Class C properties to significantly improve their occupancy rate in 2012, from an average of 91.4 percent in the fourth quarter of 2011 to more than 93 percent this year. At such a rate, Class C units would be near their peak occupancy, last reached in 2006.

Momentum varies by market

Across major markets, there was a significant difference in momentum for effective rent growth and occupancy from 2010 to 2011 (see chart). The markets with the strongest momentum included San Francisco, Santa Ana (Orange County), Houston, Charlotte, Los Angeles, and Dallas. The markets losing the most momentum were Raleigh, Nashville, Washington, D.C., West Palm Beach, New York, and Phoenix.

U.S. MultiFamily Market Update
Original Air Date: 2/02/012

The show provides an enlightening update on the U.S. multi-family industry.

The panel of multifamily experts share a comprehensive update on the multifamily market. Discussions include cap rates for various property classes around the country, the current and future investment market for core and distressed properties and rates / underwriting for apartment financing for various property classes.

Chandan Economics Chief Economist Sam Chandan weighs in on the housing market problems.

Dr. Sam Chandan is President and Chief Economist of Chandan Economics and an adjunct professor at the Wharton School of the University of Pennsylvania. A noted economist and active commentator on issues of national and global economic significance, Dr Chandan is amongst the commercial real estate industry’s leading voices in relation to capital and credit markets and the dynamic relationship between the economy, regulation, and market performance. http://www.Chandan.com