By Maria K. Maslovsky
Following some challenging market fundamentals, the multifamily REIT sector appears to be on the mend. The sector's performance has shown positive signs, and further improvement can be seen on the horizon—although that improvement will not be rapid.
Moody's Investors Service's rating outlook for the sector is stable. Out of the 18 multifamily REITs reviewed by Moody's for this article, all but three posted year-over-year occupancy gains in the second quarter of 2004. Based on Moody's calculations, "same property" year-over-year net operating income (NOI) also climbed out of the red on average for these REITs in the second quarter.
Still, seven out of 13 REITs that reported year-over-year rental rate statistics in the second quarter of 2004 posted declines. The speed of the sector's recovery depends largely on job growth, and as demonstrated by recent non-farm employment figures (an increase of only 32,000 in July 2004, although followed by a more substantial 144,000 increase in August 2004, according to the Bureau of Labor Statistics), job growth has not yet stabilized.
Market Fundamentals—More Good Than Bad
Over the past three years, publicly traded multifamily REITs have been fighting declining occupancies, decreasing rents and mounting concessions, exacerbated by record low interest rates that have encouraged apartment tenants to become homeowners. However, second quarter results reported by multifamily REITs suggest that the impact of these multiple stresses may be diminishing.
For the first half of 2004, a number of apartment REITs reported gains in year-over-year occupancy, and in the second quarter several REITs showed sequential quarterly increases as well. Recent reports have been more mixed from a rental rate perspective, where a significant portion of listed REITs are still experiencing rent rolldowns from the prior year. However, sequentially, rental rate statistics pointed to a more upbeat pattern, with increases outnumbering the declines.
| Multifamily REIT Same Store NOI Growth |
 |
| Source: Moody's Investors Service. |
Underpinning these results are some positive trends related to increasing tenant traffic and declining concessions that are more positive than anything seen in the apartment industry since 2001. These underlying shifts translated into overall increases in property revenues, on average, across the 18 REITs, which, although offset by a rise in operating expenses, still yielded the first positive same-property NOIs seen in the sector in a while. So, while the more heartening second quarter results are encouraging, there is still some recovery left to achieve.
It also is worth noting that the rise in interest rates, which was expected to reduce the rate of home buying, has not yet fully materialized. While short-term mortgage rates (under five years) have increased over the past year, both 15 and 30-year fixed jumbo mortgage rates are currently lower than three or 12 months prior, according to Bloomberg. If such mortgage rate trends persist, multifamily REITs, particularly those owning Class A properties, may continue to lose tenants to homeownership, thus slowing the pace of recovery.
Recovery Varies by Market
The fact that the recovery in the multifamily sector has been far from uniform provides further evidence of the progress left to be made. While several geographic markets enjoyed strong positive absorption and effective rent increases, others continued to be burdened by persistent vacancies in excess of 10 percent.
According to Reis, Inc., the leaders in positive multifamily absorption were Atlanta, Chicago, Dallas, Los Angeles and Northern New Jersey. The greatest increases in effective rents occurred in Las Vegas, Miami, New York, Norfolk and Northern Virginia. Reis also reported that the lowest vacancy rates could be found in Long Island, New York, Los Angeles, Norfolk and central New Jersey. At the same time, Austin, Ft. Worth, Houston and Denver
all posted vacancies in excess of 10 percent.
Multifamily
|
| # of REITs |
26 |
| Market Cap. (in thousands)
|
$40,129,251 |
| Industry Market Cap. (in thousands) |
$275,346,675 |
| % of industry |
14.6% |
| Yield |
5.6% |
| YTD Total Return |
13.1% |
| One-Year Return |
17.0% |
| Three-Year Return |
10.8% |
| Five-Year Return |
16.2% |
| 10-Year Return |
13.1% |
| Average Daily Trading Volume (Shares) |
5,397,323 |
| Weighted FFO Growth (20032004) |
4.20% |
| Source: NAREIT. Data as of Sept. 30, 2004 |
These statistics correspond to a number of REITs reporting Southern California, Southern Florida and Washington, D.C. as their strongest markets, while Denver, Houston and Dallas made the REITs' list of laggards in terms of apartment recovery.
Moody's believes that a more pronounced upturn in the markets that are already improving, as well as an end to negative trends in the markets that have suffered most during the last recession, would be key for putting the multifamily REIT segment completely on the way to a full recovery.
Benchmarks of Full Recovery
There are two external factors that are keys to the full recovery of the multifamily REIT sector. The speed of the overall economic recovery (particularly job creation), and the pace of new construction.
According to the Bureau of Labor Statistics' "Industry Output and Employment Projections" and Moody's calculations, the domestic industry output is anticipated to increase by approximately 5.7 percent per annum through 2012. During the same period, the total number of jobs created by the U.S. economy is expected to increase by 1.4 percent per year. While these long-term projections are encouraging, total non-farm employment increased only by 32,000 in July, following a rise of 78,000 in June and a 752,000 gain in the second quarter of 2004.
If near-term employment gains reverse the slowdown in job creation experienced in July, Moody's believes that it would provide vital support to the recovering apartment sector. However, if the number of potential new creditworthy tenants continues to grow at the slow pace experienced in July 2004, the tempo of the multifamily comeback could be in question. While it is impossible to formulate specific forecasts around the likelihood of further terrorist attacks, such events need to be considered as an additional variable potentially affecting the recovery as well.
Excessive multifamily construction has been one of the contributing factors to the recent recession in the sector. While the spigot has been turned off in most markets, some projects remain in the pipeline. According to statistics from the National Multi-Housing Council, construction on approximately 419,000 apartments was started in 2003, which represented close to 2.5 percent of the national apartment stock. Most markets are now working through the remainders of that pipeline, but in some locations, for example in Orange County, which has been a strong multifamily performer, new construction actually picked up in the first six months of 2004.
Even more troubling are continued supply additions in markets such as Houston, where the vacancy rate already is at 10.3 percent, according to Reis. Moody's suggests that persistent inventory increases would pose a material threat to the pace of recovery.
However, Moody's does not see immediately alarming trends, which should allow investors in this sector to rest easier. The overall improvements in the sector's performance can be seen and the recovery, at whatever pace it takes, is underway.
Maria K. Maslovsky is an associate analyst in the Real Estate Finance team at Moody's Investors Service.
