By John Meyer, Director
For those of us who habitually track the market, it seems on a weekly and sometimes daily basis, Chicagoland apartment buildings are trading at jaw dropping prices. Low cap rates, high multiples, and record breaking sale comps have been happening for years now and not just choice Chicago neighborhoods; this phenomena has extended to the suburbs as well. The question is, why?
Why are apartment buildings worth so much so soon after the recession? Why do rents (and ultimately property values) continue to increase at the same blistering pace? The short answer is: Confidence in the market. From where I stand, it has never been higher which is the primary reason buyers are bidding up prices. That said, this confidence is built on several key factors. In descending order of importance, here are the top five reasons investors are buying suburban apartments:
1. Demand – There’s simply not enough housing. No wonder the market’s so optimistic on apartments, how can prices not continue to rise when it’s a known fact we have a shortage of quality housing in America today. New developments are happening in several suburban locations but it’s only Class A which is too expensive for the average working class family. No one is building Class B or C apartments, making them all the more valuable. Strict underwriting standards have prevented many from buying a home, keeping them as renters for the foreseeable future. In addition to current demand, millions of potential renters in the form of Milliennials and Baby Boomers are projected to hit the market in the future; this perceived demand’s the underlying reason for all the optimism in multi-family.
2. Low Interest Rates – We’ve all heard this one before, but it’s true. Why not borrow when money is so cheap? And when borrowing, find an investment thatis supported by plenty of healthy data. It’s no surprise multi-family has the healthiest data of all; savvy buyers are already calculating interest rate increases into their underwriting. This way, when the Fed does the inevitable, they’re prepared.
3. Liquid Lending Environment – Banks are hungry for multi-family loansand not just traditional lenders. Huge amounts of agency debt, even CMBS, are being originated in the suburbs. It seems counterintuitive that banks are so eager to lend at record low rates, but the datais too compelling. People simply need a place to live and banks are desperate to provide capital to qualified borrowers.
4. Yield Starved Investment Community – This one is a corollary to #2. With interest rates paying nothing, it’s caused a whole new segment of the investment community to consider investing in commercial real estate. We have seen the rise of the hybrid private equity real estate model that many firms are now using, whereby they raise huge sums of equity, just waiting to be deployed in to the right property investment. It’s a fact that equity fund raising’s at an all-time high; combined with extremely available debt financing and you have an explanation as to why values in choice locations are approximately 20% higher than the previous market peak in 2007.
5. Multi-Family as a Safe Haven – The real sizzle of buying apartments is the opportunity to add significant value to the property, through re-positioning, renovating, etc. That gets all the headlines, but I feel we’re forgetting a fundamental reason why there’s so much money chasing multi-family; it’s considered the safest of havens in commercial real estate. Rather than obsessing about immediate returns, there’s a significant portion of the market looking to park money in a hard asset with predictable returnsfor the long term. Of course they intend on profiting, but for the current cycle they’re in it for capital preservation.