Apartment Sector Facing Tough Times But Should Weather Storm

Apartment Sector Facing Tough Times But Should Weather Storm

By Dawn Wotapka Of DOW JONES NEWSWIRES NEW YORK -(Dow Jones)-

Multifamily investors better brace for a bumpy ride over the next several quarters, thanks to massive job losses that ended the sector's bull run with a thud.

However, those able to withstand the turbulence will benefit from reduced new supply, a decline in home ownership rates and a surge in the key apartment renting age group. For now, mounting unemployment is set to curtail rent increases and edge up vacancy rates, likely depressing net operating income to flat or negative levels next year. The pain could be more pronounced for more upscale operators including Post Properties (PPS) and AvalonBay Communities (AVB), which recently said it was "increasingly cautious" regarding next year's outlook. The hurt is being felt. From September to October, occupancy rates slipped 0.3% and effective rent fell 0.8% in the top 20 markets, according to UBS, with the biggest monthly drops seen in Denver, San Diego and Las Vegas.

"The sector's fundamentals are weakening more quickly than anticipated," research firm Green Street Advisors said. "...While the prospect of negative [net operating income] growth for the sector in '09 seemed unlikely earlier this year, it is a scenario that now appears increasingly likely." That is because unemployment is essential to the sector. Operators count on college graduates getting their first place, new hires relocating, and those promoted upgrading into nicer digs. Post-pink-slip tenants find roommates, move home or find cheaper deals - downgrading from A-level to B-level apartments - scenarios becoming more common as the financial crisis roils the globe. October's unemployment rate hit 6.5% - the highest in years - and could top 8% by the end of next year. The 25-to-34-year-old age group, prime renters, has been particularly hard hit. Layoffs have battered every sector - media, telecom, financial - and apartments haven't been spared. Camden Property Trust (CPT) recently announced the first cuts in its history, with 79 positions shaved from corporate and regional staff and on-site positions. "Heavy job losses are exacting a toll on the sector," Green Street said. "The weak employment picture now appears to be overpowering the favorable rent-to-own dynamics that have been prevalent over the last several years and has cast a dark cloud over the '09 and '10 growth picture." The firm's most recent estimates for apartment REIT revenue growth average 2.7% for 2009 and 2.0% for 2010. But these numbers now "appear too rosy in light of the reality on the ground today and the rapidly deteriorating economic outlook. More likely, '09 revenue growth will be only half that large." Stephen Swett, a Keefe, Bruyette & Woods analyst, says revenue and net operating income growth could turn negative next year, depending on just how weak the economy gets. Richard Anderson, a REIT analyst at BMO Capital Markets, said same-store net operating income growth is likely to be negative for many players. Rent increases should be minimal, as operators work to keep current tenants, and incentives will increase to attract new ones.

Of course, few expect vacancy rates to dip below 90% anytime soon. "On the margin, vacancy will get worse, but the reality is they could just cut prices to fill units," Anderson said. Until recently, apartments were a star performer in REIT world, buoyed by access to financing via Fannie Mae (FNM) and Freddie Mac (FRE), both now under government control, but the capital remains. Back in August, the sector's year-to-date return topped 20%.

Times have changed. As of Wednesday, the apartment sector was down nearly 20% month-to-date, and more than 41% quarter-to-date, according to the National Association of Real Estate Investment Trusts. That is compared with 23% and 47% for the overall sector. Such reversals don't have industry watchers too concerned. Restricted construction lending has slowed new starts to a trickle nationwide. Issued permits have fallen by more than half since June, so little competition is in the pipeline.

In September, an annualized seasonally adjusted 233,000 construction permits were issued for five or more units, down from 489,000 in June, said BMO's Anderson. But not all permitted apartments are actually built, and that number is likely to fall further, he added.

"The actual start relative to permits is going to be significantly lower than it normally is," Anderson said. "You can say very clearly that new starts are going to decline drastically." Meanwhile, as the single-family market downturn deteriorates - prices are crumbling with mortgages increasingly hard to obtain - fewer tenants are fleeing to buy houses, something Mid-America Apartment Communities (MAA) noted in its most recent conference call. Camden Property Trust, meanwhile, highlighted the baby boom "echo" that is producing "many more" 18- to 24-year olds than the previous cycle. These younger renters are eschewing sprawling McMansions, favoring a mobile lifestyle that lets them live, work and shop in the same areas.

"When job growth returns, there will be significant pent up demand," said Richard Campo, Camden Property's chairman and chief executive officer, said in a recent earnings call. "We believe that there will be a shortage of multi-family units beginning in late 2010 and through 2013." Such optimism is enough to keep some investors in the pay-by-the-month game. Jay Leupp, whose Grubb & Ellis AGA Realty Income Fund has nearly 15% of its holdings in the sector, said: "We like apartments." -By Dawn Wotapka, Dow Jones Newswires; 201-938-5248; dawn.wotapka@dowjones.com Click here to go to Dow Jones NewsPlus, a web front page of today's most important business and market news, analysis and commentary:

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