Since I began brokering property sales in New York City in 1984, multifamily properties have always been the property type that has received the highest level of demand from the broadest cross section of the purchasing community. Investors love apartment buildings here, and there are many reasons for that.
New York’s rent regulation system, implemented as a temporary solution to a war-era housing crisis and now become about as permanent as any system could be, creates artificially low rents, leaving little downside risk from a revenue perspective. Even during the tough years in 2009 and 2010, rent levels in most regulated properties increased, albeit more modestly than normal. It should be noted that many regulated properties were lost to foreclosure during the great recession, but the reasons revolved around over-leverage as opposed to reductions in top-line revenue. In good times or bad, finding someone to pay $1,000 per month for a stabilized two-bedroom apartment in the Manhattan submarket can be done in about two seconds.
The nature of rent-regulated properties makes the net income relatively predictable, a very appealing characteristic for buyers.
Because of the general stability (pun intended) of these assets and the certainty of cash flow, banks also find this product type extraordinarily attractive. The number of lenders for multifamily assets in New York is greater than for any other product type, and the interest rates are lower on multifamily loans than on any other type.
For these reasons, investors have been flocking to apartment buildings. However, the apartment building sector has not been immune to supply constraint caused by the massive selloff in 2012, as sellers, motivated by tax considerations, rushed to close transactions by year’s end. Analyzing the first quarter of 2013 (1Q13), we see how the sector is finding a slow slog thus far, relative to the last two years.
In 2011 and 2012, there were $4.5 billion and $9.8 billion of multifamily properties, respectively, sold citywide. Annualizing 1Q13 figures, we are on pace for just over $3 billion. During those years, citywide, there were respectively 649 and 1331 apartment buildings sold. Annualizing 1Q13 results, the market is on pace for 840 properties sold. Comparing the dollar-volume figures with the numbers of properties sold, we see a bias towards smaller transactions. We are aware of several larger transactions in various stages of marketing that will help this trend in the second half of the year.
The statistics for total square footage and total number of units sold mirror the stats above. In 2011 and 2012, there were 17.1 million square feet of multifamily properties sold containing 18,600 residential units, and $35.4 million square feet sold containing 38,600 units, respectively. Annualizing 1Q13 figures, 2013 will show totals of 14.2 million square feet and 16,500 units sold. We do expect the numbers to look better at the year’s end, momentum growing as we progress through the year.
On the value side, the overwhelming demand and short supply have exerted tremendous upward pressure on value. Capitalization rates have been compressing and gross rent multiples have been growing, with citywide averages of approximately 6 percent and over 10 times (the averages would be much more positive if the metrics for the Bronx were excluded). Cap rates in the Manhattan submarket are at historic lows. The 2013 walk-up average has been 4.57 percent and the elevator building average has dropped to 3.7 percent. While these cap rates are the second lowest on record, after a 3.05 percent cap rate in 2006, buyers are still getting positive leverage, a better bargain than they were getting at the peak of the last cycle in 2007.
All of this sounds very positive, but there are some headwinds for the sector. Institutional investors have slowly been turning away from the sector as finite-term funds find it challenging to accelerate turnover to occur during the funds’ holding period. Additionally, while top-line revenue has grown by 15 percent to 20 percent over the past three years, net operating incomes have remained essentially flat, due to tremendous increases in real estate taxes and water and sewer charges. Taxes are likely to remain an issue due to upcoming budget problems in the city.
Lastly, many multifamily market participants believe the legislative environment will turn even further against owner’s interests as the next mayor begins to impact how this market operates.
Time will tell how these headwinds will affect the market, but until then, things look extraordinarily bright for the multifamily sector—something that potential sellers should consider.