US Multifamily Fundamentals Disconnected from Debt Market Economic Concerns

With the US 10 Year Treasury bill yield at 3.0 per cent (as of 6/28/10), global bond investors are clearly indicating that they expect slow US economic growth.

For US multifamily investors, the immediate effect will be a decrease in Fannie Mae and Freddie Mac mortgage interest rates, down to probably 5.0 per cent, if recent history is any guide. This 25 basis point decrease will translate into about a 3-5 per cent increase in asset values. From the peak of values in August 2007, that will be a decline of about -14 per cent; however, from the trough of values in May of 09, values are up 26 per cent.

Absent a radical reform of the US GSEs along the lines of Canada’s housing market (loans that are recourse, no tax deductibility of interest, no securitization of loans), or a dramatically pro-business climate that creates incentives to form and accumulate wealth, the US residential housing market will limp along. The multifamily market is in better shape given the continued limitations on supply (80,000 units per year vs. a historic 300,000 units/yr) and a growing age cohort of core renters (Ages 22-35, commonly known as the baby boom echo generation).

The disconnect is that all the US multifamily public companies and 3rd party rental rate surveys report robust rental increases in April, May and June. Public statements from Associated Estates, UDR, Equity Residential, Home Properties, Colonial Properties Trust, Mid-America Apartment Communities, and Avalon-Bay all point to rapidly improving occupancies and rental rates, although by no means has the recovery returned rents to their pre-recession levels.

People I know at Axiometrics and REIS concur, although their published reports won’t be out for several weeks. The euphoria is more centered around the change in momentum, from uniformly negative last year to glimpses of optimism. The explanation offered is that of “unbundling”, the reduction of fear among young adult renters who are now willing to get their own apartments after “bundling up” in the fall of 2008 and winter of 2009.

While this is good news for the top 10-20 US metro markets, there is still a lot of financially “underwater” real estate to clear, in some of non- “gateway” cities. CoStar, an information service provider reports several markets in deep trouble, with distressed sales as a % of all sales >50 per cent:

1) Atlanta- there was a lot of assets traded in the bubble from 2004-2007 and the chickens are coming home to roost. Combined with lack luster rental growth (1.6 per cent/yr vs. 3.0 per cent/yr nationally) over the last 30 years, and you have a recipe for distress.

2) Jacksonville, FL- excess supply is driving this market with values down 30 per cent and 25 per cent of CMBS borrowers already delinquent.

3) Stockton, CA- high unemployment rates (17 per cent) and high vacancy combined with declining rents are sending buyers of Class C assets into default. There aren’t many trades in this market.

4) Las Vegas, NV- large new supply of homes/condos have been converted to rentals which have put pressures on vacancy and rents.

5) Tampa/St Pete- reductions on construction and back office business employment has slammed occupancies and rental rates, and values are down 30 per cent with little reason to believe its coming back.

6) Orlando- this metro is driven by Disney which is driven by US consumer discretionary spending. That’s not coming back quickly this time around, and the pain is lingering.

The slow climb back from the abyss continues; with US economic policy have taken a decided turn to the left (increased government control, increased subsidies for banks/autos, increased spending vs. revenue generating tax cuts, an increased debt load from spending promises that cannot be kept), the stage is set for slow growth with the increased presence of government in the society. From my perspective, a left leaning, anti-free enterprise administration has always had only 3 options, given its political leanings:

1) Slow growth

2) Inflation

3) Vastly increasing immigration to change to demographic calculus.

Right now, it’s opted for slow growth, and this is likely to lead to political suicide come the November congressional elections. The vast majority of Americans do not believe that they should accept a lower standard of living and increased government power over their lives. The loss of a congressional majority means that the Democrats will attempt to pass as much of their legislative program as possible this year, knowing they are headed for the cliffs.

There are have been a lot of rumors of late that Obama will attempt to change to odds by an executive decree granting amnesty to illegal aliens in the fall and enrolling them in voter registration, in a bid to increase the Democrats minority voting bloc.

The bottom line is that one can expect the drift to continue—the November congressional elections will decide whether there is an attempt to reduce tax rates to spur growth, or ramp up inflation in the run-up to the 2012 election. As for the multifamily market place- my eyes will be on the results of what happens to rental demand in September after the summer peak season.

Email the writer: