I hate to say I told you so, but….This article highlights what we have been saying for several years now. If you have been following my blogs for a while read this and see if you can identify some of the concepts I have been harping on to whoever will listen and I will discuss some of the highlights at the end. Michal
Are Multifamily Investor Preferences Shifting?
Multifamily Executive, by Luis Mejia
Recent multifamily investment volumes indicate an early but potentially growing emphasis on low-rating properties. Indeed, as the chart below shows, from the first quarter of 2010 through the first quarter of 2013, Class B and C sales transactions were substantially higher than those for Class A properties. (The data do not reflect the recent, $16 billion Archstone–AvalonBay–Equity Residential transaction, in order to avoid skewing the results.)
A further look at the Class A and B transactions shows that their shares have changed gradually over time. In 2010, following the recession, the percentage of Class A transactions was close to 30 percent of all sales, and Class B transactions represented close to 40 percent. Between 2011 and 2012, however, the proportion of Class A transactions slipped toward the 20 percent to 30 percent range, while the portion of Class B transactions moved up, fluctuating above 40 percent.
More recently, between the last quarter of 2012 and the first quarter of this year, Class A transactions represented only, on average, 19 percent of all multifamily sales, while the average Class B transaction share during these two quarters was 47 percent. In the first quarter of 2013 alone, the Class A and B numbers were 13 percent and 53 percent, respectively. Preliminary second-quarter 2013 data roughly support these observations, with a split of 20 percent and 48 percent, respectively, between Class A and B transactions.
The Meaning Behind the Numbers
More data are needed to establish a trend, because although the slippage in Class A sales may seem significant, the change may be due to the gradually shrinking number of top-quality properties available for sale. Investor preferences may be shifting toward less-sophisticated properties because high-end properties may not now offer the return opportunities they tendered early in the recovery.
Conversely, lower-end properties may still be priced reasonably and perform well when properly marketed and managed. These properties appeal to young households with sizable student and consumer debt who are willing to trade luxury for cost and location. The communities may also attract renters who continue to rebuild their finances after transitioning out of the recession’s distress situation.
The potential shift between the class transactions, does, however, seem to be supported by the gradual compression in cap-rate spreads between high- and low-end–property transactions. Between the first quarters of 2012 and 2013, the cap-rate spread between Class B/C and Class A property transactions shrank by about 25 basis points, and the cap rates associated with Class B/C transactions declined by more than 50 basis points. The compression, which is also observed using preliminary second-quarter 2013 data, suggests that investors have progressively bid up the prices of low-rating properties.
ISO ROI
Although volume variations will likely be gradual and continue to fluctuate from quarter to quarter moving forward, one thing is clear: As the multifamily cycle peaks, especially in the top-tier property segment, investors will inevitably search for additional return opportunities by turning to more-basic, less-stylish, but well-occupied properties. This change will become even more evident if financing continues to be affordable and available.
If I were forced to point out one takeaway from this article it would be the fact that there is reduced risk and opportunity in owning assets that are perceived to be a good value for their customers. There is an old saying that says “If you sell to the classes you eat with the masses and when you sell to the masses you eat with the classes”.
In short there are far more dollars spent on Ford Focuses than on Lamborghinis and far more people make good livings selling Fords than Ferraris. In this market you are far better off operating a 95% occupied C class property that gets $550 a month in rents than you are handing out tons of concessions to have an 85% occupied A class property with demanding residents at $1,200 a month in rent that cost 3X per unit more than the C property.
Warren Buffet makes the point often that just because it is a good company does not mean it is a good buy. That is true also with apartment assets, but a lot of investors just turn their noses up at the more blue-collar assets. It would appear that the better returns are beginning to change peoples’ minds.
I often talk about how most of the apartment investing news ignores the B/C class assets and this is one of the first articles that I have read in a while that actually addresses the distinction. And it’s the first time I have seen the distinction pointed out in a favorable way.
Remember disciplined analysis of returns and what that means to your investors is what will, in the final analysis, dictate whether or not investors like your deals. I would frame this article and hand it to any investor who expresses concern over the fact that your project looks like it might be older or less aesthetically attractive than some others and help them to get their focus back on what is important….. THE RETURN ON THEIR INVESTMENT
Happy investing, Michal Ballard
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I feel so blessed to have Michal share his wise investing perspectives with us here at Foreclosures.com. I have snagged him one more time, the last we will have him this year… so make sure you do not miss out on learning from his invaluable wisdom. More here.
If you have not already done so, please register for “Earn Huge Profits Investing in Apartment Foreclosures” coming up on Wednesday, July 17th, 6pm Pacific. I promise you will learn a lot and thank me for this great use of your time. Apartment investors following his steps, are making unbelievable amounts of monies for themselves and their investors. He’ll share those details with you, and more, during his last call. Talk to you then!