May 20, 2009

Apartment Buildings as Investment Property

In general, rental property is better positioned for this downturn than most other properties.

Why Do It
According to the National Multi Family Council, U.S. apartments have provided the highest risk-adjusted long-term returns of all real estate asset classes and with less volatility.

1. Because investment income property is a cash flow business it has benchmarks and some standardized methods for determining value. Cash flow provides the investor with an objective evaluation tool.
2. Leases are generally one year, rental income makes relatively quicker adjustments than long term AAA leases or larger shopping malls etc. Apartment buildings have 12-14 month development cycles and can react in a timely fashion to the needs of the market place.
3. Apartments have a lower cost of capital and availability of debt capital thanks to Fannie Mae and Freddie Mac. Its a matter of policy.
4. Demographic trends are favorable. As a result, demand for rental housing in the U.S. is expanding at the strongest pace since the mid-1980s. 3 million new renter households were created as a result of new household formation, declining rate of home ownership, foreclosures bringing new renters to market and the
echo boomers coming of age
5. The cost of gas and the time it takes to live in suburban/exurban areas is taxing and many people are moving back to city hubs for the convenience.

Todays Market

Things are tough in commercial real estate. Vacancy rates are up and rent rates are declining. Because income property is evaluated using cash flow, values are declining and are likely to continue to do so for awhile.

Its not likely we will see the free fall that home prices have experienced, in part because investors are not emotionally driven buyers. So development didnt get out of whack and there wasn't as much of a bubble. Reis Inc., a third-party commercial real estate data provider, notes apartments will continue to be the beneficiaries of housing's ills until "expectations of price appreciation" re-emerge with stabilization of the housing market. Vacancy rates may rise and rent rates may drop, but the crashing collapse we've seen in the housing market is not likely.

Cap rates have already adjusted to lower cash flow and are now at 2004 levels. Attractive evaluations are beginning to create demand. The banks are not helpful, but Fannie and Freddie have stepped up and mortgage financing liquidity is available. The apartment market is viable, even in times like these. The national Multi Housing Council ( points out that "relative to other investment classes such as industrial, office or retail, apartments translate 83% of NOI into cash flow while other property types range between 64% and 74%.".

Higher Vacancies and Lower Rent Rates

The Renter Demographic - Who Are They

1. Echo boomers--the children of baby boomers are now driving the rental market. They make up a third of the population and are a significant segment of the renter population. This is a group of younger adults that grew up on the internet, not television. They are wired, multi-cultural, and hold more traditional values than many of their parents. The largest generation of young people since the '60s is beginning to come of age. The owner that understands this demographic will rent smarter and faster.
2. Empty Nesters - There's also a robust apartment market for those over the age of 60 who are trading large suburban homes and yards for an apartment within walking distance to shops and entertainment.

Create Your Value Proposition

Apartments themselves are changing. If you want to rent faster, you will need to understand what the new renter values and incorporate new design elements and amenities to make them more desirable.
Some ideas
1. If you have some outdoor space, consider a community garden. Fresh herbs and flowers go a long way towards making apartment living fun experience. Give tenants a space for some communtiy involvement.
2. Consider converting unused space into a small gym. Wall off a portion of a basement area, add a few Nautilas machines, some weights and mirrors and you can turn an underutilized area into a real draw.
3. The convenience of washer/dryers and dishwashers is really appreciated, echo boomers are busy.
4. Make units cable ready and offer them as pre-wired integrated telephone, cable TV and high-speed Internet service ready
5. Add Water purification systems and programmable thermostats to all units
6. Install a public internet for the building and create a blog or twitter account for tenants to communicate. Give tenants the tools to create a sense of community.

Howard Bell

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