A Look Back at 2011 and Highlights Going into 2012

 




By Mike Kelly President
Caldera Asset Management, Denver
mkelly@calderaassetmanagement.com

As we enter into a new year we look back and see if the market consensus from December 2010 actually delivered the expected impact to the apartment market in 2011. We looked at economic, political and multifamily specific factors and compared their expected results to what actually played out in the apartment market during 2011.

Highlights going into 2011 Anticipated Impact on Apartment Market Actual Impact on Apartment Market in 2011
Quantitave Easing (QE2) was announced in November 2010. $600 billion of US Treasuries and agency securities to be acquired by June 30, 2011 The program was designed to drive down interest rates and encourage borrowing and risk taking The 10-year Treasury rates started around 3.25%. Rates actually rose over the first 60 days of 2011 but subsequently long term rates fell below 2%, allowing both Fannie & Freddie to offer extremely attractive rates to borrowers. The agencies had one of their largest years on record

Large amount of cash on corporate balance sheets Companies were expected to spend part of their cash hoard and thus create jobs which would improve occupancy
Companies were reluctant to spend on new product or infrastructure. Job growth was anemic at 1.2% (Source: US BLS)

Bush tax credits extended for two additional years By removing the uncertainty of tax increases, companies were supposed to hire more, thus improving occupancy

Substantial job growth did not occur.  However, occupancy did improve across virtually all markets and asset types
Improving job market . Monthly unemployment rate was trending down from 9.8% (Nov 2010) to 9.4% (Dec 2010)

More jobs would create more renters The BLS unemployment rate fell to 9% in Nov 2011. However, much of the decrease was a result of the change in the job pool
Strong GDP growth expected in 2011. The Dec 2010 Bloomberg consensus for 2011 was 3.2%. Fed reserve forecast was 3.0-3.6%

Strong GDP would drive businesses to grow and hire GDP growth lagged significantly below consensus. Trailing 4Q 2010 to 3Q 2011 growth was less than 2%
Existing rent rolls improving Owners could aggressively move rents on renewals and new leases Owners were able to aggressively raise rents for the first 10 months of the year. Per Whitten Advisors, rent growth through 3Q was 4.3% across the country.  However, rent growth in 4Q appears to be slowing down

Very little new construction Lack of any material construction would allow occupancy and rents to continue to grow Although ramping up, new construction is still slow in relative terms. Lenders and equity investors were still cautious in many markets

More CMBS loans delinquency More distressed products in the market would create more buying opportunities Total multifamily CMBS delinquency actually fell 200+ bps (Source: Trepp). The lower interest rates from the Fed allowed more deals on the fence to be refinanced or sold, instead of going into default

Cap rates declining More transactions at higher prices 2011 was a bonanza year on the transaction side. The number of properties sold was the highest since the heydays of 2007

REITs and pension funds extremely active in core markets Core volume and pricing would continue to be aggressive REITs and Advisors were extremely aggressive in the coastal markets throughout the year. Cap rates were very low but could be justified by the high rent growths and cheap debt

Secondary markets still lagging Capital would remain in the coasts Buyers showed up for secondary markets and B grade assets. They were helped by the lower borrowing costs and the higher than expected rent growth rates


Entering January, we look at the current trends and how they potentially will impact the apartment market in 2012.

Highlights going into 2012 Anticipated Impact on Apartment Market
US Gov't is having a tough time getting legislations passed that could immediately benefit the economy and grow the GDP. Large risks looms over Europe and even China could face potential risks. More economic uncertainty in Dec 2012 than Dec 2011. 10-year US Treasuries remain below 1.90%

Uncertainty does not make companies rush out and hire the incremental worker. Companies are hiring selectively. The lack of a slug of new jobs will hurt the MF market. However, in the long term, uncertainty will help as people will be more prone to stay in rental apartments than buy new homes
Large amounts of cash still sit on company's books Companies have not shown a large appetite to spend the money on new ventures. Mergers will continue to happen but generally those are not job positive. Any material spending by companies on new projects will help the MF market
 
Potentially promising signs of job growth as the Unemployment rate is at 9%. Weekly unemployment claims have fallen to 2008 levels

If the trend continues, the new employees will potentially get more aggressive on their living choices. That can mean new net renters coming from roommate situations or living with parents.
Rent rolls continue to improve but YOY growth is slowing Rents will continue to improve but much of the low hanging fruit has already been picked. Organic rent growth will slow to 3-5% versus the 6-8% achieved in 2011. The long term positive story for apartments still exists.

Fannie & Freddie are still extremely active and dominating the permanent finance market for apartments. However the gross value of loans maturing almost triples in 2012 compared to 2011 The agencies will continue to dominate the permanent debt market and investors searching for yields will still actively buy their paper. If the 10-yr Treasury yields continue to fall, the agencies will be strong originators as they have not indicated any intentions on implementing floor rates. However, their "tail risk" losses will increase as rates go lower
 
Construction pipelines are growing in virtually every major city. Many land sites tied up. Although construction pipelines look large, most of the deals will not get done as lenders and equity providers are not likely to go back to their 2005-2007 underwriting levels. Attractive deals will still get done while marginal ones will face enormous challenges. HUD 221(d)(4) loans are slowing down significantly. Bank construction lenders are not allowing the developers to stretch their balance sheets and guarantees, thus severely limiting the development capacity of builders
The exit for newly constructed assets look very bright as core buyers (REITs and Pension fund advisors) are continuing to stay in higher quality and newer vintage assets.

CMBS is virtually non-existent for new originations. CMBS has approximately $11.5 billion multifamily loans maturing in 2012 CMBS won't come back at any substantial numbers. Any volume in CMBS will be in non-MF asset classes as the underwriting and debt yields are much better since there is no competition with agencies. Look out for a significant amount of loans maturing in 2012 as most investors are reluctant to recapitalize 2006-2007 deals

Core markets still attracting the majority of the REIT and pension fund money This trend will continue in 2012. Pension fund advisors are starting to go to secondary cities (particularly in Florida) as they can acquire decent quality products and get better yields compared to those in DC, New York City and major cities in California. Class B products will face stiff challenges as a large supply of value add fund deals transacted in between 2005 and 2007 will hit the market and need to be liquidated


About the Author
Mike Kelly is the president and co-founder of Caldera Asset Management, a turnaround consulting and restructuring services firm specializing in multifamily assets. Caldera’s team has experience working with lenders, equity investors, lawyers and other consultants to solve complex problems associated with distressed multifamily assets including turnaround, refinancing, stabilization, restructuring, dispositions and property management. For more about Caldera, please visit www.calderaassetmanagement.com.