Small City Living for Multifamily Property Buyers

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As prices for multifamily properties in big cities escalate, some investors are setting their sights on smaller markets where prices are lower and yields are higher.

These investors are following the lead of companies like Wilkinson Group Inc., an Atlanta-based apartment investment and management firm that paid $22.9 million last week for Legacy at Sandhill, a 240-unit garden-style apartment project in Elgin, S.C., a suburb of Columbia. Built in 2008, the gated complex consists of one-to-three-bedroom units that rent from $763 to $1,440 a month. It features amenities such as a resort-style pool, fitness center, business center and sports lounge with billiards.

“Primary markets are becoming more difficult to actively acquire because of the sheer flood of fresh capital, and investors are finding greater yield opportunities and less competition in secondary and tertiary markets” said Will Mathews, a vice president at Colliers International in Atlanta.

The capitalization rate on the property is 6.34%, according to Colliers, which brokered the deal. That is higher than on similar Class A properties in larger markets. The capitalization rate is a metric that compares the annual yield on property to its cost.

According to New York-based data firm Real Capital Analytics Inc., the average national cap rate for multifamily properties for the 12 months ended in March was 4.92% for the six primary markets such as New York or Chicago; 6.41% for secondary markets such as Houston and Philadelphia and 7.09% for tertiary markets such as Birmingham, Ala. or Buffalo, N.Y.

“Competition due to the amount of capital that’s flowing into the industry right now is causing people to seek out different investments, which might take them into markets where they traditionally haven’t gone,” said David Borsos, vice president of capital markets for the National Multifamily Housing Council, an apartment industry trade association, in Washington.

Large investors tend to favor primary markets in part because they have a firm employment base that expands during times of economic growth, boosting demand for rental housing. But as the economic recovery broadens, job growth is expanding to smaller markets.

That trend, in turn, is making investors more comfortable with the idea of entering less popular markets. According to brokerage Marcus & Millichap, three years ago over 60% of apartment acquisition capital was going to primary markets. Today, that share has fallen below 50%. Marcus & Millichap recently brokered the sale of 30 West Apartments, a 264-unit project in Bradenton, Fla., a tertiary market, for $25 million.

“Most of our investments are set up on a long-term hold so we are able to maybe withstand some of the peaks and valleys, which can be maybe a little higher and lower in tertiary markets,” said Matt Fransen, vice president of real-estate investments for Bloomington, Minn.-based Timberland Partners, which purchased 30 West Apartments.

Josh Champion, president of Carroll Organization, an Atlanta-based owner and operator of multifamily properties, said he actively pursues assets in all markets but finds the tertiary markets “very appealing” right now.

“We’re seeing in these tertiary markets cap rates that are two to three percent higher than in the primary and secondary markets,” said Mr. Champion, whose firm owns 50 properties comprising 17,000 units.

When analyzing a possible investment, Mr. Champion said he looks at the same fundamentals in tertiary markets as he would in larger ones: favorable location, good schools, close proximity to jobs and retail and a strong job base. But tertiary markets bring additional risk, he said—risk that is often built into the higher cap rates these properties offer.

One risk is liquidity. Since the buyer pool for properties in tertiary markets is smaller, there are fewer transactions. Hence, marketing a property for sale might take longer than in a larger market. A smaller employer base also creates additional risk because if a local company fails, layoffs would have a disproportionate impact.

“As long as investors are comfortable owning in these markets knowing that there is less liquidity on the exit, I think it’s the right place to be,” said Phil Deguire, Wilkinson’s chief executive officer.

Source: WSJ.com