According to a recent report from Yardi Matrix, “the average national occupancy rate has been above 95.0 percent for several years, and housing trends would indicate that demand will remain strong for some time to come.” Additionally, “rents have grown 2.9 percent through the first three quarters of 2019,” the same report notes. “That represents a slight slowdown from the same periods over the last few years, but the performance is very respectable compared to long-term historical trends.”
Given this, it’s no surprise that equity investors remain highly interested in the apartment market. In the National Multifamily Housing Council’s third-quarter market survey of its members, the Equity Financing Index was 55. A reading above 50 indicates that, on balance, equity is more available when compared to three months earlier, while a number below 50 means that equity is less available. A reading of 50 means conditions are unchanged.
The survey marked the eighth straight quarter in which the index came in at 50 or above.
I don’t see equity’s interest in the multifamily market decreasing anytime soon, but I do think the nature of that interest may change. In short, I think it’s possible some investors and owners may begin to grow more cautious of value-add acquisitions.
AN OVERHEATED MARKET?
For several years it seems, value-add acquisitions have topped many investors’ and apartment companies’ wish lists. It’s no mystery why that’s been the case.
When you couple the historically lower acquisition costs of value-add communities with the ability to significantly push rents after renovations, there is the potential for higher returns than you might find from core properties. However, because these communities have been so in demand, the sale prices of value-add properties have spiked, reducing the opportunity to get those desired returns.
In fact, when you combine these increased acquisition costs with the expenses of renovations that set the stage for increased rental rates—the installation of stainless-steel appliances, vinyl-plank flooring, granite countertops, etc—owners can wind up paying a core-like price and getting core-like returns.
Value-add communities can present another challenge as well: unexpected capital expenses that don’t impact a community’s ability to increase rents. After acquiring a value-add property, an owner may soon have to replace roofs, windows, concrete, asphalt and air-conditioning systems. These projects, which can be difficult to forecast when analyzing a value-add investment opportunity, can eviscerate projected returns.
THE APPEAL OF CORE
With all of these factors in play, some owners and investors who have acquired value-add properties in the past—including my company, JVM Realty Corp.—have grown extra cautious about buying these communities for now. Instead, they have increased their interest in core properties, which may carry less risk and can produce comparable returns in an environment where the pricing for value-add has reached such high levels.
Owners who self-manage their communities have even discovered they can wring some additional returns out of core properties. When a third party is managing a community, the communication and decision-making processes between owner and manager can be unwieldy and inhibit property performance. The adjustments in operational strategy and tactics needed to maximize revenue can’t be made as efficiently.
Looking ahead, value-add communities will always be a popular strategy for many owners and investors, especially as construction costs continue to climb. However, the risk vs. reward differentiation between core and value-add is giving some pause. In the end, certain investors and owners are bound to conclude that core properties are a better investment option for the time being.
Jay Madary serves as president and CEO of JVM Realty Corp., an Oak Brook, Ill.-based owner and operator of apartment communities throughout the Midwest.