Are we on the brink of a Recession?
We have had two consecutive quarters of negative GDP growth, and that is the definition of a recession. However, DC says “don’t mind that because job growth is still strong.” On the other hand, this is coming from the same folks who said inflation is transitory before it blew up to the worst in 40 years. Creditability a tad shaky?
It is a long-standing pattern: the FED raises interest rates, leading to higher mortgage rates and payments, leading to a slowing in home purchases, leading to a slowing in construction, leading to slower purchases of commodities like lumber, concrete, wiring, a/c equipment, etc., leading to a slowing in furniture and appliance sales, and, hence, creating to a slower economy.
Question: If we are experiencing the worst inflation in 40 years, do you think a “soft landing” really lies ahead of us?
Well, we like to be “data dependent” and rely on the science of statistics. So, here we go with our focus this month on the Multi-family sector in San Antonio.
Commercial Real Estate Values
Overall Commercial Real Estate values are beginning to experience a price decline. According to Green Street Commercial Property Index, which saw a decline of 3.7% in June further explaining that, “The all-property index is down 4.9% from its March high.” Values have certainly been affected by the surge in interest rates, inflation and the overall uncertainty in the market place. However, real estate is generally thought to be a shelter from inflation and apartments are one of the safest sectors.
Will a receding tide swamp all boats?
Rent Growth Above Average
Let’s look at rents, then, because that is the true source of real estate values. San Antonio’s Year-Over-Year apartment rent growth is 10.3%, down from 12.4% in 2021. This is still one of the fastest increases in the United States, although occupancies have declined just a little from 93.1% down to 92.6%, according to Apartmentdata.com. CoStar data reports that Multi-Family rents have peaked from their record-breaking heights last year. Despite the fact that they have peaked, rent growth is still above average at 9.3% in Texas and nationally rent growth saw a surprising spike of 12%, so San Antonio is in line. Going forward, Moody Economics projects a strong but more sustainable 5 to 7% in 2022 and 3% in future years. Inflation is the outlier and may push rents even higher, perhaps. Austin has seen year-over-year rent growth of … wait for it … a whopping 20%! That’s insane.
Multifamily Steps in to Fill Housing Gap
Multifamily is filling the housing gap. The surge in home prices of 18% in the past year along with the increases in interest rates has driven up home buyers’ mortgage payments, therefor, making home purchases more difficult. As a result, it would seem that many families have decided to continue to rent for now, instead of buying new homes.
“US Mortgage applications dropped to lowest level since early 2000,” reports Mortgage Bankers Association for the week ending on July 15th, 2022. This is the lowest since February 2020, the beginning of the national pandemic. Home building has been low for a decade following the Great Recession and building is now falling further, so an inadequate supply of new single-family housing is on the horizon. Here in San Antonio, we just rebounded in new home construction to the rate we last saw in 2005, back before the big drop from 2007 to 2011. Now our city has a larger populous and needs more new homes built to accommodate.
San Antonio’s Economy Doing Well
San Antonio’s Economy is still doing well with an increase of 155,000 jobs since the Pandemic low in April of 2020. The higher income sector of the major labor sectors has added close to 12,000 jobs over the past two years, indicating our Fair City is drawing more tech and financial companies than in the past. This is transforming San Antonio where government and health care have been the largest job categories. So, the increase in apartments is being absorbed by higher income move-ins. Marcus and Millichap reports that, “This correlates with the ongoing Class A vacancy reduction, as more residents have incomes to support renting at higher-quality properties with amenities.”
New Construction of Multi-Family
Current New Construction of multi-family properties in San Antonio is exceptionally strong right now. Our growth and ambience as a lovely place to live and raise a family is continuing to attractive relocating families. San Antonio’s greatest draw is from the RGV, Houston and Austin areas, not just out- of- starters like Californians. Currently, there are over 7,800 apartment units under construction in 30 separate multi-family communities, then there are twice that number in the pipeline. However, about 3,200 units will actually be added to the market this year. Remember that it takes over two years to build a complex, and not all that are planned ever get built. Occupancy levels are remaining strong at 92.6%, down just a little bit, possibly due to college graduations and summer moves.
Austin’s Market Grows Stronger Still
Austin is the #6 strongest apartment city in the U.S. according to Wealth Management Real Estate, with new construction at 5% of the current total of units, where 1% to 2% would be a “normal” number. It is considered that adding 1% of the current amount of commercial space, be it office, retail, industrial or apartments, is a healthy increase. When it rises above 2%, there better be a lot of job and population growth to soak it up, and we all know that Austin has that in spades.
Austin’s supply growth actually leads the U.S. this year, but then there is little that is normal about “Planet Austin.” San Antonio now has a 1.5% inventory expansion, which is actually one of the lowest in the southern region of the country, where job growth is the strongest. Our average annual construction expansion is 2.7%. Translation: in the Alamo City we aren’t building enough apartments so vacancies will decrease and rents will continue to increase. Yet, while San Antonio has the largest construction pipeline in our history, we are still the smallest of the four major Texas markets. For example, we have about 14,000 in the pipeline, while Austin has 31,000.
Looking back at the national multifamily construction rate over the past 16 years, since the Great Recession, there has been a slow but steady rebound. From the Census Bureau, completions of multifamily units nationally hit a 30 year low of only 129k in 2011 but then ran at an average of 244,000 per year from 2012 to 2019. Then, in 2020 we reached 364.7k, and 363.7k in 2021. But 2022 will see a record 426,000 apartment units constructed.
Single Family Housing Shortage
The Single Family Housing Shortage is nearing, in contrast to apartments. Zonda, a widely respected housing analyst, says that the rising demand for single family homes outstrips the current supply. Housing demand is inflated across the country, but it is particularly high in many Sunbelt cities. “In 2021 demand was twice as high as supply and this mismatch has resulted in a 5.6% increase in (rental) renewal rates between Q4 2020 and Q4 2021 and the number of vacant units has fallen below one million nationally.” While home building is falling into recession, we are still under-building for the long term market needs, especially in the lower end affordable area.
Kimberly Byrum, Zonda’s Managing Principal, said that “Rent prices have surged in the past 9 months.” All markets have seen an increase of at least 10% and have risen 19% nationally and according to Byrum this trend will continue. This is a result of the combination of 1) Low availability of vacant units plus 2) a limited pipeline of new housing plus 3) the highest renewal rate in in history (58% in Q1 2022) results in a housing shortage for some time to come.
Green Street reports in their July blog that apartments are considered the safest investment in economic downturns, AKA Recessions, and “2022 is slated to be the strongest one (year) for apartments” with growth of 10% by revenues. “Apartment values declined by 4% last month, but are still up 15% over the past year, and 16% relative to pre-Covid levels.” However, Apartment transactions still dropped from $10B in May 2021 to $9B in May 2022.
Now, Apartment investors are starting to focus more on newer properties. Wealth Management Real Estate Magazine reports that, “With a shrinking delta in cap rates between assets of different vintage, many investors opt to go with lower risk, newer properties with fewer capital expenditures.” In the past decade, older properties generally increased in value, with a drop in capitalization rates from 6.2 down to 4.3. While, according to CoStar Advisory Services, newer assets compressed from 5.3 percent down to 3.8 percent. So, the dramatic increase in value for older properties, may be over, making this a better time to sell older properties at or near the top of the market and then wait for a better time to buy in the future.
New Construction Defined
How do apartments get rated A, B and C? New Construction, by definition, is Class A. It is impossible to build a Class B apartment complex because costs are about the same for all new apartment construction. This encompasses the land costs, lumber, steel, copper wiring, and concrete portions of buildings; all are about the same no matter how fancy your new project proposes to be. If you thought about building a “cheap” property, it wouldn’t be that much less costly as a typical Class A property, but you would not be able to rent it because discriminating renters don’t want to be in a cheap new apartment. Actually, the break down is Class A, Class A minus and then, Class A plus for units that are high rise and very luxurious.
Generally, apartments built in the past 15 years, that is, since the so-called Great Recession, are considered Class A, having better amenities and design, so that upgrading them is perhaps less expensive, so they may appeal more to investors. Properties built from 2007 back to the early 1990’s are considered Class B, if they have been kept up with little deferred maintenance and inherently lower rents and higher costs of maintenance and remodeling. Class C properties, then, were built in the 1980’s before the Savings and Loan Crisis, also known as the RTC times.
These older properties have now been bid up to the level close enough to newer ones, that the upside is limited compared to the more expensive on-going maintenance required to keep units well occupied. There are now enough properties built in the past 15 years that need cosmetic upgrades, so they may apparently represent a greater long-term value for investors.
Older units are now seen as riskier assets, costing more to maintain, higher insurance costs, and less upside to rents. So Class B apartments are just old, and Class C are older still. These types of properties are often bought by investors who remodel and upgrade them with new interiors, flooring, fixtures, roofs and landscaping, seeking to create added value in excess of the costs of upgrades. The buyer then will raise the rents a lot higher that what the rents were before the remodel. However, they will still rent for less and appeal to slightly lower income tenants than those of Class A properties. In this way there is something for everyone!
According to CoStar, these older Class A-minus properties with a few years under their belt, account for a larger portion of the acquisitions. In 2018 the newer properties were 22 % of the market but 32% in 2021. However, older properties remained at about 11% of the market in respect to the number of transactions, as well as, dollar volume.
San Antonio has traditionally been a local investor market, with little interest from large institutions, however in recent years well-capitalized national buyers are outbidding locals, with an increase in average sale price of 40% in that past five years to $120,800, according to Marcus and Millichap. Capitalization rates are as low as 4% on the Northside and particularly the Medical Center.
An example is the Remington Ranch Apartments in San Antonio, which was bought by a California investment company. Built in 2008 with only little more than cosmetic repairs in the past 15 years, the new owner will invest $2.8-million in interior and exterior upgrades. The apartment investor said, “We thought: if we’re going to be paying these prices, we might as well look for newer, nicer properties so if the economy turns, we can hold for the next 10 years and not have to spend money on deferred maintenance.”
New Construction’s affect on Rents
New construction is putting some downward pressure on the rent spiral. Guadalupe County has a 12.8% growth, but CBD is down to a still respectable 5.6% growth rate. Consider that CBD apart development added 175% to the CBD inventory since 2010, Viva ‘Decade of Downtown.’ The Great Northern Arc of Loop 1604 from Potranco around to Converse has seen substantial new development, averaging rent growth of 10-12%. New Braunfels/Comal County is not far behind at 9.5%. Guadalupe County, which includes Schertz and Cibolo, as well as Seguin the County Seat, has added 9.4% to its apartment unit inventory in the past year. Compare this to 4.3% in New Braunfels and 1.8% in San Antonio, albeit SA’s base is far larger so moving the needle that much requires many more units. Guadalupe County has still achieved a low 4% vacancy rate in July despite all of this added inventory, and 12.8% growth in rents!
Apartment Rents and Apartment Construction in San Antonio
To pull all of this together: Apartment rents have had a big spike but are now slowing to a more normal rate of growth and single family rents are doing the same. Apartment construction in San Antonio is very strong, yet appears to be on pace to keep up with demand as the city continues to grow at a healthy pace. Even more so, as home construction moderates we may still continue to under build the market demand. Overall, apartments make a good investment sector, but it is only for experienced and well-capitalized players.