Rental Markets Are Picking Up Again

Last week, Phoenix Realty Group (PRG), a national real estate investment manager with offices in New York and Los Angeles, paid $24.2 million for 548 distressed rental units in East Orange, N.J. That property, which consists mostly of one- and two-bedroom apartments, will be operated and upgraded by PRG’s partner in this deal, Newark, N.J.-based TreeTop Development. Around that same time, Marcus & Millichap, the nation’s largest real estate investment services firm, was brokering a $15 million sale of Fresh Ponds, a 120-unit, 110,760-square-foot multifamily complex on 24 acres in South Brunswick, N.J.

These deals reflect an ongoing flurry of acquisition activity in the rental apartment sector, not only in the Garden State but also across the nation. For example, Avalon Bay Communities this month paid $146 million to acquire a 684-unit apartment community in Gaithersburg, Md., and a 348-unit community in Owings Mills, Md. On Sept. 30, Grubb & Ellis Apartment REIT closed on its purchase of the gated Mission Rock Ridge Apartments in Arlington, Texas, consisting of 225 one-, two-, and three-bedroom apartments.

Industry officials and observers assert that the outlook for rental is as strong as it’s been in several years. And the current levels of multifamily production—between 300,000 and 400,000 units in 2010, projects NAHB’s chief economist David Crowe—still fall short of anticipated demand, presenting growth opportunities for investors, property management companies, and even home builders that might be considering diversification.

Market dynamics are turning in rental’s favor, at a time when homeownership is precarious. Last week, the real estate website Trulia.com published its latest Rent vs. Buy Index, which ranks cities by their mortgage-versus-rent costs. While it’s still cheaper to buy a house in markets such as Miami, Detroit, and Phoenix, where home values have plummeted and foreclosures have soared, Trulia calculates that renting makes more sense in places such as New York, Seattle, Fort Worth, Omaha, Sacramento, Calif., Kansas City, Portland, Ore., San Diego, and San Francisco.

The recession has made homeownership less tenable for younger adults, 2.2 million of whom moved back with their parents between 2005 and 2009. In its Outlook report, Marcus and Millichap estimates that up to 4 million Echo Boomers could become part of the prime renter cohort between now and 2015.

That burst, if it does occur, could lead to unit shortages and higher rents over the next few years. In fact, that seems to be happening already. MPF Research, the research arm of the National Multi Housing Council, reported recently that during July through September, same-store rent changes nationwide turned positive for the first time in two years. MPF estimates that rental apartment absorption through the third quarter of 2010, at 283,000, was “one of the most robust totals recorded over the last two decades.”

“We’re in the throes of a recovery,” said Ryan Severino, an economist with Reis, a leading market research firm, during a conference in Las Vegas last week sponsored by Multifamily Executive, which is owned by BUILDER’s parent company Hanley Wood. “I don’t recall a time in the last 40 years that I’ve been more optimistic about our prospects over the next several years,” added another panelist, Steve Bell, CEO of Greensboro, N.C.-based Bell Partners, a diversified real estate investment and management company.

However, only 29,000 new apartments were added in the second quarter, down 18% from the same quarter a year ago, according to Marcus & Millichap, which projects that less than 30,000 more rental units would come online in the second half of the year. The nationwide apartment vacancy rate, at 7.8% in the second quarter, is expected to fall to 7.4% by the end of the year, and asking rents are expected to rise by 2% to 3%.

The buying and selling of rental properties in the second quarter hit its highest level since late 2008. Demand for these properties is ongoing, especially in markets such as New Jersey, where there hasn’t been a lot of construction activity, and where the rental vacancy rate is 5.3%. “If we start to see some job creation, I think developers are going to jump back in,” says Mike Fassano, vice president for Marcus & Millichap’s office in Elmwood Park, N.J. He’s also seen some evidence that financing is “loosening up,” especially from community lenders.

Keith Rosenthal, president of Phoenix Realty Group, agrees that more banks are now willing to release assets they’ve foreclosed on, which in turn is creating more acquisition opportunities.

Three components attracted PRG to the building in East Orange it acquired, he explains: The banks and agents who owned this distressed property were eager to sell; the building was under-occupied and needed physical improvements, so PRG could improve its net operating income through upgrades and fuller occupancy even if overall market conditions don’t improve immediately; and it fit PRG’s niche, which is acquiring apartment buildings in urban centers with access to mass transit for workforce renters, whom it defines as families with household incomes 80% to 200% of the area’s median income.

Rosenthal says his company has several other buildings under contract in both the New York and Los Angeles areas that should close in the fourth quarter of this year. He expects demand and rents to keep rising, primarily because production of new rental properties remains low. “Construction loans are being done, but on a very selective basis.” So far, at least, he's seen no evidence of home builders wanting to jump into rental, which he says is “a totally different business” because rental properties need to be managed and maintained. Rosenthal also isn’t seeing conversions of existing single-family housing stock into rental, at least not as a strategy by banks or developers.

John Caulfield is a senior editor for BUILDER magazine.

Learn more about markets featured in this article: Los Angeles, CA, Dallas, TX, Greensboro, NC, New York, NY, San Francisco, CA.