The U.S. apartment sector continues to strengthen, making it a compelling investment for opportunistic and value-add strategies, according to Marcus & Millichap Co.
The real estate firm's research unit said the sector showed meaningful gains in 2011 as vacancy rates dropped, rental rates rose and residents migrated to less expensive units, driving improvements from Class A properties into Class B and C properties.
"The apartment sector has fully moved into an expansion cycle," Marcus & Millichap said.
"The closing months of 2011 manifested meaningful increases in productivity, monthly job creation, wage and income growth, consumer confidence, and household formations, forming a powerful alliance of demand drivers," the firm said in its apartment outlook report.
Capitalization rates and stabilizing operations make the sector a good buy for the right investor, the firm said. Total sales volume for 2011 increased 39% over year-ago levels to $64.9 billion. Sales of the $40 million-plus properties dominated, rising 52% over year-ago figures. Sales in the $10 million to $20 million category followed, up 42%.
Equity funds remain active buyers of portfolios and distressed properties while real estate investment funds prefer high-density product in 24-hour cities.
"The cap rate arbitrage between asset classes, market tiers, and spreads relative to the 10-year Treasury, along with evidence of stabilizing operations in Class B assets … create a compelling investment thesis," Marcus & Millichap said.
Vacancy rates measured 5.2% in the fourth quarter, a 40-basis-point decline from the third quarter and a sharp drop of 140 basis points from just one year ago.
Effective rents grew 4% across the country, with some gateway and constrained markets achieving double-digit increases. An effective rent is the actual cost of renting an apartment after all specials and discounts are subtracted. Effective rates now meet or exceed their prior 2008 peaks in many markets, the report said. The rising rents pushed operational improvements from Class A into Class B and C properties.
About 85,000 units are under construction and should be completed this year, below the expected demand for 120,000 units although many more are in the permitting stage. The supply-demand disconnect likely will drive the vacancy rate to 4.8% this year, which would be a 10-year low.
Still, the sector faces some challenges. Fannie Mae's REO-to-rental program could compete with apartment rentals in some markets. And record-low mortgage rates and home price stability could push some homebuyers off the sidelines and into buying mode.
Headwinds in the single-family market could further boost the apartment sector's expansion as some prospective homebuyers are sidelined from buying a home by down payment hurdles, low appraisals and mortgage denials as FICO scores required to get a loan creep upward.