Western Real Estate Business

AUG 2018

Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.

Issue link: https://westernrealestatebusiness.epubxp.com/i/1012778

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Page 24 of 42

M A R K E T H I G H L I G H T: P H O E N I X 22 • August 2018 • Western Real Estate Business www.REBusinessOnline.com PHOENIX'S MULTIFAMILY MARKET IS HOT, HOT, HOT Real estate investors continue to favor the Valley of the Sun as Phoe- nix multifamily activity maintains a torrid pace. The strong in-migration and job growth that have fueled Phoe- nix's robust rent increases over the past few years show no signs of stop- ping through 2019. According to ARA Newmark research, Phoenix posted the third highest employment growth in the U.S. year-over-year, due in large part to a 10 percent surge in construc- tion jobs. To its credit, Phoenix has smartly managed its housing inventory since the downturn by not overbuilding multifamily or single-family markets. The size of Phoenix's rent increases, as well as its affordabilitys stand out. The region's low vacancy, increasing rents, investor activity and trading volume tend to match national in- dicators. As many large investment groups have seen across the country, housing affordability often limits rent growth. Here, prices remain in the 35 percent range of monthly income — well below many other large cities around the country. Phoenix is among a handful of mar- kets nationwide experiencing above- average rental growth on the heels of strong absorption, according to ARA Newmark research. The Valley outperformed U.S. annual effective rent growth by 2 percent in the first quarter of this year. Not surprisingly, multifamily investment sales also hit a record 12-month volume. If any market dynamic comes as a surprise, it is likely vacancy rates. Rates may stay lower than some ex- pect with the current construction pipeline — while rent growth may stay stronger than most expect. As our desirable downtown push- es through a brief blip in deliveries (3,500 units in development), Scott- sdale, Tempe, Gilbert and Chandler remain in high demand. Some tend to overlook Mesa, but this submarket is poised for significant growth and, consequently, large appreciation and investor interest. Since high-ceilinged, individually metered assets from the '90s remain similar to what is being built today, their functional obsolescence is much less noticeable, if at all. What is notice- able is that the offer volume for these types of value-add properties is al- most double that of apartments lack- ing such characteristics. The area's most active buyers tend to be a mix of local, regional (mostly California), private capital and value- add investors. Still, Phoenix draws plenty of interest among regional, na- tional and international entities who haven't purchased here yet. Most re- cently, Canadian investors have been seeking yield in the Phoenix apart- ment market. Many of today's buyers aren't look- ing to implement a value-add pro- gram to unit interiors as we've seen in recent years. More focus may be on in-place and trailing cap rate with the modest market and wide rent growth. The reason for the switch in focus is that many properties have already un- dergone a rehab and value-add pro- gram. There is simply less to be done to increase rents. Sellers might want to pull out their listing agreements with the large appreciation the market has seen in a very short period of time. Buyers, on the other hand, might want to consider underwriting a lon- ger investment hold to achieve the IRRs they are targeting — and most are. Multifamily brokers are listing buildings that sold just 18 months ago. These investors targeted a lon- ger hold as well, but with growth in Phoenix, many have been able to achieve these goals in a shorter pe- riod of time. Brad Goff Executive Managing Director, ARA Newmark PHOENIX RISING These days, it is more than just the temps that are white hot in Phoenix. Competition among both buyers and lenders is heating up in the Phoenix apartment market. Transaction volume is down from levels set in 2016, but demand is stronger than ever with a record- high level of buyers and capital in the market. The common complaint is that there are more buyers than there are for-sale properties. It is not unusual to have eight to 12 qualified bidders on a deal — twice the number that existed a few years ago. NorthMarq recently brokered a 200-unit, Class C, value-add sale in Phoenix that drew 12 offers with five going into a best and final. At the end, there were four very credit- worthy bidders who all had offers in within $100,000. The financing avail- able for the acquisition was a 10-year, fixed rate of 4.40 percent, 75 percent LTV and an initial five-year, interest only. The main driver behind this ap- petite for apartments is that buyers see a good growth story. Phoenix has come a long way since its housing bubble burst more than a decade ago. The metro is enjoying strong employ- ment and job growth with more than 50,000 new jobs being created and 80,000-plus new residents moving to the area annually. On top of that, the apartment mar- ket has been producing rent growth at 5 percent to 7 percent with signifi- cant room for more growth ahead. Average rents in Phoenix are about $1,000 per month, which is well be- low other metros, such as Denver at $1,400 per month or Los Angeles at $1,900. Despite the competition, buyers are finding opportunities across the board from stabilized Class A proper- ties to value-add assets. Phoenix has been delivering about 7,000 to 8,000 new units per year, which is keeping pace with current absorption levels and providing a steady stream of new for-sale inventory. Investors are also pursuing value- add opportunities. One interesting dynamic is that some value-add as- sets that were repositioned five or six years ago are now seeing a second round of improvements. NorthMarq is currently selling an apartment project that underwent a major ren- ovation a few years ago that is now being marketed as a "second-gen- eration" value-add. There is an op- portunity for new ownership to push the value-add play further by taking steps like replacing cabinets or appli- ances to create even more value. Availability of debt remains a criti- cal ingredient to keeping the invest- ment sales momentum going and borrowers are continuing to find good liquidity and favorable rates. Capital providers are sitting on mas- sive amounts of capital that need to be deployed. Anemic loan origina- tion in 2008 and 2009 has resulted in less business from loan maturities. Lenders are chasing new permanent loans, which has resulted in spreads that have narrowed and effectively absorbed increases in the 10-year Treasury that have occurred in the past year. A year ago, 10-year loans were get- ting done at 190 to 200 basis points over the 10-year Treasury rate. Today, that same deal is getting priced at 150. That compression really speaks to the strong demand and competi- tion on the lender side to do deals. The dominant source of financing for apartments continues to be Fred- die Mac and Fannie Mae. Combined, the two agencies put out $140 billion in debt nationally last year, and they want to do the same amount in 2018. Freddie Mac alone did $10 billion in loans in the Phoenix metro in 2017. Yet both agencies also are seeing fewer maturities. Although they are sticking to sound underwriting prac- tices, the agencies are willing to be aggressive on pricing loans for Class A, B and C assets. Phoenix remains an incredibly competitive market for both lenders and investors. However, this is not a runaway train by any means. Fun- damentals are solid with strong rent growth and vacancies that are below the national average. It is exciting to see the activity on the investment sales side with buyers who are will- ing to turn over every stone to find a deal in Phoenix. On the flip side, lenders are keeping acquisitions in check with solid underwriting and higher equity requirements to com- pensate for cap rate compression. James DuMars Managing Director, NorthMarq Capital Jesse Hudson Vice President, NorthMarq Multifamily

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