Transactions market in Phoenix

There may be an oversupply of residential rental options in the volatile Phoenix market, but the opposite is true of transaction opportunities.

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“Transaction velocity is still very stagnant, contrary to popular belief,” said multifamily investment specialist Steve Gebing, whose group operates under the Marcus & Millichap umbrella in the Valley of the Sun.

It’s easy to compare this year with last year and say transaction velocity is increasing, he said. In 2008, a total of 19 apartment communities with more than 100 units changed hands. As of Nov. 23, that number stood at 29.

“So, velocity is up, but not that much, compared to where we were in previous years, especially when you look at the hyper-growth years of ’05 and ’06,” he said of the boom time when many unwise decisions on the multifamily investment side were based on speculation.

At the peak of the market in 2005, Phoenix saw 219 transactions, dropping to 184 in 2006 and 124 in 2007. “My belief is that we’ll close out this year somewhere in the range of 30 to 33 closings for the calendar year, which will be around 75 percent. So that’s a good sign. But, more importantly, the key indicator for us as brokers is demand. The pent-up demand is no longer pie-in-the-sky. The facts are the facts and now we are really seeing true activity,” said Gebing, who, along with his partner Cliff David, operates a boutique brokerage service.

When a multifamily property is listed in Maricopa County, especially if it’s an REO (real estate owned) Class A property that has been taken over by the lender after an unsuccessful foreclosure auction, it’s not uncommon to see anywhere from 20 to 50 property tours and in the low to upper 40’s in offer activity.

Of the deals that sold between the beginning of this year and Nov. 23, almost 100 percent went to private buyers. Almost 50 percent of them were distressed sales, with 12 REOs and one short sale. The only sale to an institutional buyer in the desert market this year was the June short sale of the 232-unit Sky View Ranch that Fairfield Residential completed in 2007. Memphis-based Mid-America Apartment Communities bought the community in Gilbert, a southeast suburb of Phoenix, for $17.5 million or $75,431/unit.

But such opportunities are few and far between, said Gebing. Although Phoenix is ahead of the national game in the distressed asset sale department, there isn’t a huge floodgate of opportunities opening up to satisfy the pent-up demand.

There are 939 properties with 100 units or more in Maricopa County, 41 of which are listed for sale through brokerage houses and 50 percent of those have been on the market for more than a year. “When they’ve been listed for more than a year, clearly there’s a lack of motivation on the seller’s behalf or they’re not priced to sell in this market and they’re really not deliverable assets. So, you’re looking at 20 to 25 properties that are truly deliverable and, when they do surface, the sharks are on board,” said Gebing, whose brokerage firm does all of its own market research.

In general, he expects offer activity to range from 15 to 20 when opportunities come to market, but it’s not uncommon to see more than twice that many, if the deal is right. A good example is the August sale of the 316-unit, 20-year-old San Tropez in the upscale suburb of Scottsdale to Santa Barbara, Calif.-based private NALS Apartment Homes, which operates 12,000 rental units across the country. That deal attracted 43 offers and north of 60 property tours, which is not unusual for a Class A deal in an A or B+ location, he said.

San Tropez sold for $29 million, around 94 percent of the original list price, but not all deals in Phoenix are so accurately priced. “There’s a deal right now that was listed for almost $80 million and it’s in escrow for just under $48 million,” said Gebing, who estimates cap rates for Class B properties are in the mid-seven to the low-eight percent range and anywhere from 6.75 to 7.25 percent on A’s.

“With the Class C properties, it’s a complete guessing game right now,” he said. “If it’s a good mix of two-bedroom and one-bedroom floor plans and was built in the early to mid-’80s, it’s probably going to sell for $15,000 to $18,000 a unit, but in most cases right now, those buildings are in such poor locations that they are 50 to 60 percent physically occupied, so there really is no cap rate to speak of,” he explained.

Those communities were populated largely by illegal immigrants, who have been forced out of the state by Arizona’s Immigration Sanctions Reformat that went into effect in January 2008 and imposes civil penalties on employers of suspension or revocation of their business licenses if they are found to have knowingly hired illegal immigrants.

Couple that with metro-wide loss of around 200,000 jobs over the past two years and you’ve got an exorbitant amount of supply with very limited demand, Gebing said. “Because rental rates have declined so dramatically, people who were in C buildings can maybe move up to B- or B buildings and the people in the B’s are moving up to A’s.”

While almost 50 percent of the deals that took place between the beginning of the year and late November were properties built after 1990, with the majority constructed in the late 1990s and early 2000s, he predicts the real transaction opportunities over the next eight to 16 months will be in the C space, where assets are seeing the most distress and are in the most inferior locations and lenders are starting to come to grips with the facts.

With just north of 3,000 units still under construction in Metro Phoenix and scheduled to deliver next year, Gebing believes the heavy concessions on Valley apartments that averaged around two months free in October and November, likely have peaked, but rent decreases will continue for a while.

However, once the foreclosure activity on single-family homes returns to historic norms and jobs begin to return to the market, Phoenix has all the elements in place for future prosperity. According to a recent copy of MarketMonitor 360, which Gebing and David prepare and present monthly, Newsweek magazine expects Greater Phoenix to be the second largest job engine in the country through 2025 and the Sept. 15 issue of U.S. News & World Report ranked the city one of the ten best places for technology jobs.

The Wall Street Journal reported in May that the Valley of the Sun is a hot spot for young professionals, attracting college-educated, single people between the ages of 25 and 39 at a higher rate than all other cities in the country.

“The business climate in Greater Phoenix is also very conducive to entrepreneurial startups, ranking number one in the nation to start and grow a business,” MarketMonitor 360 says, also noting that “driven by expectations of increasing demand for renewable energy, Arizona will soon have $350 million in new incentives at its disposal in January 2010 to woo renewable-energy firms. Emerging as the new frontier in economic development, the payout will be jobs.”

Gebing, who sees the operational bottom for the Phoenix apartment market some three to six months away, believes the Valley will come out of this recession stronger than ever. “People want to be in Phoenix. We’ll never see that change. So I think we’re going to see a rebound that’s going to be pretty impressive when we get through this cycle,” he said.