Making hay while the sun shines

Reporting steadily rising rental rates, occupancy that could hardly get better and healthy balance sheets so far this year, multifamily REIT executives sounded almost jubilant during recent first-quarter earnings calls.

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“The economy appears to be on a path of sustainable growth. U.S. businesses have healthy balance sheets and plenty of liquidity-consumer debt has declined to levels not seen since the early 90s,” said AvalonBay Communities, Inc., CEO Tim Naughton at the beginning of May.

In addition, he said, the single-family housing market recovery continues to strengthen, which should stimulate economic growth going forward. With that macro environment as a backdrop, AvalonBay execs remain optimistic about apartment fundamentals, which will benefit from a combination of strong household growth and favorable demographics.

“The young adult cohort is growing and these individuals are finding employment at an increasing rate. In fact, job growth for this cohort is the strongest since the 1970s and has accounted for about 45 percent of net new jobs since 2010,” he said.

Due to changing lifestyle preferences and a desire for greater flexibility, the 25- to 34-year-old prime renter cohort is less likely to purchase a home than in past recoveries, he said, adding that, despite tepid economic growth, “apartment absorption has been stronger than any period since 2000 and the continued growth in the echo boom demographic should be a strong driver of apartment demand over the next decade.”

Gearing up to meet that demand, AvalonBay had 30 communities under construction in Q1. The REIT took over development and construction management of five Archstone communities under construction and added six new development rights to the apartment REIT’s shadow pipeline when the $16 billion acquisition of Archstone Enterprise LP from Lehman Brothers Holdings, Inc., by AvalonBay and Equity Residential closed last February.

“We completed three AvalonBay developments this quarter for a total capital cost of about $180 million,” reported CFO Tom Sargeant at the beginning of May. All three communities-the $68.7 million, 204-unit Avalon Garden City in Garden City, NY; the $77 million, 354-unit Avalon Park Crest and the $33.3 million, 138-unit AVA H Street in Washington, D.C.-were delivered ahead of schedule and have outperformed original expectations. Each of those completions is projected to produce an initial stabilized yield of 7.5 percent or better.

“For those communities under construction and in lease-up for the entire quarter, performance is equally impressive, with achieved rents that are about $80 ahead of pro forma and projected initial yields that are about 60 basis points better than pro forma,” he said.

The REIT also started two new AvalonBay developments this year, totaling $260 million, and acquired five Archstone developments underway for another $280 million in projected costs. “Altogether, we had 30 communities under construction during the first quarter, representing $2.4 billion in total capital investment with a projected stabilized yield of 6.7 percent,” Sargeant reported.

“We were also active with the development pipeline, adding four AvalonBay development rights with over $300 million in projected capital investment and six Archstone development rights for another $700 million in capital. Our shadow pipeline now stands at about $3.6 billion. We expect construction underway to continue to grow over the next several quarters before peaking in the first half of 2014 in the $3 billion to $3.5 billion range,” he predicted, adding that there’s “tremendous profit potential embedded in that pipeline.”

In addition, Sean Breslin, AvalonBay Executive VP of Investments and Asset Management, said a majority of the Archstone assets have redevelopment potential and AvalonBay teams were going through all of the company’s assets and resequencing the REIT’s redevelopment pipeline to integrate the new Archstone assets with AvalonBay’s.

Equity Residential, which saw its 127,814-unit nationwide apartment portfolio increase by 20,160 units in the Archstone deal, brought six Archstone assets with a total development cost of $400 million into Equity Residential’s pipeline.

“Of these new additions from Archstone, our current expectation is that only the Marina del Rey project is a long-term hold and we would expect to sell the others following lease-up and stabilization,” Equity Residential CEO David Neithercut explained during the REIT’s Q1 earnings call on May 1.

Equity Residential had $1.4 billion of active development underway at the end of March. That number increased during the first quarter when the REIT got started on 170 Amsterdam on Manhattan’s Upper West Side on a site that was tied up in early 2011. EQR plans to build 237 units on a long-term ground lease at the location.

As part of the Archstone transaction, Equity Residential also acquired 14 new land sites and plans to hold six of those-one in Washington D.C. and five in the San Francisco Bay region. The eight sites the REIT plans to sell include three in Arizona, one in San Diego, two in South Florida and two in Maryland about 30 miles south of Washington D.C.

“With the Archstone land sites that we intend to keep, we now own a total of 17 land sites and control two others, all in our core markets, representing about 6,200 units in great locations in Washington, D.C., San Francisco, Seattle and Southern California, with a development cost of $2.5 billion,” Neithercut explained during the REIT’s Q1 earnings call.

In addition to the $130 million of projects already started this year, Equity Residential has the potential to begin construction yet this year on as much as $1 billion more of development and all potential development starts will be addressed on a case-by-case basis with a close eye on appropriate sources of funding, he said.

“But, at the present time, we expect to begin another $500 million to $700 million, bringing our total starts for the year to as much as $800 million and adding great assets to our portfolio in key locations,” said Neithercut.

And, the company also sees plenty of upside in redevelopment opportunities at the recently-acquired Archstone communities.

“I have been to most of the properties. There’s a lot of CapEx that was in process. I think they did a reasonable job of maintaining the integrity of the buildings. I think the opportunity is in the interior of the units, the rehab opportunity,” said David Santee, EQR’s chief operating officer since April, when he was chosen to oversee both the company’s operations and property management. Previously, he was EVP of operations at EQR, where he has served since 1994 in a variety of roles.

He said EQR plans to take advantage of those rehab opportunities and, at the beginning of May, was gearing up to start makeovers on eight to 10 apartment communities.

Adding some color, EQR EVP and CFO Mark Parrell said, “We have about 1,200 Archstone rehabs we expect to complete this year. We have 3,600 Archstone units that we’ve approved rehabs to do and we expect to knock out 1,200 or more each of the next few years.”

He expects the REIT will spend well below the amount the company would ordinarily expect on a new, one-off acquisition and well below the total amount of expected spend for CapEx when EQR underwrote the Archstone deal.

Parrell said he expects to spend around $1,500 per unit on the same-store side on rehabs and a little bit more than that on the Archstone units, but not much more.

And Neithercut said rehabs offer the biggest value-creation opportunity for the former Archstone assets. “I think that the Archstone/Lehman team did an adequate job taking care of the properties, but we don’t think that they took advantage of opportunities that were there with a little extra capital and I think that it’s the rehab,” he said, adding that EQR is skilled at executing multifamily facelifts.

“We’ve really got it down to an art here,” he said, explaining that, on the rehabs the company had underwritten so far, the REIT could see 15 percent returns on another $35 million of investment in the Archstone assets. “So, we think that will create a significant amount of upside for us,” he said.

Tom Toomey, CEO of UDR, Inc., which owned or had an ownership position in 54,195 units across the country, including 2,887 units under development as of the end of April, said that development and redevelopment are the most attractive of accretive investment opportunities available today.

“Our $1.2 billion pipeline, of which 43 percent is expected to be delivered in 2013, is nearly 52 percent funded and is comprised of projects in desirable locations that will help drive high-quality cash flow growth per share in the coming years,” he predicted.

The multifamily REIT spent $111 million on development and redevelopment projects during Q1 of this year, including $2 million on the recently completed $126 million Capitol View on 14th in Washington, D.C., where the company has yet to feel any negative impact from impending new supply in the nation’s capital, which is the only major market in the country of concern to multifamily players, as the U.S. government cuts back on employees in response to economic concerns.

UDR’s $98 million, 391-unit Fiori in the REIT’s Vitruvian Park development in Addison, Texas, delivered first units in late March and was 10 percent leased a week later and the $150 million, 467-unit Residences at Bella Terra development in Huntington Beach, Calif., was 17 percent pre-leased at the end of April, with delivery of first units expected in mid-May.

The REIT’s $65 million, 256-unit Domain College Park development, located across the street from the University of Maryland’s business school, was 11 percent pre-leased at the end of April, with expected delivery of first units in June.

UDR Senior VP of Asset Management Harry Alcock told analysts during the company’s Q1 earnings call that he doesn’t expect any more new starts until early next year. Also active on the redevelopment side, UDR completed the makeover of 424 units at its $36 million, 583-unit Westerly on Lincoln in Marina del Rey, Calif., by the end of Q1, averaging a 15 percent increase in rental rate on those units. At quarter end, demand remained strong at the community that was 98 percent leased and 96.4 percent physically occupied.

UDR saw a 12 percent increase on the 205 units that were redeveloped by the end of the quarter at the $60 million, 706-unit Rivergate in Manhattan that was 94 percent leased and 91 percent occupied at the end of Q1.

The REIT also completed redevelopment of 220 units at the 964-unit 27 Seventy-Five Mesa Verde in Costa Mesa, Calif.

Toomey said third-party research providers estimate that five new jobs are required to generate demand for one apartment unit. “Using this relationship, 18 of our 20 markets are expected to have more than sufficient demand to fully absorb the new multifamily supply that is forecast to come online over the next three years.”

Camden Property Trust CEO Ric Campo also debunked concerns about possible apartment oversupply. “The supply that’s being delivered in and started in 2013 doesn’t come close to meeting new demand and filling the supply deficit that was created during the financial crisis,” he said, citing Witten Advisors’ estimate that a deficit of nearly 500,000 apartments was created during the 2009-through-2012 financial crisis.

Improvement in the single-family housing sector, along with an increase in home prices and new construction, will benefit the apartment industry, he said.

“We welcome the improvements in the single-family home market, as it adds jobs and creates more rental demand than move-outs to home purchases take away from rental demand, so we end up with net new rental demand, as a result of the stronger economy,” said Campo, adding that the continued above-trend performance in the multifamily rental sector should keep growth above trend through at least 2016.

“We’re off to another solid start this year,” Camden President Keith Oden told analysts during the company’s Q1 earnings call. He reported historically strong NOI growth for the quarter, when same-store average rents on new leases were up 1.9 percent from the previous lease rate and renewals were up 6.9 percent, with revenue growth strong across almost all of the company’s 16 markets and double-digit increases in Houston and Charlotte. Occupancy across Camden’s same store portfolio, which as of the beginning of May encompassed 43,869 units of the 64,835 units in the 192 properties that the company owns interests in and operates across the United States, stood at 95.6 percent, leaving Camden well-positioned heading into peak leasing season.

And, despite aggressive renewal rate increases, turnover at Camden’s apartments declined by one percent from 48 percent to 47 percent year-over-year and reported move-outs for financial reasons or job loss fell a percentage point from 6.1 percent to 5.1 percent.

In addition, Camden experienced higher than expected leasing activity at each of the REIT’s three lease-up communities in its development pipeline. For example, the 268-unit, $36 million Camden City Centre II in Houston, which began lease-up in the first quarter of this year with expected completion in Q2, was 46 percent leased and 33 percent occupied at rental rates of more than 20 percent above original pro forma by the beginning of May.

Confident of the unlikelihood that anything will derail multifamily’s gravy train in the next several years, Camden execs are comfortable starting $250 million to $400 million of new apartment communities over the next couple of years, but will keep the development pipeline at moderate levels by finishing projects before starting others to manage overall exposure.

“We’re also making sure that we fund these developments as we go, either through dispositions or other capital market activities. We feel comfortable as long as we can continue to get yields that are 150 to 200 basis points over the trended yield and cap rate that you can buy in a new asset and we’re going to continue to develop,” said Campo. Final development decisions will depend on the micro aspects of the submarket for each development.

As of March 31, Camden had a total of 2,269 units under construction with a total budget of $550 million. In addition to City Centre II, the REIT is underway on the 320-unit, $110 million Camden NOMA in Washington, D.C., and the 314-unit Camden Lamar Heights in Austin, Texas, both of which are scheduled for completion in Q2 2014; the 424-unit, $78 million Camden Flatirons in Denver and the 261-unit, $54 million Camden Boca Raton in Boca Raton, Fla., both of which are expected to wrap up construction in Q4 2014 and the 303-unit, $115 million Camden Glendale in Glendale, Calif., and the 378-unit, $110 million Camden Paces in Atlanta, which both are scheduled for completion in 2015.

Also underway are two communities Camden is building in joint venture-the $88 million, 276-unit Camden South Capitol in Washington, D.C., and the $40 million, 300-unit Camden Waterford Lakes near Orlando, Fla.-that are scheduled for completion in Q3 2013 and Q3 2014, respectively.

On redevelopment, said Oden, “We are putting in roughly on average $9,000 to $10,000 per door and getting an 11 percent increase on that. That’s in addition to whatever market rate increase would be in whatever submarket that happens to be in,” he said, estimating around $105 per door across the entire program.