Yield PRO TV presents NAHB Power Hitters. Host Linda Hoffman talks with Bill McLaughlin, EVP Development & Construction of Avalon Bay.
Transcript: NAHB Power Hitters interview. Linda Hoffman with Bill McLaughlin, recorded October 6, 2021
Linda Hoffman: Multifamily housing starts were up in August. Way up. Rising 21.6 percent to 530,000 units annualized. Multifamily permits also increased: up 15.8 percent, on pace for 674,000 units.
The seasonally adjusted year-over-year increase in multifamily construction starts was 10X that of single family in August. Such news is welcome against a continued backdrop of, otherwise, wall to wall bad news including weak GDP, high inflation, and soaring gas prices.
Most importantly, the increase in construction activity was accompanied by a rise in builders’ confidence. Concerns around lumber prices have finally eased. And while materials shortages, and supply chain issues, continue to draw out project completions, it seems we’re working our way through.
Fueling it all is a continued great migration. The great affordability migration is moving away from the West Coast and Northeast to more affordable markets in the Rocky Mountains and smaller metros.
Today’s guest is at the center of it all. Avalon Bay is the nation’s third largest apartment owner with nearly 80,000 units in its portfolio—and the 13th largest apartment manager. As the company’s EVP of development and construction, Bill McLaughlin knows a great deal about apartment production and inventory. Something that is changing daily. Bill, welcome to the show.
Bill McLaughlin: Well, thank you, Linda. It’s a pleasure to be here and looking forward to catching up.
Linda Hoffman: Bill, if you would, give us a quick snapshot on your background, and how you came to run development and construction at Avalon Bay.
Bill McLaughlin: Sure will, thank you. I’ve been with AvalonBay for over 27 years, and have been in the development business for about 35. I got my start locally, in Cambridge, Massachusetts, right out of college, and my first foray into real estate was owning and redeveloping rent-controlled properties in Cambridge, which was quite a baptism by fire. But, I’ve been at it for a number of years, now, and I’ve seen an awful lot of development, a lot of changes and trends in the industry, but, enough to be in one place for a majority of my career.
Linda Hoffman: CoStar’s U.S. land price index is up over 150 percent since bottoming out in Q2 of this year. How big of a hurdle is land to development?
Bill McLaughlin: You know, land continues to be a challenge, especially land permitted for multifamily development in virtually all of our markets, but it’s only one of the challenges we’re facing these days. The biggest component of cost is hard costs, construction costs, and that continues to climb even though we seem some relaxation in lumber pricing. But it’s always a challenge, and I will say this, there’s just a ton of capital flooding into our space, so it’s just a very competitive environment.
And good site gets bid up by 8, 10 potential developers at a time.
Linda Hoffman: What is driving the low supply of good sites? Are the good ones gone, or have land-use restrictions kept good sites off the market?
Bill McLaughlin: Yeah, I’m not sure there’s a terrible shortage of good sites, they’re just very expensive and competitive to control. In fact, in most of our markets we’ve seen a fairly substantial, and steady clip of supply added in most areas, except for the urban core. So new supply’s down in most cities, themselves, but the surrounding suburbs have been very active, and the transit locations near the city core are also very active. So, it hasn’t gotten easier, that’s for sure.
Linda Hoffman: Local governments, including those in Minneapolis and California, have eliminated single-family zoning to allow more housing. While it boosts small-scale development… it doesn’t seem as helpful to a large-scale developers like Avalon Bay. What regulatory reforms would open the door for larger projects?
Bill McLaughlin: I think that’s a great question. You know, the efforts in California I’m familiar with, and I think it makes great sense to try to get small-scale development scattered throughout the communities. It’s not going to make a big dent in new supply, but it certainly helps.
Where we’re seeing the most opportunity is in mixed-use development. There seems to be a lot less demand for retail, some of the hotels, certainly movie theaters, or other uses, which are no longer the highest best use for certain types of sites, or locations make great sense for multifamily, or multifamily with additional other development; retail, office, whatever the case may be. So, we’ve seen some relief in that area from a regulatory perspective. And frankly, those tend to be in an infrastructure-rich location, so, that they lend themselves to greater intensity of development, more for multifamily density.
Linda Hoffman: Avalon Bay’s focus, seems, on suburban markets—post COVID approach, or part of a long-term strategy?
Bill McLaughlin: Well, I think, historically, we grew up in the suburbs, but we have been pretty agnostic in terms of the business we’ll do. Typically, the barriers to entry in cities have been costs, not so much zoning. And there are certain points in the business cycle where new urban development makes sense, and points where they don’t. I would say that the suburban development opportunities are more evergreen. Frankly, they’re less risky, and they’re less costly. So, and, we’re able to serve a price point that is broader than the really top of the market, urban rents.
So, that has been a focus of ours, although we do have a number of high-rises underway or plan. The pandemic, certainly, has set that business back further or we’re retreating from it on cost, and on economics. But I would say, maybe, a couple years before makes it makes a lot of sense to be building in, say, New York or San Francisco.
Linda Hoffman: So, when, Bill, if ever, do you see the urban core coming back?
Bill McLaughlin: Well, I’m a little bit of a contrarian. I am sort of looking for those green shoots now. You know, I think the key is obviously going to be folks getting back to the office. Right. And frankly, the giant adjustment in price on a relative basis between towns and the suburbs—the market demand in the suburbs is through the roof—so rents are up significantly there. They’re down a lot in the cities. At some point in time, that pendulum’s going to swing back. And it may not be this year, may not be next year, but it’s not a forever transition.
Linda Hoffman: Half of Avalon Bay’s new developments are in the Northeast—a region known for slow growth and high regulation. What’s the attraction?
Bill McLaughlin: Well, Linda, I think that’s a great question. It’s probably a two-fold answer there. One is, the locations we pick in the Northeast tend to be the better locations, and harder for others to do business in. We’ve got a 20+ year track record, and we think that’s a competitive advantage for us. You know, we used to characterize them as high-barrier-to-entry markets, you know, Darien, Connecticut, or, you know, Newburyport, Massachusetts, other places such as that. But the other piece of it is, that’s where we have herd advantage.
So, we have a lot of tenure, a lot of experience, a lot of relationships in those markets. This is still very much a people business, and so we see the opportunities that are presented to anyone in the market; we’ll likely see it as soon as anyone. And we’ve been able to build a big book of business over a really long period of time. That doesn’t mean that we are not going to be really focused on the expansion markets we’ve identified. And, over time, we’ll see a significant shift, I think, in our assets. But today, it’s still a great business for us to be doing.
Linda Hoffman: Materials prices have been surging. Supply chain issues are everywhere. What’s this done to your line of sight on project completions and budgets?
Bill McLaughlin: Well, it’s tough to have any confidence in your schedule or your budget these days, schedule in particular. I had, we tend to be the preferred client, and preferred employer for the subcontractors. The material delays and shortages of staff can scratch your schedule, for sure. But we’ve generally been able to hold pretty steady on our budgets. It’s tough. And I think it’s tougher for others than it may be for us, and it’s tougher in some regions than others. I know that the Denver area, and California are particularly tough. We’ve seen some unevenness in how difficult it’s been.
Linda Hoffman: Which is the bigger problem: materials or labor?
Bill McLaughlin: I think it actually all comes down to labor, right, because what’s holding up the supply chain is the labor to deliver, right, truck drivers, and manufacturing in the plants, so, whether it’s a slowdown in appliances, or a delay in drywall deliveries, it really all comes down to labor shortages, in my view.
Linda Hoffman: Bill, shifting gears a bit, Avalon Bay is a participant member of GRESB. Is this important to attracting investment funds?
Bill McLaughlin: You know, I think it is the wave of the future to be a fully focused firm on all stakeholders, including, you know, the environmental concerns that people have, including good governance, including taking good care of your associates. So, I guess the short answer is yes, I hope we’re a little bit ahead of the curve. We certainly focus on it project by project in terms of LEAD certification, or Energy Star, or other measures. And, I was interested to see, about 30 days ago, we actually issued our first bonds for three quarters of a billion dollars, at perhaps the lowest rate we had ever issued ten-year debt.
So, I think it plays on both sides, right. There is great demand for those bonds, not only here in the U.S., but from European pension funds.
Linda Hoffman: Congratulations on the green bonds. That’s a score.
Bill McLaughlin: Thank you.
Linda Hoffman: Well, this has been fascinating, Bill. All in all, apartments may be the single brightest point on the horizon. Thank you for joining us.
Bill McLaughlin: Well, it was great to see you today, and I appreciate the time.
Linda Hoffman: Thank you. Multifamily has recently given housing starts a badly needed boost. In fact, nearly all of August’s gains were linked to multifamily. It’s welcome news. The next hurdle… supply chain disruptions. Suppliers are having to work around West Coast ports of entry where COVID protocols are slowing imports. Certainly, the market must a way to solve this problem for builders. Until then, production will feel the sting.
Well, that’s all for today. Thanks for joining us. I’m Linda Hoffman. See you on our next exciting episode of NAHB power hitters.