las vegas multifamily - q1 2016

8/16/2019 Las Vegas Multifamily - Q1 2016

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CommercialResearch

LasVegasMultifamilyTrends,Fundamentals,LandAcquisitionandDevelopment

Winter2016

MarketIQ


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Multifamily continued its multi-year run as arguably the most favored asset class by bothinstitutional investors and individuals. Additionally, developers have returned to Las Vegas andare delivering some impressive projects, mostly geared towards the luxury and renter-by-choicemarket segments.

Clearly developers are responding to fundamentals, which have improved substantially sincethe recession. Local rent increases in the sector typically surpass other commercial segments,such as oce, which continues to lag the recovery cycle and industrial and only recently starteda turnaround, albeit with a surprisingly strong drop in vacancies in 2015. Retail remains broadlychallenged despite stronger retail sales locally, presumably because some pockets of retail aredoing great while other centers remain challenged. Additionally, industry trends are shifting andsome anchor tenants had exited the Las Vegas market, including Food 4 Less, Haggen and Fresh& Easy. The volatility and unique property risks in these sectors likely drives some of the interest inthe multifamily sector by both buyers and nancing providers.

In the prolonged low-yield environment, a search for yield has propelled many categories ofinvestors into the space, including REITs, pension funds, high net-worth individuals and familyoce capital. There are simply not a lot of options in which to place money that are considered

mild to intermediate risk. Similarly, the asset class is perceived favorably by many lenders rangingfrom community banks to commercial mortgage-backed securities investors, so the cost ofborrowing is relatively cheap, preserving some of the spreads despite compressed cap rates.

Mom and Pop investors continue to be interested in Class C structures but these deals havebecome even more sparse in the Las Vegas market with a widening bid/ask spread. Similarly,Class B properties are paced on the market infrequently and the trades we see are often principalto principal, rather than using the traditional brokerage channels with many marketed as unpricedlistings. Additionally, a lot of investors want value-add opportunities, however, many sellers ofchallenged buildings are pricing them as though they were stabilized. In Las Vegas, the lower-end

YIELDPERSPECTIVES

Globally,yieldsremainfarbelowhistoricallevelsManycentralbankscontinuetobeaccommo-dativeinthefaceofweakGDPgrowthandlittleinationarypressure.Asa

result,manyofthelowerriskdividendandinterestrateinstrumentsremain

pricedtoalowyield.

Toachievehighyields,onemusteithermoveabruptlyontheriskspectrum(emergingmarketsorjunkbondsforexample)oracceptlowerliquidity(realestate).Givensomeofthevanillachoices,it’snotsurprisingcommercialrealestatehasbeenreceivingalotofinterest.

Figure 1Relative Yields Across Asset Classes


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segment of the market is largely broken with a drought in listings and many buyers, whom rangefrom professional investors to the largely uniformed. We note just a handful of trades that haveoccurred within the Class C segment in Las Vegas for 2015. Smaller buildings with less than 100units get a lot of buyer interest, but often have issues during inspection so we estimate there is amultitude of failed escrows over the transactions we actually see close.

Capitalization rates have been relatively low for several years, with cap rates for Class A Las Vegasproperties in the low ve percent range on average. Nationally, IRR measures the average U.SSuburban Class A cap rate at 5.48% and the West Region is posting an average of 4.80%.1 Caprates are so low in core markets that many investors are searching in second tier markets likeLas Vegas. Cassidy Turley measured the lowest cap rates in New York at 3.5%, San Francisco at4.3% and Orange County at 4.4%.2 We also understand sub-4% cap rates have been observed inSan Diego. While rental rates and occupancies have long been strong in these areas, SouthernNevada has registered strong improvement as well. It is therefore no surprise that investors haveshown interest in Las Vegas. Multifamilyexecutive.com notes that the cap rate spread betweencore and secondary markets has narrowed from 200 to 300 basis points and down to as low as 50basis points. Similarly, we have seen Southern California investors get priced out of their marketand search in Las Vegas.3

When we think in terms of historical spreads between cap rates and the “risk free” rate proxied by10 year U.S. Treasury bonds, spreads are still wider than they have been in recent years. In 2006,when nearly everything in the real estate sector was in a bubble, spreads were only about 100

1. IRR Viewpoint: 2016 Commercial Real Estate rends Report

2. http://news.theregistrysf.com/wp-content/uploads/2014/09/Cassidy_urley_US_Multifamily_Report_2014_Review_2015_Forecast.pdf 3. http://www.multifamilyexecutive.com/business-finance/debt-equity/chasing-yield-the-2015-dealmaking-outlook_o

Figure 2Class A and High Quality Class B Going-in Cap Rates

Source: Costar, Clark County NV, Fred II, Coldwell Banker Premier Realty.


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Figure 3Las Vegas Apartment Average Asking Rent

Figure 4Las Vegas Apartment Vacancy Rate

Map 1Class A Apartment Occupancy

December 2015 snapshot.Source: Costar, Coldwell Banker Premier Realty.

FUNDAMENTALS

Theleasingmarketisbifurcatedbetweenlowerqualityandhigherqualityprojects.Figure4illustratesthatsignicantdierencebetweenoccupanciesintheoveral

market,whichincludesasignicantamountofClassCprojects.Ifwecouldalsoaddanewcategory“D,”thatwouldbeinthereintheformofsmallerandolderbuildings.Weknowofatleast300buildingsintheurbancorethatwerebuiltbefore1970.IfweanalyzeClassAbuildingsorhigh-qualityClassB(whichweconsidertobethosebuiltafter1990,havemorethan200unitsandachieverentsofatleast$0.85/sq.ft)buildingsseparatelyfromtheoverallmarket,vacancyratesareaslowastheywereduringtheboomdaysof2005.

Source: Lied Institute for Real Estate Studies, Costar.Source: Lied Institute for Real Estate Studies, Costar.


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points. Spreads were probably widest in 2011 and 2012 and with current Treasury yields at 2.06%that is still about 300 basis points for most Class A projects in Las Vegas.

FUNDAMENTALS

The cap rate spread is only part of the story. Improving fundamentals in the Las Vegas regionare also added to pro forma gains. Although the Las Vegas MSA has not yet returned to theemployment high of 2007, job growth is on the rebound and we are observing some mild wagegrowth as well. Additionally, both single family rental rents and Class A and B apartment rentsappear to be growing. Further, occupancies across the Class A segment are very strong with manybuildings in the high 90’s. There is also some evidence that concessions have burned o furtherwith ALN noting that apartments oering concessions dropped by 21.1% year-over-year (Dec2015 data). The average concession package was 4.4%, down 16.7% from the same time last year.4 4. alndata.com

Figure 5Visitor Volume - Clark County NV

Figure 6Non-Farm Employment - Clark County NV

Additionally, Las Vegas’ majorsector, leisure and hospitality, isexpected to grow further with theaddition of Genting’s Resorts WorldLas Vegas, which broke ground in

May. The project is anticipated tobe 3,000 rooms in its initial phase.The project is estimated to supportmore than 13,000 direct andindirect jobs.5 The Lucky Dragon, aboutique hotel near Allure Condoson Sahara, continues construction.The Las Vegas Convention andVisitors Authority (LVCVA) is alsoexpanding into what will ultimatelybe the $2.3 Billion Las Vegas GlobalBusiness District. As a testament tothe strength of the LVCVA’s plans,it purchased the Riviera Hotel andCasino in 2015 and in November2015 approved a contract todemolish the project to make wayfor the Global Business Districtexpansion.

We anticipate that added

construction on the Las VegasStrip and Downtown will driveemployment back to it’s 2007high within a short period of time.Unemployment rates remainelevated at 6.3%, however year-5. http://lasvegassun.com/news/2015/may/05/group-says-new-las-vegas-strip-resort-casino-rise-/

over-year job growth is occurring at a faster rate than the U.S average and is 2.6% for the LasVegas MSA compared to 1.9% for the United States.6 The area was hit disproportionately hardwith a combination of a national recession and a deating housing bubble. Currently, housing

6. nevadaworkforce.com, Nov 2015 data.

Source: Nevadaworkforce.com.

Source: Las Vegas Convention and Visitors Authority.


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prices have returned to pre-bubble trends and distressed housing inventory is no longer a dragsince the majority of closings are traditional sales. Additionally, visitor volume to Las Vegas hasnever been higher than it was in 2014 and that strength continued into 2015, a new record yearwith over 42 million visitors.7 Growing employment opportunities have helped return the area topositive migration and retirement remains a motivation for some individuals.8

Gaming Revenue is not matching the trajectory of visitor volume, revealing a much milder upwardtrend. Las Vegas has adapted well to changing consumer tastes, with a sizable nightclub sceneand a greater focus on maximizing hotel and food and beverage revenues. As a result, gaming,while still important, is of less signicance than in the past. For example, MGM Mirage Corporationwhich is the largest single operator in Las Vegas and is a good barometer for the region, hasdiversied on-property greatly. In 1994, gaming revenues were 59% of gross revenue comparedto 2014, where gaming revenues were 38% of total revenues. Growing shares of revenue went tofood and beverage, hotel and entertainment and retail according to the company’s annual reports

Total non-farm employment is now almost 12,000 jobs short of its 2007 high. Measured inNovember, on a year-over-year basis, Las Vegas added 23,000 jobs. If this rate continues, weshould be back to peak employment in the next 6-12 months. It has taken a long time to heal

the economy and some lingering issues remain, such as rising but relatively weak wage growth(ination-adjusted) and a prevalence of part-time workers that desire full time work, however, thenet result paints a positive picture for the region.

In addition to major gaming projects like Resorts World Las Vegas, we are also seeing non-gaming growth in the Valley with new entrants like Asurion, which provides mobile phone andtablet protection insurance, Catamaran RX in the medical space and manufacturing, includingCannon Safe. Sutherland Global, a business process outsourcing and technology company, ismoving into the shuttered Citibank campus in the Lakes area of Las Vegas. 2,000 employeesare expected to work at the campus. Faraday, which unveiled a concept electric car at theConsumer Electronics Show in Las Vegas, is expected to build a plant in Apex, an industrial

park in North Las Vegas near the I-15. Tony Hsieh’s aliated VegasTechFund also continues toseed startups and continues to have investments in a large portfolio of companies, primarily inonline sales, electronics and education. IKEA, which is opening its rst Las Vegas store in 2016, isalready hiring. In the summer of 2015, Fidelity National Financial purchased a 22,000 square footoce in Summerlin and this represents some positive absorption for some long vacant space.Barcleycard leased the former Zappos headquarters in Henderson and was anticipated to have700 employees by now.

Wage growth is not evenly spread out over the employment sectors so Class C will continue toplay an important role in workforce housing. There is still signicant vacant supply in this category,

so we don’t anticipate strong rent growth in the next couple of years. We have observed someowners over-improve for the area but this has not been reected in stronger rents, implying thatbuilding quality is at best a minor premium located within a challenged area.

On the other side of the quality spectrum, Class A occupancies are best described as stellar andseveral of the newer builds have quality and amenities a step above traditional two-story walk-up buildings. There does appear to be a premium for quality in popular submarkets and thosecommunities with strong walk-ability. Some traditional design projects are achieving rents ashigh as $1.38 per-square foot for 1-bedroom units. The Gramercy, which is a multi-story, amenityrich mixed-use project, is achieving rents up to $1.80 on 1-bedroom units. The Calida Group has7. http://vegasinc.com/business/2015/dec/30/las-vegas-set-to-crack-42-million-visitors-this-ye/8. United Van Lines survey reveals that 57% of the moves they facilitated were inbound to Nevada. Further, electric meter hookups, a proxy for household formation, continues in a positive trend.


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Figure 7Homeownership Rate - Las Vegas-Paradise MSA

been delivering amenity rich projectswith interesting architectural elementsand we understand that these recentlydelivered projects are performing well,indicating strength on the upper-end of theapartment rental market.

The demographic story is positive formultifamily and many expect a higherproportion of future new multifamilydeliveries versus single family deliveriesnationally. The aging of baby boomers islikely to account for some of this shift in

demand.9 Millennials, are nally seeing some job prospects after many delayed the milestone ofmoving into their own place. This cohort is generally described as those born between 1982 and2000 and make up about 95 million Americans. Nationally, Millennials are nally coming o of theextreme weakness exhibited within the cohort during the recession, where the employment to

population ratio for 25-34 year olds was as low as 73.4% and after a seven year period, has grownto 76.3% (as of November 2015).10 Locally, developers are tailoring properties to the Millennialmarket, in addition to empty nesters. Some projects have almost no families with children.Importantly, Millennials have a high propensity to rent. Green Street Advisors estimates thatindividuals under the age of 35 have a 63% propensity to rent.11

Although it is challenging to dene this age cohort, technology, quality gyms and open spaceappear to be attractive to many Millennials. In leasing, a strong online presence is important.All these features are expensive yet many Millennials are paying for it. While many lackdownpayments or credit history to buy a home, high-quality Las Vegas apartments appear toremain in reach judging by the occupancy levels in many of the higher rent projects.

This age group is important because these individuals are the source of household formationfor the next several years. The Millennial generation’s peak birth-rate occurred in 1990, many ofwhom are likely to be renters.12 The generation does have its challenges. Household formationshave been held back in recent years by slack in the labor market and likely student loans. A bigunknown concerning Millennials is what occupations will be in the next ten years. For example,technology workers are used to moving often and may not like the burden of owning a home,which they would either have to sell or rent if they moved. Additionally, many Millennialsrecognize that homes can be illiquid and therefore fall into the “rent by choice” category, ratherthan renting because they lack the ability to nance a home. Employment within this cohortremains challenged but with an estimate of nearly 75 million nationally, this age group is going to

dene a large share of housing demand long-term.13

The Urban Institute recently released a longitudinal of household formation and homeownershiprates, predicting that the homeownership rate would decline through 2030 with thehomeownership rate dropping from 63.7% in Q1 2015 to 61.3% by 2030. The study authorsanticipate a rental surge of 13 million renters and renters will outpace new homeowners overthe next 15 years.14 Projections can often be taken with a grain of salt, however, given that both

9. https://www.kansascityfed.org/publicat/econrev/pdf/13q4Rappaport.pdf 10. http://www.axiometrics.com/blog/young-adults-earnings-growth-pace-lags-job-gains11. https://www.reit.com/news/reit-magazine/july-august-2014/millennials-move12. http://www.forbes.com/sites/billgreiner/2015/02/25/how-a-lack-of-income-for-millennials-effects-household-formation/3/13. http://www.pewresearch.org/fact-tank/2015/01/16/this-year-millennials-will-overtake-baby-boomers/14. http://www.urban.org/sites/default/files/alfresco/publication-pdfs/2000257-Headship-and-Homeownership-What-Does-the-Future-Hold.pdf

Source: U.S Census.


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Figure 8Multifamily Permits - Clark County NV

government support for homeownershipand lax lending in the early 2000’scontributed to an articially highhomeownership rate, the author’s forecastsmay have merit.

An additional component of demandin Las Vegas is likely to remain formerhomeowners who lost their homes throughforeclosure or still have tarnished creditproles due to a short sale. We haveobserved that many prior homeownerschoose to rent single family homes. Inthe past, single family rental homes wereusually held by “mom and pop” owners.Some renters had fear of leasing from anabsentee landlord and tended to gravitate

towards apartments. Today, many homes are held by institutional investors or rms organized as

REITs or are privately owned homes managed professionally by property management rms, sothere are many rental options within Las Vegas. The degree to which higher-end apartments compete with single family rentals is unknown to

Map 2Class A Apartment Average Rent Per-Square Foot & Median Household Income

Source: UNLV-LIED,U.S Census.

Source: ESRI,U.S. Census, Costar.


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able 2Under Construction Projects

able 1Proposed Apartment Projects

PROPOSEDPROJECTS

Thetableabovenotessomeoftheprojectsthatweunderstandcouldbedeliveredwithinthenextthreeyears.Weareawareofseveralparcelsthatareinescrowthatareextremelylikelytobecomeeithertraditionalapartmentsorseniorapartments,howeverwecannotmentionthempubliclyatthistime.Assuch,weshouldnotconsidertheabovetabletoberepresentativeoftheentireuniverseofproposedprojects.

us, however we suspect that there is mild crossover and that family size and age of householderremain the primary determinants of who lands in which rental category. Single family rentalsare probably fringe competition for the two and three bedroom units in higher-end apartmentprojects.

Some prior homeowners may only be in the rental market for a transitional period and re-enterownership after curing credit issues. These are the so-called “boomerang buyers”, of whichit is estimated that 700,000 individuals nationally are now eligible for credit again this in 2015according to TransUnion.15 The principal question is how many individuals are willing to buy or areaware that they can buy. Currently, the pendulum that swings between renting and owning is stillswinging towards owning if you examine rent versus mortgage payments on an equivalently sizedhome. Ultimately, this will be sensitive to mortgage interest rate increases and in theory, rentingcould become nancially equivalent to owning in an abrupt fashion. Many of these individuals andfamilies are likely to be renters for an extended period, gradually trickling back into ownership ifthe labor market continues to strengthen.

DEVELOPMENT

Following the global nancial crisis, both single family and multifamily construction dropped15. http://www.cnbc.com/id/102773427

Source: Clark County, City of Henderson, Coldwell Banker Premier Realt y.


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able 3Recently Completed Projects

Somedevelopershavedepartedfromthetraditionaltwostorywalk-up/gardenstyleapartmentsandarebuildingtrueluxuryapartmentswithagreatervariationinarchitecture,amenitiesandnishes.TheleftphotoshowsCalidaGroup’sElysianatTheDistrictandDGDe-velopment/ForePropertyCompany’sVolareproject,whichincludesgaragesandisrarewithinthismarket.

sharply. Multifamily construction almost died o completely while many developers focused onbroken condominium projects and other distressed deals.

Recently, multifamily permits have been ticking higher but remain low relative to pastobservations. It is important to note where the activity is concentrated, since success of a

particular project is largely determined at the submarket level rather that at the Valley level.Map 3 illustrates where a lot of the recent activity has been occurring geographically. Notice theconcentration of projects along the southern portion of the 215, in Henderson near major corridorsand on the South Strip. These areas tend to justify projects based on area incomes, proximityto employment centers and are attractive due to major arterial access. Many of these projectsare amenity rich and relatively expensive, however there appears to be signicant demand forsenior housing also and there is obviously a need for aordable options, however this is oftendetermined by land availability and proximity to existing infrastructure as osites have becomequite expensive. Margins may be under pressure as land prices have ticked up for both primelocations and areas for more aordable type projects.

Source: Clark County Assessor.


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Map 3Las Vegas Area Planned, Under Construction and Recently Built Apartments

ShownaboveisPicerne’sprojectonSouthDurangoandTheWarmingtonGroup’sMartinApartmentsonFortApache.Bothprojectsare

locatedintheSouthwestpartoftheValley.

One area that seems to have a major decit in both recent and planned development is in

Downtown Las Vegas. Higher-end projects like Juhl, The Ogden, Soho Lofts and Newport Loftsare seeing strong demand for rentals. Of those four, Juhl is the only pure rental project, althoughoriginally conceived as a condominium. Both Juhl and The Ogden have had high occupanciesand even occasional waiting lists. The owners of The Ogden have been oering units for salesince late last 2014 and a substantial number of closings have occurred. Soho Lofts and NewportLofts are condominiums which often are used as rentals, so it is challenging to determine thesize of the market for higher-quality rentals in the area but there does appear to be a shortage ofquality rental units in the Downtown area. We understand that Juhl remains near full occupancy.The Wol Company has an approved 226-unit mixed-use project on Fremont St, a strong positivefor tenants who have often found it challenging to nd newer space within the submarket.


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Juhlisoneofthemoresoughtafterresidentialrentalsdowntown.

TheOgdenhasmadeupalargeportionoftheDowntownrentalpool.Currentlytheownerisactivelymarketingthesecondominiumsonanindividualbasis.

NewportLoftsareindividuallyownedcondos,howeversomeoccasionallybecomeavailablefor

rent.Salepriceshavebeengraduallyclimbingwithintheproject.

able 4Rent Price Per Square Foot in Downtown

Source: GLVAR multiple listing service, Costar, Coldwell Banker Premier Realty.*Asking rent. All others are transactions.

Apartment vacancy rates within the redevelopment area are about 10%, which on its own doesn’tsound great. However, when you parse out what those buildings are, the picture becomes clearerMany of the buildings in the area were built between the 1930’s and 60’s. If we look at some ofthe more recent buildings from the 1990’s and 2000’s, occupancy is extremely solid with severalfully occupied and some hovering between two and six percent vacant. Towards the end of2014, we examined the nancial reports of a renovated apartment project within the Arts District.The property was nearly 100% occupied and had an occasional waiting list. Given what we areobserving within Newport Lofts, Soho Lofts, Juhl, The Ogden and the Arts District Apartments, weexpect that if a developer could deliver product geared towards urban Millennials, it would fairvery well. In some Las Vegas submarkets, we see apartment rents in amenity rich apartments ashigh as $1,600 for a two bedroom, with several between $900 and $1,200.

The Downtown submarket could probably use a signicantly higher supply of modernapartments, especially with more employment centers on the horizon, such as the nearby ResortsWorld Las Vegas (estimated to support more than 13,000 direct and indirect jobs.16 ) on the northstrip, The Global Business District and The Federal Justice Tower which is expected to open soon.Another potential source of renters are the current Zappos employees, many of whom do notcurrently live in the area but may have a desire to if they can nd suitable housing. Additionally,

we expect the Las Vegas Medical District will gain some traction.16. http://lasvegassun.com/news/2015/may/05/group-says-new-las-vegas-strip-resort-casino-rise-/


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Map 4Apartment Land Sales

able 5Apartment Land Purchases in the past 18 months

LANDPURCHASES

Basedonpriceperdoororpriceperacre,itisclearthatthereisbroadvariationinpricing.Itshouldbenotedthatmostofthehighdollarlandpurchaseswerebyluxuryapartmentdevelopers,alargelynewcategoryinthemarket.

Source: Clark County NV, Costar, Coldwell Banker Premier Realty.

The single most active submarkets are in the Southwest near the 215 curve and in Hendersonnear the 215 by both Stephanie Street. and Gibson Road. These areas boast some strong incomes,and favorable demographics and a good supply of developable land in these areas.

Based on what we are seeing in escrow, we can expect signicant development in the next fewyears and this may impact occupancy rates in some submarkets. Nevertheless, we believe thatfavorable demographics will be in play for most of this forward inventory. As with most projects, itreally comes down to the skill of the developer and the leasing team.


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* Average Physical Occupancy. MAA reports occupancy at December 2014 and Camden provides the 2014 average.Source: MAA Communities,Camden Property rust 10-K.

able 6Public Apartment REIT Las Vegas Buildings

able 7Sale Panel of Class A and higher quality Class B Apartments 2011 - 2016 YTD

* Tis sale included undeveloped land.Source: Costar, Powerbroker Confidential, Colonial Properties rust 10-Q, Clark County, Coldwell Banker Premier Realty.


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PERFORMANCE

Map 2 in the fundamentals section illustrates the strong occupancies found in Class A projectsthroughout the Valley. With occupancies strong and rents rising, it makes sense for developersto move forward with several projects. Additionally, relatively low cap rates are generatingmore interest by developers, particularly in a national and regional context with both privateequity monies and REITs engaging in ground-up development. Camden Properties Trustexecutives discussed their development pipeline at REITWeek 2015. They are planning 85% oftheir new pipeline to come from development and repositions rather than acquiring properties.In recent years, they have been selling properties in order to reallocate resources, such as theOasis portfolio in Las Vegas, which they held an interest in and sold to The Wol Company. Ondevelopments, they noted an expectation of a 7% yield which is substantially better than goingout and buying the cap rate, with the exception of having to take both the construction risk andthe lease-up risk.

Similarly, Lennar, long known for their single family product, has been developing apartmentsin recent years and listed 24 communities under construction in Q1, 2015 sold their rst twocommunities in 2014. In this space, Lennar acts as a merchant builder and uses third-party

institutional capital on a deal specic basis. Lennar stated in their Q4 2015 earnings call that theycompleted their Lennar Multifamily Venture, an equity fund which allows them to hold incomeproducing assets in order to have a recurring income stream. They have a pipeline of over 21,000apartments. Lennar expects to sell 8 to 10 communities in 2016.17 To get a sense of the returns,Lennar stated they expect IRRs to exceed 25% with cash multiples larger than two (Q2 2014

17. http://seekingalpha.com/article/3765836-lennar-corporations-len-ceo-stuart-miller-q4-2015-results-earnings-call-transcript?part=single

earnings transcript). We are not aware of anyLennar apartment projects in Las Vegas but thisgives us an idea of what some builders mayexpect, particularly since Lennar has severalprojects in high cost California.

While Map 1 gives a sense of occupanciesreported by Costar, there are several publiclytraded operators which own projects inLas Vegas that provide a deeper sense ofoccupancies in the region. MAA Communitiesowns two buildings in North Las Vegas, bothacquired through the Colonial Properties Trustacquisition. Camden Property Trust owns 15Class A and Class B apartments in Las Vegas,

each with a reported average occupancy near95% for most of their buildings. This is probablya pretty good proxy for what a professionalmanagement company can expect. Examiningthe sale panel in Table 7 and in Figure 2, onecan see a gradual decline in cap rates over thepast several years. Presumably, even projectsthat traded in 2011 or 2012 may even be valuedhigher in the market of today. For example, TheCroix Townhomes traded in December 2010 fora reported 6.5% capitalization rate and traded

Figure 8Major USD Currency Pairs

MACROISSUES

ThestrengtheningoftheU.S.Dollarrelativetomanymajorcurrenciesmayinuenceforeigndevelopersandpresentachallengetopropertyacquisition.

ForcurrentownersofU.Srealestate,particularlybyCanadians,thismayinuencetheirdecisionastowhetherornottheyshouldre-balancepositions

orenjoyrelativelybettercashowinrepatriatedterms.

USD/CAD

EUR/USD

AUD/USD


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TheGramercy,shownhereontheright,isanexampleofaprojectoriginallycontemplatedasfor-salecondominiumsandwasstalledduringthedownturn.Theprojectwascompletedandpositionedintotheluxuryrentalmarket.

again in 2014 for 5.3%. In 2015 there was an apparent slowdown in Class A and B transactionsrelative to 2014, perhaps indicating that owners are happy sitting on the cash ow or remainbullish on improving rents under continued strong occupancies.

RISKS AND REWARD

Some investors are beginning to question what happens to cap rates in a rising interest rateenvironment. First, despite an announcement in December in which the Federal Reservestated they would target short-term rates upward by a quarter point, many Fed observers onlyanticipate small increases in rates going forward and possible no increase in March. Additionally, adepressing world wide economic outlook may imply safe haven buying in the U.S. and in doing sokeep bond yields from rising. Some positive U.S economic gures, combined with some terriblegures coming out of Europe and Asia further confuses expectations of where bond yields andultimately cap rates will go.

While many owners use 10-year Treasury rates as their performance benchmark, the relationshipbetween Treasuries and capitalization rates is far from lockstep. Breaking it down further, caprates are also a function of local supply and demand factors and a cyclical nature of buildingin many local markets, which don’t all ways integrate well into national models of cap rate andTreasury market trends.

Concerning interest rates, there are a few schools of thought on what needs to be done movingforward. Some market observers believe that a prolonged period of easy money has led toMalinvestment, or the purchase or nancing of projects that otherwise would not make senseunder most other conditions. As such, they believe that the Fed should attempt rate hikes as partof a “normalization”, despite the potential for shaking out some of the weaker projects. Othersbelieve that the Fed will respond to improving economic conditions, so higher rates will in partbe a function of an improving economy. In any case, the natural question remains, will higherrates damage the commercial real estate sector? If indeed higher rates are a function of a bettereconomy, the presumed higher cost of capital may be oset by strengthened demand in thecommercial space market and for dwellings. This view may be challenged by observers of foreignmarkets like China and Europe and the potential for nancial contagion.


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One cannot look at interest rates and capitalization rates in a vacuum and make broadconclusions. Another important factor is the overall performance of the debt market. John Ducaand David Ling (2015) of the Dallas Federal Reserve nd that cap rates are negatively related tothe availability of credit (more credit availability leads to lower cap rates).18 As a result, commerciareal estate prices can be vulnerable to shocks in the CMBS or other capital market channels andthis was made more obvious by the global nancial crisis. It may also make the case for using, ifpossible, assumable debt on a building.

Some believe that recent prices are the result more of maintaining reasonable spreads overthe cost of capital or performance benchmarks, rather than from lower risk premiums. So whilecurrent cap rates may not be predicated on a herd mentality which leads to bubbles, nancialmarket gyrations may lead to a bump in risk premiums built into required rates of return. Howeveragain, if local market dynamics are favorable and investors expect rent increases, there may bean oset there. Additionally, multifamily projects tend to oer some ination protection in the formof increasing rents, which is harder to achieve in oce or industrial buildings which often featurelong-term leases at pre-specied rents.

In the end, there are a lot of unknown causalities and non-linear relationships within the world

of real estate so making simplied conclusions is challenging. However, examining some ofthe multifamily REITs that trade publicly, it doesn’t appear as though participants in the equitymarket are super concerned about long-term interest rates, which aect REITs and other propertyowners since they tend to use more long-term debt than short-term instruments. AlthoughREITs have been impacted along with the broader stock market, operator specics appear tobe the overriding cause of movement in share prices.19 Further, any individual property can beuncorrelated with the major headlines, at least in a short-run sense.

Multifamily projects tend to have less volatility in net operating income when compared toother property types, hence, lower cap rates in general. Lower cap rates are symptomatic ofinvestor beliefs in how well net operating income buers against rising rates and economic

shocks. As occupancy weakens, landlords can adjust pricing quickly to re-optimize given thenew circumstances and then re-adjust over several periods after the economy strengthens. Thisis contrary to many retail or industrial projects that can lose large tenants altogether, regardlessof accommodative rents. So this characteristic of apartments is very positive. Nevertheless,apartments are subject to capital market risk and recent troubles in China and elsewhere pointtowards a re-evaluation of risk, which in our minds was a long time coming. Federal bankingregulators have recently expressed concern about the concentration of multifamily loans withinsome banks and they are concerned that rising rates could harm the sector. The Comptroller ofthe Currency, Thomas J. Curry, notes these issues, but also highlights that credit quality hasn’tsuered while demand for these loans has increased.20

Finally, much of what works in the commercial real estate world is derived from intimateknowledge of a particular trade area, along with strong execution in entitlements throughconstruction and lease-up. In Las Vegas, the market seems to be crowded on the acquisition sidewith little play on the sell side. Additionally, there appears to be further room for well-conceivedprojects in some submarkets, although several are beginning to get crowded and may inuenceshort-term occupancies.

18. http://www.dallasfed.org/assets/documents/research/papers/2015/wp1504.pdf 19. https://www.reit.com/news/articles/reits-outpace-broader-market-january 20. http://www.occ.gov/news-issuances/speeches/2015/pub-speech-2015-147.pdf


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The information contained in this report is deemed reliable but is not guaranteed.

The information and opinions expressed in this document do not constitute investment advice.

Market IQ

Author: John McClelland, Vice President, Research

8290 West Sahara Avenue, Suite 200

Las Vegas, Nevada 89117

las vegas multifamily - q1 2016

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