By Rue J. Bax, Senior Managing Partner, ABI Multifamily
We are back to a more stabilized multifamily market in Arizona and more specifically in the Phoenix market. The impact of the recession was felt, but with that came a tremendous amount of opportunities. Those who bought between 2009 and 2012 have welcomed the rise in pricing and many have sold and realized significant returns. Some clients achieved this by completing renovations and others by stabilizing occupancy. As we head into 2014, buyers will have to do more to realize similar returns.
Phoenix has always been a place where tourists and prospective residents have come to escape the colder climates of the East and the Midwest. Phoenix has become the nation’s fifth largest city and the Valley is again immersed in new development, primarily multifamily. There are many positives to look at. Apple is coming. Ebay, Amazon and Intel have arrived. Arizona State University (ASU), which has the largest main campus enrollment in the nation, has continued its expansion. They have been a catalyst for downtown Phoenix and continue to drive Tempe growth. Phoenix has expanded the Loop 303 that will be finished at the end of this year. It will continue the growth of the West Valley. The overall vibe is that better times are ahead, but in this transitioning market we must ask where will the multifamily sector go?
There are very few foreclosures in the multifamily sector left from the Great Recession. In fact, much of the B / C landscape of properties has been improved by groups buying at a low basis and using the recovery of the overall market to improve their properties. This has been a boon to the overall multifamily market in Arizona, as many properties that were in disrepair with residents living in truly substandard conditions, have been improved greatly with rehab via new paint, floors, cabinets, roofs, etc. The hail storm that hit Phoenix in October 2010 also had a substantial benefit to many multifamily properties as insurance companies’ dollars paid to replace roofs, covered parking, air conditioners and windows. This helped many of the pre-’80s multifamily properties that didn’t have the cash flow to justify the capital expenditures that were provided by these insurance proceeds. Even with all of the positives that have happened, the reality is that owners still have not maximized the operations of these properties and there is still a lot of runway left for them or new buyers to improve NOI.
Over the past six months the most conservative, experienced investors have been saying the market is currently overheated, pointing to the low cap rates and strong prices per unit for A-product. Pricing is back to peak levels. Although it should be noted that the new Class-A properties have reached, in some cases, rents close to $2/SF. The Phoenix multifamily market has never seen higher rents before. The low interest rates have definitely been the impetus for these low cap rates. Most people believe that the Federal Reserve will continue its efforts to contain rates until late 2015 or early 2016, but the interest rate volatility that was felt in mid 2013 began to stir investor concerns over interest rate risk. The possibility of these rising rates could coincide with the potential slowing of purchasing power due to inflation. This would have very negative effect and is something for current owners who are thinking of selling in 2014-15 to give credence to.
There are several other head winds that may affect the Phoenix multifamily marketplace. One unknown in the marketplace is the cost of Obamacare. We have no idea how this will affect renters’ monthly net income. As rents continue to rise, this could affect occupancies. With all the potential problems, there is much opportunity ahead. Rents still have a lot of room to grow. The average rent per square foot in 2008 was $.95/SF. Today, we are at $.93/SF. Rents have not reached their peak of 2008 and that they will eventually move higher. With the overall supply increasing by over 7,000 units between 2013-14, there will be a lot of new competition for renters. Combining the aggregate of the past several years of development , Phoenix will still need more rental housing.
Overall, the Phoenix multifamily market is in strong shape. New buyers will have to know how to take the existing operations to a new and improved level. The A-product is really in good shape as the replacement cost continues to rise to record levels. The only outlier is how many renters or respective family incomes can handle the Class-A rents that will be north of $2/SF rents for new built product. B and C product is where we see the most potential for growth. There is improvement needed in the management, amenities, exteriors, interiors, clubhouse and landscaping in just about every marketed Class-B and -C property which will translate to higher occupancy and higher net effective rents. The buyers that see this opportunity and take advantage of it, will see the returns in years to come.
