Despite shifting sands in the multifamily sector, stable foundations persist Matt Baker February 25, 2020 Share on Facebook Share on Twitter Share on LinkedIn Share via email When the housing bubble burst in 2007/2008, it ultimately led to the most incredible economic recovery in U.S. history. It also created an environment in which residents were more inclined to rent rather than own, leading to the multifamily sector’s boon during this cycle. But cycles, by their nature, come full circle and many worry that we are nearing the end of this expansion. Though that has been a concern for a couple of years now, a downturn or a plateau is imminent. The question is, how will multifamily investors fare during this inevitable turn of events? “We’re already feeling the effects of a slowdown,” said Lee Kiser, principal and managing broker of Kiser Group. “Velocity is down to a degree.” Looking for more insight on the trends coursing through the local multifamily sector? Hear from Lee Kiser and more than a dozen more expert speakers at our 11th Annual Multifamily & Apartment Conference on March 5th. While the multifamily sector may be feeling new pressures on a national scale, Kiser points to a dynamic unique to Chicago, the changeover in the Cook County assessor’s office. The prospect of higher assessments may leave a lot of investors unwilling to gamble until they see how the situation will actually play out. “I think the market was already slowing somewhat. But with the assessor’s office as a factor on top of that, there isn’t as much trading right now,” said Kiser. “In general, it’s just not a good time to be aggressive on price.” Investing in a down market Kiser has also seen a drop-off in speculative dispositions—owners feeling out the market that are willing to quickly pull down a listing if bids aren’t hitting a specified floor. As we move deeper into the year, this type of activity will likely become more infrequent. “The speculative sellers are what keep those sales volumes really high in an up market, but it’s kind of leveling out,” said Kiser. “You can look at the velocity of sales and the velocity of appreciation and there’s an almost direct correlation to rents and movement of residential rents. We’re definitely seeing a flattening of that right now.” While the end may very well be nigh for the cycle, that doesn’t necessarily come with apocalyptic implications. In fact, a dearth of multifamily product up for sale can create a healthy environment for buyers. There might be fewer properties on the market, but those that do seek buyers will likely be high-performing assets. “If indeed we are headed into more of a bear phase, I think that is positive for investment. Sam Zell always said, ‘when everybody goes left, go right.’ So, I think the coming years will be, in retrospect, really good investment years,” Kiser said. “There will be less to choose from, but what you do choose from should offer reasonable, quality returns.” Baby Boomers As they long have with so many other aspects of American life, Baby Boomers are driving the direction of the multifamily sector. This demographic—projected to double in size from 52 million in 2018 to 95 million by 2060—is opting more and more to move from single-family houses into urban-centric apartments where they can downsize both square footage and maintenance costs. Much of this activity is occurring in warmer climes. According to a recent white paper from Newmark Knight Frank (NKF), The Future of Commercial Real Estate: 12 Trends for 2020 and Beyond, seven of the top 10 markets with the largest increase in renters over the age of 60 were in Sun Belt states. The Chicago market was one outlier. There were more than 7,000 apartment units delivered downtown and in the suburbs in 2019, many of which are targeting boomers during lease-up. The 111-unit Kelmscott Park Apartments, for example, a development by Focus in Lake Forest, has tenants over the age of 45 occupying more than three-quarters of its units. However, it’s not all good news for Chicago. The NKF white paper also points to a growing trend of investors targeting secondary markets, away from supply-constrained primary cities like Chicago. For several years now, the share of U.S. multifamily investment into secondary markets has expanded, exceeding 65 percent every year for the past three years. Deconversions The apartment-to-condo conversion craze that preceded the collapse of the housing bubble left a marketplace flooded with owned units. This oversupply—not to mention the preference of both boomers and millennials alike to rent by choice—resulted in a deconversion craze that added numerous income-producing multifamily buildings to Chicago’s housing stock. That trend stalled out last year with the city’s passage of legislation increasing the vote ceiling. Whereas more than 75 percent of owners needed to agree to a deconversion sale, now anyone trying to put one of these deals together needs to convince 85 percent of the unit owners. “It has significantly cut the supply of deconversions,” said Kiser. “It was very difficult at 75 percent; it really has to be a situation where all the stars line up to get over 85 percent.” Kiser Group recently closed three separate condo deconversions in suburban Oak Park: the $8.8 million sale of a 56-unit property, a 26-unit deconversion that sold for $3.6 million and a 48-unit property that traded for $8.3 million. Taking one of those deals as an example, the building faced roughly $3 million in necessary cap expenditures, the residences had an 80 percent increase in market value as rental rather than condo units and half of the owners were already subletting to renters already, which drove down the price on individual condo sales. That deconversion passed with 83 percent of the vote. Even with all the fundamentals screaming out for a deconversion, the votes wouldn’t have been there had the building been located two miles to the east in Chicago. “That legislation was kind of crippling for deconversion business in the city. Which I think is exactly what it was intended to do,” said Kiser. Despite those three deals, the new legislation isn’t necessarily diverting deconversion attention to the suburbs. Suburban assets that met the criteria in the first place were already harder to find as most municipalities are less dense and there were fewer apartment-to-condo conversions at the turn of the millennium. Moving forward, there will be far fewer deconversions within Chicago proper and only in more dense, urban suburbs like Oak Park. There’s still time to register for the 11th Annual Multifamily & Apartment Conference on March 5th. Reserve your spot now.