Apartments Demand Is In Overdrive

Editor’s Note: Dennis Fassett is a former corporate finance executive turned real estate investing “Cash Flow Mercenary.” Dennis specializes in single-family and multi-family cash flow properties and thoroughly enjoys assisting his fellow investors with their own strategies, including how to buy your first apartment building.

As an ongoing contributor to Mogul’s “Market News Updates,” Mr. Fassett provides us with his own unique, lively, and thought-provoking commentary on the timely industry news and events of today that are impacting our industry. And be sure to check out his other super-helpful Market News Updates. For now, enjoy...

I know we talked about this last week, but the news is so good I wanted to continue the discussion because I found an article that added some additional insight to what we learned last week.

What’s interesting is that toward the end of 2014, the “experts” expected rent growth to decelerate for the rest of 2014, but that’s not what happened. Rent growth held steady in Q4 at 4.7% with 94.9% occupancy, and resumed its climb to 5.1% in Q1.

Also, the industry expected new supply to impact those numbers, but despite new units coming on line, vacancy rates didn’t rise. At 95% occupancy, a property is functionally full, which empowers landlords to keep pushing the rents.

However, rents can’t go up forever at these rates. Affordability will become an issue. Some analysts expect mild deceleration to ease rent growth toward 3.6% throughout the year.

The cherry on top, though, is that pretty much nobody is anticipating rent growth to fall below the long-term average of 2.2% for at least another 4-5 years.

Can investors make money in smaller markets?

Everyone always likes to talk about class-A projects in big city markets, but what about opportunities in smaller cities? The truth is, you can achieve fantastic returns in smaller markets because there’s a lot of opportunity and generally less competition, so the cap rates tend to be higher.

One strategy is to look for class-C properties, built in the 1960s and ‘70s, that are in need of attention. High vacancies or low rents usually disguise a value-add situation. Once you acquire these types of properties, you renovate, reposition and raise them up to class-B.

There are 4 things that make a smaller property successful for investors who are interested in smaller markets:

Work closely with your property managers and set high standards. Consider learning how to ‘manage the manager’ by doing that job yourself for a few months.

Don’t syndicate or plan to pull cash out by a specific time. Too many cooks in a project can result in conflicting goals.

Upgrade and reinvest in the property including the rent increases as they grow.

Treat people well and engage their loyalty. They’re not just tenants — they are human beings and your customers.

How do you assess market performance in smaller markets?

So much depends on the community and the property. A smaller city doesn’t have the momentum of a major metro area, so it’s important to be a savvy buyer. Many buyers wont buy anything lower than a 9-cap… and prefer 10 and above.

Being savvy means truly understanding the market. That means doing an assessment of employment prospects, because as we’ve seen firsthand with the current recovery, occupancy improves as unemployment declines.

It also means doing an assessment of demand to make sure it’s a market where people rent apartments. That may sound strange, but if you buy an apartment building in a market where most of the young people leave town when they move out of their parent’s houses, well, then you’re going to have skinny kids, as the saying goes.

The multi-family machine keeps humming.

Overall, though, it looks like another awesome year ahead for apartment owners…

And if you’re looking for opportunities, those smaller markets may be the key. New construction is proceeding at a moderate pace, and nothing appears to be overheating.

It should be a great year ahead of us!