(NOTE: Want to learn how to flip houses to hedge funds? Click here for our “Partnering With Hedge Funds” special report.)
From Jason Payne, Market News Analyst …
Earlier this week, Moody’s Investors Service reported that U.S. apartment prices decreased 0.2% in September – the first monthly decline in nearly four years.
Although the apartment prices in major markets increased by 1.3%, the group’s overall regression was primarily driven by a 1.1% dip amongst multifamily assets located in smaller cities, according to the ratings company.
Meanwhile, the broader Moody’s/RCA Commercial Property Price index revealed that values for all commercial property types continued their upward march in September, increasing by an average of 1.8% for the month. (This gauge of general commercial real estate prices has now climbed 47.2% over the last four years, after bottoming in 2009.)
So, what gives?
Why did the resilient apartment sector underperform most of its peer groups in September?
Was this development a statistical fluke? Or does it imply something more meaningful for real estate market watchers?
Well, one month’s data is not sufficient to constitute a “trend”, so investors will be wise to maintain a healthy perspective of September’s recent decline in multifamily prices. Simply put, it’s too early to tell whether or not the party is ending for apartment buildings.
So rather than automatically assuming that the music has “stopped playing” (as some of our peers have prematurely announced), we here at Mogul acknowledge that the proverbial deejay may simply be changing tracks.
However, the recent underperformance of multifamily assets should not come as a surprise to investors – because property values in the apartment sector will almost always be among the first to change during any new economic cycles.
Apartment Values Are Frequently “Leading” Indicators
You see, the real estate industry provides a veritable buffet of investable sectors and subsectors, and each property type represents a unique sensitivity (or lack thereof) to macroeconomic trends.
And while different analysts may choose to view the industry’s sectors through slightly different lenses, my predecessors on Wall Street taught me to build my personal analyses around the following property classifications:
-
Healthcare
-
Hotels
-
Office & Industrial: Medical Office Buildings
-
Office & Industrial: Self-Storage
-
Office & Industrial: Suburban Office Buildings
-
Office & Industrial: Urban Office Buildings
-
Office & Industrial: Warehouses
-
Residential: Mobile Homes
-
Residential: Multifamily Homes (Apartments and Most Student Housing)
-
Residential: Single Family Homes
-
Retail: Regional Malls
-
Retail: Shopping Centers
-
Undeveloped Land
As a general rule, the economic sensitivity of each individual property type is closely related to its average lease length.
For example, hotels typically lease their space only one day at a time (and sometimes hourly), which represents the shortest average lease length in the entire real estate industry. As such, hoteliers are able to adjust their rental rates more quickly than any other landlords…
…and the dynamic value of their highly sensitive hotels typically serves as a leading indicator for pending value changes across most other property types -- ahead of most cyclical upswings or downturns in the U.S. economy.
(By the way, recent data from the hotel sector shows positive fundamental trends across the board.)
Conversely, it is not uncommon for some urban office buildings to lease their space for up to thirty years (and sometimes more), which ranks among the real estate industry’s longest average lease lengths. Accordingly, trends in the value of these office assets will often lag the pricing trends in other sectors.
But in light of Moody’s recent report about September's modest decline in apartment values, it is especially prescient to note that apartment buildings typically have short lease lengths of only 6-12 months. At the risk of oversimplifying some fairly complex economic models, this feature generally ranks apartments (along with hotels) among the industry’s shortest and most sensitive lease-pricing structures.
Be Prepared for Economic Changes
As leading indicators of real estate pricing trends, apartment buildings should be among the first property types to experience a slowdown (or reversal) in price growth when the Federal Reserve eventually begins to taper its current economic stimulus for the U.S. economy.
Of course, I’m not saying that September’s apartment data represents “Chapter One” in a concerning new story about cyclical downturns. And I’m certainly not saying that all the other property types will soon follow multifamily assets into a deflationary tailspin of cataclysmic proportions.
But what I am saying is this: Stay nimble. Be prepared. Keep your eye on the monthly and quarterly pricing data for apartments, hotels and other property types with short-term lease structures (student housing, mobile homes, etc.).
It is common for these sensitive subsectors to set the pace for trends across the broader real estate industry, and if you can develop a good “feel” for these predictive tremors, then you can greatly improve the timing of your investment activities…
…and your portfolio will thank you.
Jason Payne’s next Market News Update is currently scheduled for Wednesday, November 20th.
Jason Payne
is a management consultant and founder of the Groundwar Group -- a private consulting firm providing premier corporate advisory and leadership training solutions for business leaders and investors worldwide. Mr. Payne is also the Senior Market News Analyst and a featured "Mindset" advisor for more than 15,000 entrepreneurs and investors at RealEstateMogul.com -- roles he has held since 2013 and 2014, respectively. In these capacities, Jason draws from more than a decade of successful business and investment research on Wall Street to provide insightful commentaries on a wide variety of investing- and leadership-related topics.
Mr. Payne began his career as a research analyst in the award-winning Equity Research department of Morgan Keegan & Company, where at 26 years of age, he became one of the youngest published analysts on Wall Street -- with a specialized focus on real estate investment trusts (REITs). Jason also holds a degree in Finance from New York University's prestigious Leonard N. Stern School of Business, and he is currently completing his professional residency within the Global Leadership Training program of Uruguay's multinational Geronimo Center for Innovation & Leadership.