Fortunately, for those who own commercial real estate, eliminating the 1031 exchange probably won’t make Biden’s near-term agenda after all.
The 1031, also known as a like-kind exchange, benefits small business owners who want to sell their properties. It allows sellers to defer capital gains tax when their proceeds are reinvested into other investment properties.
Right now, the 1031 exchange is more important than ever. During the coronavirus-caused economic downturn, it has helped relieve the tax burden on those who are selling investment real estate that may be tied to struggling sectors such as hospitality. Investors who own other types of real estate, such as rental homes, apartments, retail centers, restaurants, bars, farms, and ranch lands may also use a 1031 exchange.
Dodged A Bullet For Now
However, with COVID-19’s recent resurgence, the focus of the new administration will likely be on health and economic stabilization. At the same time, infrastructure will be a heightened focus, especially for the first two quarters of 2021. And even if a proposal to narrow or eliminate 1031 exchanges was brought forward, it seems unlikely (though anything can happen), that Congress will take on efforts to cancel or modify Section 1031 of the Tax Code for now.
This is great news for business owners, entrepreneurs, and commercial real estate investors. Indeed, it can be good for job growth and the economy overall. 1031 exchanges facilitate liquidity—particularly important for small business owners or individuals who don’t have access to the same sources of financing as larger institutions. Not only that, but these transactions can often boost local employment as suffering properties are transferred to owners who have the time and resources to invest in improving and maintaining the property.
Incentives to transform out-of-favor properties into new uses can have far-reaching, positive effects throughout local communities.
Section 1031 like-kind property exchanges have been part of the American real estate DNA since 1921. Tax-deferred exchanges give businesses — and ordinary people — much more flexibility and liquidity than they would otherwise have in reallocating their investments.
As much as 20 percent of commercial real estate transactions over the last decade relied on 1031 like-kind exchanges, according to a 2020 economic study by professors David Ling and Milena Petrova.
A stubborn misconception clings to the 1031 exchange: That it’s a loophole used primarily by ultrahigh net worth individuals and corporations to avoid paying taxes. That led to a proposal by the Obama administration to limit 1031 deferrals to an annual $1 million per person. Republicans considered eliminating it as part of the 2017 tax reform bill. Biden said he’d consider phasing the benefit out for investors with incomes over $400,000.
That would fly in the face of mounting evidence that 1031 exchanges benefit a much broader group of Americans while contributing federal, state, and local tax revenues, creating liquidity and deal flow in the real estate markets, and creating jobs.
The Ling and Petrova study —which reviewed more than 1.1 million commercial real estate transactions—found that many perceptions about 1031s are false.
For one, exchanges may lead to future taxable transactions, offsetting some fears that 1031s erase tax revenue entirely. According to the study, on average 63 percent of 1031 exchange properties are eventually sold in a taxable transaction at a later date. Of course, it’s impossible to determine what real estate transactions might have occurred — or not — without the 1031 benefit.
The study also found that like-kind exchanges result in 7% less debt compared to taxable transactions, reducing the financial vulnerability of the real-estate sector.
A separate economic study in 2015 by Ernst & Young found that that eliminating 1031s would result in less tax revenue and shrink the U.S. economy by up to $13.1 billion annually. Even if the pandemic hadn’t revealed its benefits in such sharp detail, the economic fallout from cutting the tax benefit could be devastating.
Huge Economic impact
By keeping money flowing through real estate investments, 1031s stimulate and support a plethora of jobs in the sector, ranging from title company employees to appraisers to contractors who are hired when people buy and improve properties. The Ling and Petrova study found that a repeal of section 1031 could result in lower investment activity, a fall in real estate prices, an increase in rents, an increase in holding periods for property, and a rise in the use of debt.
Even at the best of times, that would be an economic blow to businesses and communities across the country. Without it, more investors are likely to sit on their properties to avoid taking a tax hit, slowing the repurposing of property.
With 1031s in place, someone who owns a restaurant or retail store will more easily be able to sell to another investor who plans to turn the space into its highest and best use. Take away the 1031 incentive, and there’s significantly less chance of that sale occurring. The result: more underutilized properties, more depressed areas, less economic activity, and fewer jobs.
If the Biden administration’s goal is to revive the economy, create jobs, and bring back business and consumer confidence, getting rid of 1031 exchanges would be an effective way of shooting the economy in the foot.
Fannie Mae headquarters. Image courtesy of Fannie Mae
Rumors that the outgoing Trump administration would spring an 11th-hour effort to privatize Fannie Mae and Freddie Mac were set to rest last week when the government-sponsored enterprises’ overseers reached an agreement to limit their growth—but without major structural changes.
The agreement between the Federal Housing Finance Agency and the Treasury Department includes such elements as a permanent ceiling on the agencies’ multifamily lending volume; locking in requirements to focus on affordable housing; enabling them to retain much more of their profits, and an obligation to comply with rules that require them to set aside more regulatory capital.
Taken together, these provisions put Fannie and Freddie on a path toward ending conservatorship by strengthening their long-term financial position. Although it could diminish their dominance of the multifamily lending market somewhat, the new rules fall short of the all-out effort to privatize the agencies that was rumored to be in the works.
“The amendment will allow FHFA Director Mark Calabria to move the GSEs slightly closer to a conservatorship exit, (but) it doesn’t open the door to ending conservatorship without buy-in from the Biden administration or new legislation from Congress,” said David McCarthy, senior director of government and policy relations at the CRE Finance Council, a Washington, D.C.-based trade group.
Running Out the Clock
The Trump administration, particularly FHFA Director Mark Calabria, set ambitious goals to release the GSEs from conservatorship, where they have been since being bailed out by the federal government in 2008. After he was appointed to a five-year term in 2019, Calabria ended the cash sweep that sent Fannie’s and Freddie’s profits to the federal treasury, the first step toward financial stability and setting them free.
The upcoming change in the administration on Jan. 20 set off a regulatory clock for Fannie and Freddie. Not only will the new Treasury Secretary—Joe Biden plans to nominate former Federal Reserve Chair Janet Yellen—have a different perspective on the GSEs, but the new president could try to dismiss Calabria immediately. It remains unclear whether that is Biden’s intention, but the president’s power to fire an agency head without cause is the subject of a case before the Supreme Court.
That left Calabria and Treasury Secretary Steve Mnuchin to walk a tightrope between negotiating an agreement that would help achieve their goals of privatization and reducing the market footprint of the GSEs without roiling the real estate lending industry, which has been operating without much trouble in recent years. Industry housing trade groups including the Mortgage Bankers Association sent a letter to Mnuchin last month urging him to not push the agencies out of conservatorship before they had enough capital.
In the end, it was impossible to raise the capital needed to release the GSEs from conservatorship in the time before the new administration took charge. Thus the agency heads opted for incremental change that puts Fannie and Freddie on the path to privatization, but which can’t be achieved without the support of a future administration.
Weaker Competitive Position
The new agreement does put some limits on Fannie and Freddie that leaves more room for competitors. The most obvious limits are an $80 billion annual cap and the requirement that at least half of originations are on properties that meet a threshold of affordability. The FHFA has set annual caps in the past; for 2021 it is $70 billion, following an $80 billion limit in 2020.
The new cap is permanent, although it could be changed through an agreement between a future Treasury Secretary and FHFA director. That gives Calabria some control if he can stay on as FHFA director through the end of his term, a possibility which depends on the outcome of the lawsuit before the Supreme Court.
Another element of the agreement is that enables the GSEs to retain capital beyond the previously agreed-to level of $45 billion ($25 billion for Fannie and $20 billion for Freddie). To date, Fannie has accumulated about $21 billion and Freddie $14 billion, according to CREFC. Now, however, the agencies can retain earnings up to a combined $280 billion, which is what the FHFA estimated was the necessary level for privatization.
For more than a decade after conservatorship began in 2008, Fannie and Freddie were required to sweep profits into the federal coffers. The GSEs’ preferred stockholders, which own about $31 billion of preferred stock that has not received a dividend since 2008, remain embroiled in a lawsuit that contends the cash sweep agreement was illegal. The Supreme Court is expected to rule on the case during its current term, which ends in June.
Another element of the new agreement is that it binds the GSEs to the capital framework adopted by the FHFA in 2020. The rule requires the GSEs to maintain tier 1 capital of 4 percent of assets, which amounts to an increase in the amount of regulatory capital the GSEs must hold. That serves to make them safer from losses but also increases their cost of capital.
These and other parts of the new agreement, taken together, put Fannie and Freddie on the road to better financial health while slightly reducing their competitive position in the multifamily market. The GSEs’ chief advantage has been their low cost of capital, which enables them to beat competitors on loan rates. That advantage is diminished somewhat by the higher capital threshold. Meanwhile, Fannie and Freddie are also constrained by origination limits and the requirement that half of their business must encompass properties that meet the test of affordability.
Permanent reform has been discussed for years, and the commercial mortgage industry would prefer a permanent framework for the GSEs, but the agreement has been impossible. No solution has a consensus among policymakers and the lack of an imminent problem in the mortgage markets has made it less of a political priority.
As such, the new agreement is being well-received by most of the industry. Lenders such as commercial banks, insurance companies, and CMBS programs would all like a better competitive position relative to the GSEs so they can originate more loans on apartments. The utility of the agency model, however, was demonstrated in 2020 during the pandemic, when Fannie and Freddie remained active as most lenders stopped writing new business because of COVID-19.
Rob Van Raaphorst, vice president of communications at MBA, said the new agreement “preserves and extends a level playing field for lenders of all sizes and business models while avoiding near-term measures that could have threatened market stability … It is critically important that measures guide the GSEs’ market footprint carefully balance the need for them to meet their affordable housing mission for both single-family and multifamily homes.”
To some, the action was mostly about optics since most of the changes can be reversed when new appointees gain oversight powers. “The only thing going on is that earnings can continue to be retained,” said one long-time industry insider. “The rest is about optics and politics and actually is unlikely to last very long.”
Collections for public housing reached 97% of 2019 rates, and affordable housing reached 83%—the highest level for the latter class since June.
By Les Shaver | January 14, 2021, at 07:09 AM
Even though money from the recent stimulus hadn’t yet reached the economy, rates of collections in affordable and public housing were high in December, according to MRI Software.
MRI says collections for public housing reached 97% of 2019 rates, and affordable housing reached 83%. That was the highest level for the latter class since June.
Collections increased as new applications increased significantly YOY in both public and affordable housing, by 56% and 14%, respectively. MRI says this represents a significant shift in direction since the start of the pandemic when new applications trailed the numbers of 2019.
The December data also showed occupancy tightening across all asset classes, as move-ins outpaced move-outs for the sixth consecutive month. Move outs were down across the board but fell 80% in affordable housing.
While occupancy tightened across the board, some of MRI’s indicators show market-rate housing struggling more than affordable.
The year started strong for conventional apartments, with pricing up 2% over 2019, but it quickly eroded over the summer, according to MRI. Apartment operators relied on concessions, and those steadily increased from September through December.
In December, lease prices fell 2% for market-rate housing. In all, aggregate concession values for market-rate housing increased by over $6 million YOY.
MRI’s data also showed an increase in new payment agreements in conventional housing, which allows residents to manage past due balances formally with their landlord.
This highlights National Multifamily Housing Council’s latest rent payment data, which found that collections for conventional apartments fell 3.4% year-over-year in December 2020.
The NMHC’s Rent Payment Tracker, which surveys 11.5 million units of professionally managed apartments across the country, found that 89.8% of apartment households made either a full or partial rent payment by December 20. That’s 393,952 fewer households than the share who paid rent by that date in 2019. NMHC data shows that 90.3% of households paid rent by November 20, 2020.
When it comes to navigating multifamily real estate investments through a global pandemic, life in the suburbs has been pretty good. Of the two dozen development deals that The NRP Group had on the books in January of last year, 23 of them were closed successfully, resulting in a record production year for the Cleveland-based developer of affordable and market-rate housing.
“We started 5,000 units representing roughly $1.4 billion in real estate value, and 60% of that pipeline was in the affordable business, so we do feel blessed and very thankful again that we are a diversified company,” says NRP principal and president of development Ken Outcalt. “And we’re bullish on both sides of the business going forward. Our past experience of not getting aggressive in high-density urban deals has benefited the portfolio, and we don’t have any of those urban deals right now. We are 100% suburban.”
To be sure, 2020 was not without its challenges. The onset of the pandemic and related shelter-in-place orders in March and April resulted in a virtual freeze on apartment investment and development activity as debt providers vanished, equity players sat on cash, and contractors temporarily shuttered job sites. But despite a hard stop on buying and building in the second quarter, most multifamily firms report a rebound across the second half of the year and are buoyed by stability in underlying business fundamentals and capital markets that portend a thriving rental sector for 2021.
Like NRP, Charlotte, North Carolina-based Crescent Communities headed into the year with high expectations and the deal flow to match. “Obviously we were at the height of the real estate cycle,” says Crescent senior vice president and chief investment officer Jason LaBonte. ”Everyone was flush with cash, the fundamentals were phenomenal, and our pipeline was strong. We do roughly 10 deals a year, and we were out looking to capitalize the 10th for 2020 when the pandemic hit.”
Although six of those development deals were paused due to pandemic-related capital market pricing issues and two deals had joint-venture partners that ultimately walked, Crescent was expected to close out 2020 with all 10 deals intact.
“A lot of equity partners simply needed some insight into what the future was going to look like, and we all needed to get further into this and realize that people still needed a place to live and that Class A multifamily would be impacted less by the job losses,” LaBonte says. “The JV partners are back in the game, and we’ve replaced the ones who walked, so we’ll get all of our deals done for the year.”
Investors, developers, owners, and operators across virtually all multifamily asset classes report similar positive business fundamentals headed into 2021. At Philadelphia-based student housing company Campus Apartments, executive vice president and chief operating officer Miles Orth say occupancies and performance have remained relatively strong across a portfolio of assets serving 50-plus universities and colleges in 18 states.
“That’s not to say that there was not significant disruption,” Orth says. “Operators had to pivot quickly and address new issues and concerns while remaining laser-focused on supporting their teams. But now that we’re nine months into the pandemic, student housing occupancies and collection rates are among the highest in the real estate industry and are clearly demonstrating that this sector is strong, stable, and vibrant.”
Follow the Money
Indeed, strong multifamily asset performance during the pandemic while other real estate classes have foundered is boosting already high rates of global investment into the apartment sector, catalyzing development and possibly sparking consolidation via the acquisition and disposition of portfolios in 2021.
“There is so much capital out there that is ready to invest into multifamily, and a big reason for that is that until the pandemic is resolved, hotel is uninvestable, office is not for the faint of heart, and retail is dead,” Outcalt says. “So there is a lot of dry powder out there looking for apartment deals because most of the other international options for these investors are really risky.”
Equity already allocated to multifamily investments but forced to the sidelines in the second quarter of 2020 also has rushed back into the market, and lending commitments to the apartment sector made by Fannie Mae and Freddie Mac have admirably filled the momentary void from banks, life companies, and CMBS lenders who are now reentering the market. In November, the Federal Housing Finance Agency announced a combined $140 billion commitment to multifamily for 2021, with 50% of that allocation committed to affordable housing.
“Given the pause in activity, the agencies would have to have had just a rocking and rolling fourth quarter to meet the [2020 allocation of $200 billion],” explains PGIM Real Estate head of agency lending Mike McRoberts. “But the amount of capital still chasing the preferred equity and mezzanine parts of deals is still there, and sellers are seeing close to pre-pandemic pricing, which encourages a lot of cross pools that can tie assets together and go to the agencies to structure a credit facility. We did over $1 billion of that in 2020.”
As operators across a majority of markets report only slightly depressed—if not steady—rent fundamentals, buyer appetite in 2021, absent a force majeure event, will remain robust.
“There is a significant amount of pent-up demand for quality multifamily product in quality locations because of the slowdown from the pandemic. A lot of equity players have to get that capital into play or return it,” explains Kevin Keane, executive vice president, and chief operating officer for the Wellington, Florida-based Bainbridge Cos. “We are certainly looking at 2021 as a portfolio buyer because we have those funds in play with investors who want to make those kinds of purchases.”
With asset valuations driven by net operating incomes that are heavily weighted toward rent rolls, it’s remarkable that multifamily pricing has remained steady in the face of epic U.S. unemployment and a national eviction moratorium. While rents have remained fairly flat, operators are yet uncertain whether they’ll face exposure to delinquencies across 2021. Anecdotally, the so-called urban exit of renters who no longer need to be close to core office employers and desire lower population density due to the pandemic seems to be bolstering rather than dragging down apartment fundamentals.
“We had some properties that went into lease-up in spring where leasing velocity was down in the 20s versus 30 to 40 units per month, but we did not have to discount rents,” says Keane. “But we are conservative with our underwriting and in some cases even beat our expectations. We think we are benefiting by migration to the suburbs because we are already here. A lot of competitors are still looking for sites, and we have a healthy pipeline of seven developments slated to close in 2021.”
Healthy development pipelines are keeping builders busy, too, and veteran general contractors say the action is hottest in the suburbs, where the pandemic has accelerated millennial household formation and renters escape the dense urban environments that could increase the risk of exposure to the pandemic. “All of these factors are shifting demand for multifamily housing to the suburbs,” says Richard Lara, president, and CEO of RAAM Construction. “It’s bringing us more business, and we expect to see huge upswings in demand for affordable communities in suburban markets in the next few years.”
Outbound urban population migration could also offer insurance to student housing operators should universities and colleges struggle with lingering pandemic issues. In particular, off-campus, purpose-built student housing in smaller college towns or suburban submarkets could be repurposed to meet market-rate demand.
“We have some properties where we were able to pivot to market-rate given their location and proximity to desirable locations in addition to the university they serve,” Orth says. “Five of our properties benefited from that pivot and were able to stabilize occupancy by reaching out to market-rate renters, but that won’t work in every instance, which is why we’ve accelerated our leasing program for 2021 to encourage early decisions by students in their housing selection for the fall.”
As president of Walker & Dunlop Investment Partners, Sam Isaacson oversees a $1.2 billion commercial real estate portfolio and one of the largest multifamily lending and brokerage shops in the country. While Isaacson agrees that softness in the multifamily market has thus far been limited to the urban core, Class A assets, and could perhaps trigger a larger market shift toward suburban development, he’s unsure if multifamily assets as a whole have yet to prove themselves so bulletproof against the pandemic and its socioeconomic aftershocks.
“Multifamily will not be insulated from millions of people being unemployed and having to change careers,” Isaacson says. “We are taking a risk-off position and taking preferred equity instead of joint-venture last dollar exposure, and are avoiding going 100% on the stack given what is going on. If we are taking last dollar risk, it will be on ground-up construction because the risk-adjusted return is better, and we expect a shift there to more suburban product and even single-family build-for-rent given the migration patterns.”
The Long Haul
That’s not to say that luxury urban core is dead as an asset class. On the contrary, veteran multifamily investors and owners feel that market challenges in 2021 and beyond will help winnow an overcrowded playing field of yield chasers and me-too operators and managers, with firms that can adapt without being reactive championing over their peers.
“It’s still too early to predict if there are going to be defaults beyond San Francisco, New York City, and Chicago luxury, and whether or not there has been a true flight to the suburbs,” says LaBonte. “Yes, urban is depressed right now, but time and again those markets have proved to be resilient, and you will see capital come back to core investments. By 2023 and 2024, you will have some suppressed pipeline coming into most of the market, and as long as you are not going in with a merchant build model and build in an eight- to nine-year hold, there will be great opportunities there.”
Like Lara, Outcalt sees increased opportunity in affordable housing across NRP’s markets, particularly given the perfect storm of migration, millennial household creation, and agency allocations to projects meeting affordability thresholds. Playing into the firm’s diversified model (roughly 60% of the portfolio is affordable), NRP is also having success offering third-party construction services to developers anxious to get communities out of the ground.
“In both property management and construction there has been a real flight to quality, and we have 10 deals in our 2021 pipeline that we’ll be building for third parties,” Outcalt says, adding that NRP isn’t hesitant to take on projects in submarkets where it operates its own assets. “Those are the markets where our sub base is the strongest, and one way or another someone is going to build it, so why not us?”
Politics and the economy, too, will continue to shape multifamily real estate across 2021 and beyond. While drastic changes are not expected to agency caps and allocations, leadership at the FHFA is likely to see an overhaul with the rest of the executive branch, and housing policy, in general, is likely to become more stringent and shift further toward affordability.
“Obviously it’s not just getting at the virus with a viable vaccine and treatment. There is a relief rally in the stock market that can provide higher confidence in your top-line underwriting,” McRoberts says. “Then what is the direction of the recovery, and how quickly can we employ people? The speed of that recovery, the speed of changes to the tax plan, the rent control, and eviction moratorium will all have to settle out.”
Navigating portfolios through those challenges might not be such a bad thing, Isaacson says. “Over the last 10 years, anyone could do well in multi-family, and we expect that 2021 will see a separation of the good from the not so good. A bifurcation in performance is coming that will present new buying and business growth opportunities for top performers.”
Historic Year for Apartments as Cities Lose Their Edge and Suburbs Gain
Last year turned many apartment fundamentals on their head in ways that could have lasting effects.
The pandemic and economic downturn led to developers starting the lowest number of new apartment units in almost a decade last year, even as they completed the highest amount of units this century, according to CoStar.
That dynamic could help meet some growing demand in the suburbs this year while helping to relieve the growing vacancy pressure in urban areas. That demand shift began as more Americans started working remotely in March and April, and urban apartment renters flocked to the suburbs, chasing cheaper rents and more space.
“By May, asking rent trends showed a clear divergence between suburban product and downtown product, a trend that would accelerate during the summer as offices remained closed,” John Affleck, vice president of market analytics with CoStar Group, said in a year-in-review video report.
Rent declines were most pronounced in large, expensive cities and are expected to remain below the peak for the foreseeable future, he said. In San Francisco, the nation’s most expensive apartment market, rents fell 17% by the end of the year.
By contrast, rental rates grew in cities within a few hours’ drive of pricier markets, where renters could pay cheaper rent, drive to their urban office when necessary but otherwise save hundreds of dollars a month and have more space.
In the coming months, apartment demand is expected to exceed normal seasonal levels as renters chase affordability in suburban and regional markets. Renters are also expected to continue to take advantage of the steep discounts that urban landlords are offering.
“And the passage of additional financial support — and the prospect of more to come — puts money in the pockets of renters,” Affleck said.
More Apartment Dwellers Paid January Rent Than in Prior Month, Latest Figures Show
More residents in professionally managed apartments paid their rent this month than in December, but they still trail the number of renters who paid a year ago, according to new figures from a multifamily industry advocacy group.
About 76.6% of apartment residents had made full or partial payments toward their January rent by the 6th of the month, according to data from the National Multifamily Housing Council, a Washington, D.C.-based group that represents 11.3 million professionally managed multifamily units in the United States.
That reflects a 1.2 percentage point increaseover the number of renters who paid their December rents, according to the data, but represents a 1.7 percentage point decrease in those who paid January rent before the pandemic created widespread economic uncertainty.
“While there is light at the end of the tunnel with the rollout of vaccines, the country and the multifamily industry continue to face steep challenges,” Doug Bibby, NMHC president, said in a statement.
Rental payment patterns have hovered stubbornly around 75% of tenants paying their apartment rent since the pandemic began in March, creating a surge in unemployment as well as in residential eviction moratoriums to help protect struggling renters.
December was the worst month for rental payments during the health crisis, as about 75.4% of renters made payments toward their rent by the 6th of the month. That compares to the best month for rental payments, which came in June, when roughly 80.8% of apartment dwellers made full or partial payments, according to the data.
The rate of rental payments in any month may be influenced by a slew of factors, such as closed leasing offices or the effect of stay-home orders on residents being able to pay rent in-person or via mail.
Vaccines that could help to bring an end to the pandemic could also help bring more stability to the multifamily market. As of Jan. 10, more than 150,000 people in the United States have received their two doses of the coronavirus vaccine, according to a survey conducted by The New York Times. And roughly 6.7 million Americans have received their first dose of the vaccine, per the Times.
The NMHC has been advocating for additional government support and stimulus payments that could help more residents pay their rent. Bibby encouraged an efficient rollout of the newest federal COVID relief package that he said included $25 billion in “desperately needed rental assistance as well as expanded unemployment insurance.”
And with President-elect Joe Biden’s inauguration quickly approaching, renters could be poised to receive another stimulus check. Biden is expected to unveil a comprehensive coronavirus relief package that he has said will be “in the trillions of dollars” and is expected to contain measures to send a $2,000 relief check to many Americans.
National US Rental Demand Closes Out Year at Strongest Level Since 2000
The United States ended the year with the best fourth quarter for apartment demand in two decades with large Sun Belt cities driving the most traffic, though some high-priced coastal markets hit hard by the coronavirus pandemic initially now appear to be rounding the corner.
Despite the traditionally slower fall leasing months and a slowing economic recovery, apartment demand, or net absorption, in the fourth quarter of 2020 blossomed. Nationally, net absorption totaled more than 70,000 units in the fourth quarter. That led to the nation ending the year with the best fourth quarter for net absorption since 2000, beating out the previous record set in 2015. National fourth-quarter net absorption has averaged about 45,000 units since 2015, while quarterly net absorption for all quarters in the same time period was about 77,000 units.
The strong fourth-quarter numbers were likely a result of the unusually long leasing season induced by the pandemic. As the lockdown went into place during the second quarter, leasing activity ground to a halt across the country. But as lockdown orders lifted and society gained a greater understanding of the virus, apartment demand returned as tenants that were forced to delay leasing decisions in the early months of the pandemic either moved or renewed late in the year.
Dallas-Fort Worth led the country once again in the fourth quarter, with roughly 5,000 units of positive net absorption. This marked the third straight quarter it led the nation in apartment demand. Perhaps most impressively, the region posted its best fourth-quarter net absorption since 2000.
Other consistent demand leaders, such as Houston and Atlanta, ranked in the top five for net absorption in the fourth quarter. Both cities trailed Dallas-Fort Worth, but Atlanta set a new market record for the fourth quarter, and Houston had its best fourth quarter for demand since 2012.
But fourth-quarter demand also turned positive in many cities where it was negative in the months immediately following the onset of the pandemic. Falling rentshelped stabilize the situation in many pricey coastal cities, as opportunistic renters likely sought out discounts in previously struggling regions. New York rebounded from two consecutive weak quarters, while Washington, D.C., and Boston each posted strong follow-ups to relatively robust third-quarter performances.
Demand was also positive in Los Angeles, with the region recording roughly 2,400 units of positive net absorption after four straight quarters of negative demand.
Miami, Fort Lauderdale, and Palm Beach in South Florida also had strong fourth quarters on a percentage basis. With financial companies openingnew offices, the rebound in apartment demand is understandable and a welcome sign to local landlords.
Meanwhile, the situation in the Bay Area stabilized in the fourth quarter as San Francisco and San Jose saw relatively flat demand after big demand losses earlier in the year. But those areas still ranked in the bottom half of all major metropolitan areas for apartment demand in the final quarter of 2020.
Chicago was the only city that saw notable negative net absorption in the fourth quarter. The Windy City was also one of the few markets that underperformed its typical fourth-quarter trend, which is usually slightly positive.
The poor performance in the fourth quarter tipped Chicago into the red for the year. More people moved out of Chicago than moved in, one of only six markets nationally that saw that same trend, joining San Francisco, New York, Los Angeles, San Jose, and the East Bay.
Dallas-Fort Worth, Atlanta, Houston, and Phoenix were the top four metropolitan areas for net absorption last year. These four areas led the nation in nominal population growth in 2019, and CoStar data heavily implies that once the Census releases new data at the city level, these markets will remain at the top of the list in 2020.
Other leaders included San Antonio, Denver, and Charlotte, North Carolina, three cities that have continued to benefit from positive net migration trends from Northeastern, Midwestern, and West Coast areas.
Looking forward, continued improvement in apartment demand will depend on the nation’s economic recovery as well as the speed and effectiveness of the coronavirus vaccine rollout.
While additional fiscal stimulus and an improving public health situation should boost economic conditions, leading to more demand for housing, record-low mortgage rates and a sharp increase in single-family home construction could serve as a drag for rental demand in the coming quarters.
The pandemic, however, has accelerated that trend, according to San Francisco-based Al Pontius, senior vice president, real estate investment services, at brokerage firm Marcus & Millichap.
Office leasing continued to decline nationally in the third quarter, with renewals dominating leasing activity, according to Bruce Miller, a senior managing director in the capital markets group of real estate services firm JLL. He notes that suburban submarkets saw declines in leasing that were identical to office buildings in CBDs in the first and second quarters of the year, with new leasing activity in each quarter declining by 50 percent. In the third quarter, however, CBDs saw an 18 percent quarter-over-quarter decline in leasing activity, while leasing in suburban submarkets fell by a more modest 4 percent.
“The top-performing suburban assets over the past several years and amid the pandemic are those that best emulate the environment of a CBD within a lower-cost, lower-density environment,” says Miller. Newer, class-A office assets that recreate the appeal of an urban environment, with transit connectivity and nearby amenities, outperform older-vintage suburban product in more distant suburbs, he notes.
As a result, investors continue to seek quality office assets in suburban locations, according to Pontius. However, “Investors are still being cautious, so credit and term are critical, and there is a direct correlation between those two criteria and execution probability.”
Pontius notes that investors are targeting suburban office assets based on a number of factors, including the offered cap rates, which vary widely from about 6.3 to 8.5 percent. Other important considerations include asset quality, rental rate, lease length, and tenant credit quality.
Miller contends that many investors are looking for high single-digit to low double-digit levered returns, and contrary to prior cycles, suburban assets have consistently outperformed CBD assets in terms of total returns over the past several years. That has been largely due to cap rate compression in the CBDs.
Over the past year, prices on office buildings in CBDs have increased by 3.5 percent, according to the Commercial Property Price Index produced by real estate data firm Real Capital Analytics (RCA). During the same period, prices on office buildings in suburban locations fell by 1.6 percent. Over the most recent three-month period, prices on CBD office buildings rose by 1 percent, while prices on suburban office assets rose by 0.5 percent.
However, while office investment sales activity has fallen across almost all U.S. markets (office sales volume was down 44 percent year-to-date through October, according to RCA, compared to the same period last year), Miller says investment in suburban assets has fallen less (by 42 percent at the end of the third quarter), compared to investment in CBDs, which fell by 56 percent.
In fact, Miller notes that 18 institutional investors acquired suburban properties for the first time in 2020, collectively investing $460 million in suburban office acquisitions. The largest of these was Korea Investment Holdings, which purchased 2 MacArthur in Orange County for $86 million.
In addition to new entrants, there are a number of investors who have significantly increased their suburban office acquisitions in 2020 relative to historical standards, he says. These include Invesco Real Estate, which invested more than $1 billion in suburban assets this year, well above the $300 million the firm acquired in that subsector annually over the past decade. Additionally, 11 other institutional groups have acquired more suburban office buildings in 2020 than any other year, according to Miller, who says that institutional investors are highly focused on growing suburban markets.
CHICAGO (WBBM NEWSRADIO) — The city of Naperville has taken an initial step towards requiring developers to include affordable housing in their plans, but the city council wants to be careful not to stymie development.
The state has twice cited Naperville for its lack of affordable housing. Now, the city council plans to research a possible Inclusionary Zoning Ordinance that would have an affordable housing component. The mayor and council members say requiring affordable housing must be balanced with not deterring development.
“We have seen a lot of cities get it way wrong, too, and so that’s my concern,” said Mayor Steve Chirico.
Chirico added that that does not mean Naperville can’t get it right.
Councilmember John Krummen said there’s a need for affordable housing in Naperville. He uses himself as an example.
“I look at people 10 years older than me. I’m widowed. I’m single. What am I doing in this big house? And, the only reason I stay is that there’s nowhere cheaper for me to go,” he said.
Krummen asked why he would downsize and up a budget?
Council members indicated they wanted to get it right too and not kill development.
“In the 12 years that I’ve been on Council, I’ve been both pro-development and pro-affordable housing and I see those as extremely consistent,” said Member Judith Brodhead.
Developers, the Naperville business community, and housing advocates will be asked for input on a new affordable housing ordinance.