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Real Estate Indicators For Today's Apartment Markets

Discussion in 'Real Estate Investing' started by JScott, Sep 23, 2007.

  1. JScott
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    JScott Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR

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    Forgive any rambling, but I haven't yet organized all my thoughts around this topic yet...

    While the gist of this post is, "Where do you think we will see good apartment markets in the next year or two?", I'm going to disguise it with some additional thoughts... :coolgleamA:

    For anyone who has read Vollucci's book, you know that there are several indicators for defining apartment markets, including:

    - Employment Trends
    - Demographic Trends
    - Phases of Apartment Cycles
    - # of Allocated Building Permits
    - Etc...

    Now, I've spent a bunch of time analyzing data around these criteria for many of the major metro areas (MSAs) in the U.S., and have found exactly what you'd expect at the height of a real estate boom:

    - For almost all MSAs, job growth has increased tremendously over the past 5 years;
    - For almost all MSAs, population growth has increased tremendously over the past 5 years;
    - For almost all MSAs, the number of building starts (and completions) has dropped off tremendously in 2007, relative to the last 5 years.

    All of this indicates that we may be in the "end of boom" phase of the apartment cycle in most of these markets. Unfortunately, I haven't been through a full real estate cycle (where I've actually been paying attention), so I have a lot of questions for those investors who have been through this before:

    1) First, am I off in my reasoning above? Are there people here who believe we're likely *not* at the peak of this particular cycle in most major markets? If so, what indicators are you using that I might be missing (or am I just not examining the right markets)?

    2) Is it common for a majority of the U.S. markets to be at the peak of the cycle at the same time? Or is this a phenomena somewhat unique to the boom of the last 5 years?

    3) If you believe that we are at the peak of the market in most MSAs, what would your strategy be for apartment buying over the next couple years? For example:

    - Should we be looking for the few areas of the country where the market is not in the peak phase?

    - If so, and if everyone starts doing that, won't those few good markets become overly competitive and won't it likely soon be difficult to actually make money in those locations?

    - Or should we be looking at smaller or more niche markets?

    - Or should we just be much more selective about the deals we make, and only jump on the truly exceptional deals where we can make money by adding value vs. through improving market conditions?

    - Or, worst case, do we just wait a couple years?

    Lastly, how do you expect the macro-economic factors that we're currently seeing to impact the localized trends that I identified above?

    For example, all indicators lead me to believe that most major markets are at a peak in the cycle (and therefore not a good time to buy), but macro-economic trends (i.e., the credit crunch) are creating some conditions that are beneficial to buyers.

    So, how do you rationalize the major local trends with this weird macro-economic trend? Does it just prolong the peak phase? Does it create a buyer's market in selective locations? Or is this just a blip on the radar that likely won't have long-term effects?

    Btw, I realize that every area is unique, and I'm making some very generalized statements; I'm just trying to understand all this from a macro perspective before diving into specific markets.

    Oh, and if anyone wants to share their thoughts on where might be some good locations to buy apartments over the next year or two, feel free to share... :smx9:
     
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  2. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    You are thinking. That is good for you and your plans. This is what will make you an expert in the field some day.

    I agree with parts and disagree with some of the conclusions. This will take a bit of time to respond to though so I will come back soon.
     
  3. BeingChewsie
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    BeingChewsie Silver Contributor Read Millionaire Fastlane Speedway Pass

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    Hi,

    Its funny you write this post now. I'm going to be asking some similiar questions though not quite the same later today..once I get into makes some sense format.

    We joined a RE group in Souhern CA, they give out a list of metro areas and list which phase of the cycle they are in based on the Vollucci book. I have taken that list and started at square one looking up all the raw data on several of the metro areas based on the Vollucci book and I have been left feeling much like you...it seems many of these places are on the upside already...I wondered if it was normal for so many to be up at once. I have looked back at historical data on some of these areas and it looks like they were at the bottom in 2004-2005...like that could been the optimum buy time. Granted I'm just scratching the surface on places to pull data on and I'm sure you have looked at a lot more areas than I have.

    I have found some pockets and sub-markets that seem at least at first blush to meet the criteria, overbuilding, condo-conversions being brought back as apartments, vacany rates up and the area has a strong employment and strong future employment outlook..and then I have found a couple areas that seem to have a temporary job loss* so vacancies are up, permits are up over past years..so I guess part of my question is do you look for the overall metro area to meet the criteria or are sub-markets that do just as viable?

    Today I have several new areas to look at, I'm just learning so part of that process is comparing data so I get to know what I'm looking for. I plan on asking some questions I have formed from the Berges book related to finding value-play opportunities in these pockets/submarkets.

    Thank you JS for asking all the stuff you did, it was eerily similiar to the stuff I have been thinking about this weekend as I look at all the data I have pulled so far.

    Sue
     
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  4. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    Basically your discussion is about the macro cycles of the US economy. This is the wildcard that makes predictions on most types of investments difficult. In Vollucci'a book and in my investment process, it is the micro cycles that are the biggest drivers. How are each individual metro markets doing compared with the other metro areas.

    Clearly, the macro economy needs to be followed but the complications with determining the outcome should be influencing the buying and/or selling levels. This is what you are getting at in your post.


    Job growth has been good nationally. Some areas have done better than others though. Take Phoenix for example. It have lead the job growth engine for a number of years. Compare it do Detroit or Cleveland. The real question is where the leaders will be going forward. I have my bets on the energy sector.

    Population growth has tended to increase in the South and the West. If I am not mistaken, these are the areas that you have been looking at. I can guarantee that population growth has not been the same in all metro areas in this country.

    With regards to building starts, is your data through the end of the year or just year to date? Building costs have increased and put a damper on the total number of units built. The condo and house craze in some areas really took the developers in another direction and drove land prices up. It made economic sense for them to build homes for sale and not for rent.

    The tables are starting to turn in SOME locations though. With vacancies lower and houses not selling, apartments are coming back onto the table. Is this the case everywhere? Absolutely not. This is why you need to compare the different metro areas.


    Let's look at the key elements that will drive apartment values.

    Income and expenses
    Cost of capital
    Demand

    Income is the main driver that I focus on. Cost of capital is the biggest wild card. There is a counter balance effect that is created when income goes up but interest rates go up as well. If I can get 6% rent increases over a couple of years, it will more than counter a 1% increase in interest rates. If I can obtain another 2% reduction in vacancy over that time period, the income and thus value will likely have gone up for me. I factored in expense increases of 2% annually which should be sufficient.

    Demand can be looked at nationally and locally. Buyers tend to flock to areas that are doing well. The national market will draw investors if the market is performing well or looks to be doing so. Apartments have a favorable long term forecast at this time.

    Building has slowed as a result of higher costs. It will take some improvements in income to get the engine going full speed again. In the meantime, rents should continue to improve.

    The improvement in occupancy and rent increases should take apartments to a higher level.

    There are a lot of other demographic factors that are coming into play as well that should tend to see a lot of people moving into apartments. I am not going to go into all of these here but it will likely be aiding the market.

    The national economy is always the wild card. If we go into a negative job growth cycle demand will likely slow. The point of looking at metro areas stands out here as well. If you do a good job of finding a location that continues to have decent growth while the national economy slows, your bets will be hedged.
     
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  5. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    There are macro and micro cycles. Lower cap rates are primarily due to lower cost of capital. Income on apartments was lower during the housing boom and has been improving recently. Many buyers were evaluating based on proforma rents but this has slowed in the past couple of years. All in all, I see values increasing as a result of improved rents in some areas. The locations that were purchased on proformas that are not being met are turning into buyers markets. Areas that sold a lot to condo converters seem to be at risk as well.

    While values have increased, there are many areas that had remained fairly stagnant over the past few years.
     
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  6. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    This is an interesting statement. The whole premise should be to buy in markets that don't look so good to others but have all the potential to improve. You then sell when everyone else is looking at it favorably.
     
  7. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    I am buying in Houston TX. Lots of energy job growth that is expected to continue. High vacancy rate (highest in all large MSA's) and a lot of motivated sellers. Many owners saw a light at the end of the tunnel when all the Katrina evacuees moved in only to see the vacancy increase again as the FEMA money went away. Overall low prices that have been fairly stagnent for a while.
     
  8. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    I don't have any idea who the group is and how they track their data. I do know that a group came into Phoenix with a presentation on their cycles. I compared them to mine at the time and was amazed that we were 180 degees apart in our conclusions. So, I called them to ask what the returns were. They would not give me specifics but responded with an expected average that was less than a third of what I had been getting.

    The thing that really got me was that they were trying to tell us that Phoenix was in a sell cycle at the time. I lived here and understood the market well enough to know that their data was completely wrong. Turns out that my choice to keep buying here at that time was a good one.

    So, be careful in who you listen to. It sounds like you are doing your own homework as well.
     
  9. JScott
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    JScott Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR

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    Thanks both of you for the replies...lots of great info to think about...

    It's always nice to realize that there is so much more to learn...if it were easy, everyone would be good at it... :)
     
  10. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    It is all very difficult but very important. The work that you are both doing will go a long way towards understanding.
     
  11. BeingChewsie
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    BeingChewsie Silver Contributor Read Millionaire Fastlane Speedway Pass

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    Hi Steve,

    This was going to be part of my question later today because when I go and find the data and compare it to where they say the location is in the cycle..I'm getting a different picture and outlook on it, not on every one but on enough of them that I wonderd if I was doing something wrong. The only thing I'm using it for is to grab metro areas to look at. It is important to me that I learn to how to do this and not just rely on what someone else thinks. If I reach the same conclusion great, if not at least I can ask how the other person reached their conclusions. Thanks for the advice!

    Sue

     
  12. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    What areas are they suggesting? You can send me a pm if you don't want to post the data.
     
  13. JScott
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    JScott Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR

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    This actually really simplifies the whole thing for me. It clarifies the relationship between all the economic and demographic indicators that drive apartment values.

    For example, Income and Expenses directly tie to the "Rent Growth" and "Inflation" indicators; Cost of Capital directly ties to the "Interest Rate" indicator; and Demand directly ties to the "Vacancy", "Job Growth" and "Building Permit" (which defines Supply) indicators.

    One question:

    I wonder how much Cost of Capital truly affects demand, as it is in-a-way a hedge against itself. For example, when cost of capital increases, your margins decrease (bad for apartment buyers) but at the same time the ability for people to buy houses decreases (good for apartment buyers). Additionally, when cost of capital increases, it's harder to sell your apartments (bad for apartment owners) but cap rates increase (good for apartment owners).

    Overall, do you believe that cost of capital is a major indicator for apartment cycles? If so, is increased cost of capital necessarily a bad thing for buyers/owners?

    Perhaps I'm missing something else?
     
  14. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    Everything tends toward equalibrium. Our game is to catch the upswings.

    Cost of capital will definitely affect apartment prices. But, you are correct in your conclusion that it will likely create renters as well. It just takes a little more time for all the data to catch up with everyone.
     

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