sacramento

Multifamily Developers Seize Opportunity

Opportunity Zones have been discussed at length since their inception in Q1 2018. Interest is high, and 300+ investment funds had targets to raise ±$50 billion to invest in Opportunity Zones as of Q2 2019.

The impact of Opportunity Zone incentives is mixed and should be described in nuanced terms. Overall, investment volumes appear to be primarily influenced by cyclical factors. Total investment in Opportunity Zones since the creation of incentives (Q1 2018), transactions have accounted for 10.5% of overall U.S. volume.

The share of volume in these zones remains largely unchanged compared with the 18 months prior to the program (10.7%). Furthermore, annual volume growth in Opportunity Zones has been quite reflective of the broader market throughout the entire cycle, even during the past 18 months (6.7% vs 7.2%) when compared with the preceding 18 months.

While transaction volumes do not appear to have an impact on aggregate demand, demand has shifted around in some ways and there are meaningful localized impacts, including the rise in development site acquisitions since the start of the program.

Development Site Acquisitions Stand Out

Development site investment in the period from Q1 2018 through Q2 2019 totaled $87 billion and was 14.6% higher than the 18 months preceding the program. In contrast, investment outside of Opportunity Zones was only 1.2% higher than the six months leading up to the program.

Development of raw land is one of the most straightforward ways to deploy capital and maintain compliance with program regulations, thus qualifying for tax benefits. As a result, transaction activity for opportunity zone development sites has increased sharply, indicating some impact in this segment of the market.

Investment in land sites for multifamily development experienced particularly significant gains since Q1 2018. Multifamily development site acquisitions jumped 66.2% from the 18 months leading up to the program while development sites for all other property types experienced either losses or only moderate gains over the same time period.

Multifamily site investment accounted for 35.1% of all development site buying in Q1 2018 through Q2 2019. In the prior 18-month period, multifamily represented 24.2% of total development site investment.

In terms of the dollar value of construction starts, multifamily represented over one-half (53.2%) of the total commercial real estate value invested in Opportunity Zones over the last 18 months. Consequently, the estimated dollar value of completions is expected to rise through the end of 2019.

Site Investment by Location

New York City, Los Angeles and San Jose led in investment volumes of development sites since the start of the program. Secondary markets such as Salt Lake City, Denver and the Inland Empire had strong showings in terms of absolute gains as well as total volume.

It is also worth noting that these cities have attractively-located opportunity zones—even encompassing downtown areas in some cases.

The top five markets for percentage increases were Baltimore (896%), Birmingham (728%), Boston (572%), Philadelphia (479%) and Denver (413%).

Clearly, the increased buying activity of development sites in these markets were driven by many transactions that would have taken place regardless of incentives. Favorable locations and other transaction characteristics were also drivers. Still, significant multifamily development is taking place in Opportunity Zones and tax incentives will only help steer more capital into blighted communities.

By George Entis, Senior Research Analyst, CBRE

Construction Momentum Varies Greatly Across U.S.

Multifamily development is still very active nationally and close to peak levels.

Completions of 259,600 units in the four quarters ending in Q2 2019, however, represented a 9.7% decline from one year ago. While the 259,600-unit total is the lowest four-quarter total in three years (since Q3 2016), it is still 7.5% above the five-year average.

CBRE Econometric Advisors forecasts the four-quarter trailing totals to rise over the second half of 2019 and first half of 2020, reaching a new peak for this cycle of 330,200 units in Q2 2020. After that, CBRE EA projects completions to slowly decline.

While I generally agree with this outlook, I expect the second half of 2020 to remain at peak levels of deliveries given the active development pipeline and only modest decline in construction starts this year. Completions should then slow in 2021.

Construction momentum varies significantly by metro, however. The extent to which industry players should be concerned about completions and potential oversupply varies greatly by metro (and by submarket).

Completions Close to Stable Across Tier I Markets

Tier I markets, as a group, had the smallest year-over-year decrease of multifamily completions among the three tier groups (-3.5%).

Construction slowed more noticeably in Tier II and Tier III markets, overall, with completions declines of 13.0% and 15.5%, respectively.

However, within all tier groupings, the markets exhibited significant variation.

Inland Empire & Seattle Lead for Largest Unit Gains

For the 66 markets analyzed, completions for 22 markets were higher on a year-over-year percentage basis for the year ending in Q2 2019, one-third of the total.

Another 32 markets had lower levels of multifamily deliveries. Completions were essentially stable in 12 markets.

Among all markets, absolute gains on a year-over-year basis were largest in Seattle (3,400 units), the Inland Empire (3,300), Tampa (2,400), Philadelphia (2,300), Miami (1,900) and Portland (1,700).

The largest percentage increases in multifamily unit completions among Tier I and II markets were in the Inland Empire, Ventura, San Jose, Tampa and Philadelphia. All of these markets experienced increases of 60% or more.

The leading Tier I and II metros for declines in deliveries were Orange County, San Diego, Baltimore, Nashville, Houston and Dallas, all with declines of 35% or more.

For Tier III metros, Birmingham, Colorado Springs, Hartford, Jacksonville and Detroit experienced the largest percentage gains. Many of the gains, however, were off a very low base, but are notable nevertheless.

By Jeanette Rice, Americas Head of Multifamily Research, CBRE.

Secondary Shift

In search for yield, product availability, better market performance and/or other factors, capital is moving to smaller markets.

Last year’s dollar acquisitions volume held up better in the secondary and tertiary markets than primary markets. Total investment for assets in the nine Tier I metros (the six “gateway” markets plus Seattle, San Diego and Miami/South Florida) fell 17% year-over-year.

The Tier II metros collectively experienced a much smaller drop of -5.2%. Also, Tier II’s investment market share almost caught up to that of Tier I metros. For Tier III metros, investment rose 3.7% in 2017. Tier III’s market share also reflected a gain over last year.

The movement of capital to Tier II and Tier III markets will likely continue in 2018 (but one should also recognize that many Tier II markets are still very large markets). The gateway and other Tier I markets will remain very attractive for investment with Los Angeles and Seattle likely heading this list.

Investment by Metro Tier Groupings

 

Yet for a large share of investors, the potential for higher returns outside Tier I markets will remain enticing, and we expect Tier II an Tier III market shares to rise again in 2018.

New York, Los Angeles, and DFW top metros

New York metropolitan area led the U.S. in total 2017 multifamily acquisitions with $12.2 billion or $8.1% of the total. While impressive, New York’s share has fallen from previous years (12% in 2016).

Southern California (Los Angeles, Orange County, Inland Empire) and Dallas/Ft. Worth ranked second and third (as they also did in 2016). Investment in Atlanta was also particularly active at $7.5 billion or 5% market share.

The top four metros combined represented more than one quarter of all U.S. multifamily acquisitions in 2017. Half of the volume was represented by only 11 metros.

U.S. Metros Ranked by Investment 2017

Philadelphia leads YoY change

Among the 20 metros with at least $2 billion of acquisitions, seven metros had increased volumes: Orlando (32.9%), San Antonio (31.8%), Baltimore (25.8%), Washington, D.C. (12.6%), Chicago (9.6%), Boston (4.5%) and Las Vegas (1.1%). Among all markets, Philadelphia had the largest gain with 2017 more than double its 2016 level.

Among the metros with $2+ billion total investment, New York had the largest y-o-y decline (-39%) followed by Miami/South Florida (-23.9%), San Francisco Bay Area (-23.4%) and Austin (-17.2%).

For all U.S. multifamily investment, 2017 was down 6.9% from the prior year. Without New York, the y-o-y change was only -2.3%.Note, that changes in buying volumes are not only governed by market performance and investor sentiment, but also by product availability and by large portfolio purchases which can skew y-o-y changes in both directions.

Dallas/Ft. Worth leads for unit count

Dallas/Ft. Worth led the nation for total units acquired in 2017 with 90,300 units (8.1% of U.S. total), followed by Atlanta with 70,300 units. Of the top 10 metros by unit count, six were Tier II metros, providing additional evidence of the importance of Tier II markets for multifamily investment.

Of all multifamily units bought, 21% were in Tier I metros compared to 23% in 2016. The market share for Tier II markets also fell, but is still largest among the three tier groupings at 36%. Market share grew in the “other” category which represents mostly smaller tertiary markets.

San Francisco has highest sales price

In 2017, seven markets had sales price per unit averages over $200,000: San Francisco ($332,700), Boston ($262,200), San Diego ($259,700), Seattle ($241,700), Los Angeles/So. Calif. ($240,800), New York ($231,800) and Denver ($212,900). Portland, Miami/South Florida and Washington, D.C. were also very close to $200,000.

Kansas City experienced the largest rise in average sales price in 2017 (37.5%), followed by Sacramento (36.0%), Orlando (24.4%), Philadelphia (23.8%), Detroit (23.8%), Tampa (22.5%) and Seattle (20.0%). All of the markets with gains over 20%, except Seattle, were Tier II or Tier III metros. (Note that the sales price changes reflect changes in asset mix of assets acquired as well as value changes).

By Jeanette Rice, Americas Head of Multifamily Research, CBRE.