Business

Ward A. Katz and Jerry Miller: Rapid apartment construction offers pitfalls, opportunities

pecial to The Star

The term “implode” might best describe the direction of the multifamily real estate market in the next 24 to 36 months — both nationally and in Kansas City. For now, however, multifamily markets are considered to be strong.

Since 2011, apartment occupancies and rents in the 20 largest apartment markets, as well as in many smaller markets, have enjoyed steady increases. Pent-up demand, employment gains, more rigorous qualifications for mortgage loans, changes in attitudes toward single-family home ownership, gentrification of urban areas, the bubble of the millennial sector and the desire to downsize by aging baby boomers are contributing factors.

As a result of all this, and low-cost borrowing, developers have responded with the highest construction levels for multifamily projects since World War II. Completion of new units averaged 301,000 from 2000 to 2007. In 2009, there were 163,000 completed units and, in 2012, 104,500 units were completed. In 2013, 195,000 units were completed.

Skip ahead to the future. Completion of new projects is expected to reach 300,000 units by the end of 2014. Multifamily starts in August 2014 soared by 42.9 percent over August 2013 to a seasonally adjusted rate of 413,000 units. Quite simply, new construction is on overdrive. Current apartment overbuilding will eventually result in low occupancies and high marketing costs for current owners as supply outstrips demand in many markets.

In Kansas City, for example, there are an estimated 132,500 apartment units. About 7,000 new units were under construction or in the pipeline as of September, but the market historically has been able to absorb 1,500 units a year. So if all those units are built, say over three years’ time, there will be nearly five years of supply to be absorbed. Such overbuilding can lead to what the industry refers to as negative absorption and even “hyper-supply.”

In such situations, generally the rents of newer units decline, to achieve or maintain stabilized occupancy; the rents of newer apartments become competitive with older apartments, while expenses remain the same or increase; occupancy at older apartments declines, further placing stress on them; and as cash flow declines, deferred maintenance increases.

Fortunately, where there are problems, there are opportunities — particularly for investors. These conditions, while presenting challenges to operators and owners of existing and new projects, represent opportunities for them to engage experienced managers to provide management and consulting services and for astute buyers who can identify these situations and move quickly to acquire apartment assets at competitive prices.

The best strategies for existing apartment owners and operators to avoid problems and to remain competitive include taking a pre-emptive approach — maintain occupancy with leasing strategies that look two to three years out, be aware of the competition, including their lease terms, features, amenities and shortfalls, and improve customer service, product and technology.

Secondly, develop a capital reserve study and a funding plan to systematically upgrade property with cost effective cosmetic interior and exterior improvements. Though possibly deferring the distribution of some cash flow, investors will find that in the long run their property will continue to be competitive in the marketplace, resulting in higher rents and occupancies.

Finally, “partner” with an experienced management company or apartment operations consultant in developing and implementing these strategies.

The authors

Ward Katz and Jerry Miller are co-founders of Signature/DRS Management LLC and recently combined their companies to provide multifamily management, lease-up and consulting services, as well as investment opportunities to qualified investors. Katz and Miller and their companies, DRS (formerly Dunes Residential) and Signature, have 55 years of combined experience in developing and managing conventional and affordable apartments. They can be reached at info@signaturedrs.com.

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