South Florida housing heats up
May 31, 2013
Over the past few months, I had the pleasure of attending two conferences on the state of the multifamily and housing markets: RealShare Apartments East and Urban Land Institute’s “Make Room—Residential Housing is Back.” Both were heavily attended by developers, investors, lenders, and brokers. While the RealShare conference included both national housing indicators as well as South Florida specific discussions, the ULI event focused on the South Florida and Southeastern part of the U.S.
In ULI’s keynote presentation, John Mcllwain, Senior Resident Fellow of ULI and Chair of Housing for the J. Ronald Terwilliger Center, addressed the future housing needs of aging baby boomers and their effect on current and future housing supplies. He noted that many boomers are moving into urban areas as they desire activities and opportunities not available in the suburbs. At the same time, younger generations have less desire to settle down in their 20s and buy a house. Most recent college grads expect to live in several cities while building careers and do not plan to settle somewhere until their 30’s.
These sentiments are reflected in the major trends in the South Florida market. Here are the four biggest market movers that were discussed at the conferences:
1. Housing supply is drying up as demand continues to increase.
The South Florida housing inventory has decreased sharply over the past three years as investors have looked to residential real estate as a primary investment. Rental rates have increased while vacancy has decreased over the past several years in South Florida. New properties have leased up faster than expected. This is due to a combination of foreclosures, which forced families into apartments; lack of new supply for several years immediately following the crash; and a decrease in multifamily housing supply as apartments were taken off the market and converted into condominiums during the boom years. Due to the high cost of housing in South Florida, developers and owners continually convert existing apartments into condos that typically allow buyers to purchase a home or condo at a lower price point while allowing the developer to achieve a premium price for the unit compared to a rental. Multifamily developers are working to replace the supply taken off the market and satisfy the strong demand of a growing population. Demand is so great that many multifamily projects under construction have resident waitlists for new units.
2. Development challenges: Rising construction costs and lack of available land.
One of the major development issues is a rise in construction costs, primarily due to an increase in material costs and skilled labor, both of which have resulted in cost overruns for several recently completed projects. Additionally, South Florida multifamily developers are often challenged by condo developers, who compete for the best Class A urban infill locations and price the rental market out of the game. Developers have reverted to redeveloping existing infill locations in “A” locations.
3. Financing limits available properties, could raise cap rates.
Many buyers were “chasing yield” after 10-year treasuries sank over the past year, creating significant institutional demand for Class A multifamily properties. As a result, investors priced out of the market are turning to Class B and C assets. One issue on everyone’s mind is interest rates, and while almost everyone at the conference agreed that interest rates will rise at some point, nobody knows when. An increase in interest rates will ultimately result in higher cap rates. At the moment, Class A multifamily cap rates in South Florida are 4.5 to 5 percent for new Class A product in good locations. Current multifamily buyers should also be aware of significant supply coming online in their markets in the foreseeable future. This new supply will lease up with concessions if need be, while providing a superior product with greater amenities in most cases. As a result, buyers (and underwriters) should be forecasting more conservative exit cap rates, modeling rental growth forecasts, and considering the forecast of a project’s competitive position against current and future supply. Cheap appraisals without fundamental supply and demand analysis are dangerous during this inflection point.
4. Investors snatch up single-family homes.
Investors account for a third of single-family home purchases in South Florida. Hedge funds and private equity firms are buying thousands of homes at a time, renovating them to a rentable condition, and then putting them back on the market as rentals. Managing and maintaining 1,000-square-foot homes is completely different than managing a 1,000-unit apartment complex within a single site area, but ultimately, the bulk buyers’ exit strategy will determine their success. When the funds want to sell in several years, they cannot afford to place all the homes on the market at once, or the significant supply will likely tank sale prices. Several funds report plans to either stagger the homes within distant neighborhoods or possibly selling to current renters who can build purchase points through the rental program. For the everyday consumer, these bulk investors are making it difficult to purchase a desired home, and in some submarkets, these investor purchases are skewing real appreciation rates. Most sellers are not even considering the typical homeowner buyer, due to investors paying cash and full list price.
In conclusion, the South Florida housing market is bouncing back, but in unexpected ways. Demand is fierce for multifamily properties, but the high cost of construction and materials and lack of available land may impede rampant construction of new product. New supply and competition in the multifamily sector will slow rent growth, and interest rate and exit risk should be commanding a risk/yield sensitivity analysis now to manage overly aggressive future assumptions.
