Multi-family Real Estate Market Q4 2007

In our last article, we stated that we thought the housing market slump would continue through year end and start to stabilize in early 2008.  Unfortunately, there has not been any news that changes our belief.  Some of the recent statistics indicate that we may still be too optimistic.

  • The Commerce Department reported on August 16 that housing starts in July decreased 6.1% to a seasonably adjusted 1.381 million annual rate.  This was the lowest rate in ten years as sales continue to slump and credit tightens.
  • The Commerce Department reported on August 24 that sales of new single family homes increased 2.8% in July to a seasonably adjusted rate of 870,000.  However, new home sales were 10.2% lower than July 2006 and the average price decreased to $300,800, down 3.4% from July 2006.  The median price increased to $239,500 a .6% increase over July 2006.  An estimated 74,000 new homes were sold in July.
  • On August 27, the National Association of Realtors reported that sales of existing homes in July were down .2% to a seasonally adjusted annual rate of 5.75 million units, the lowest since November 2002.  The median price was $228,900, down .6% from $230,200 in July 2006.
  • The inventory of unsold existing homes as of July 31 was estimated to be 4.59 million, a 9.6 month’s supply at the current sales pace.(Source – Real Estate Journal)
  • Unsold new homes on July 31 were estimated to be 533,000, a 6.5 month’s supply as compared to a 5.9 months supply at December 31, 2006. (Source – Real Estate Journal)
  • Lenders continue to tighten requirements for mortgage lending and this has decreased the number of first time home buyers.  The troubles in the subprime mortgage market and the rising number of foreclosures are causing lenders to tighten their lending standards.

What is a subprime mortgage?  Subprime lending refers to the practice of making loans to borrowers that don’t qualify for the best market interest rates because of their credit history.  Subprime mortgages are offered at higher interest rates due to the increased risk.  Some of the common subprime mortgages include:

  • Interest only – Only interest for a period of time
  • Pick a Payment – In some cases, negative amortization occurred
  • Initial fixed rate that converts to a variable rate.

The multi-family section should enjoy another good year as the number of potential residents should increase in part due to the tightening of lender’s requirements and the number of foreclosures.  However, many of the potential renters returning to the rental market because of foreclosure may have bad credit and may not meet the qualification criteria to rent.   Owners should be able to increase rents 3 – 5%.  Developers should see land prices stabilizing, or maybe decreasing, as the demand for land from condo developers has cooled.

The multi-family market, like other sectors of real estate, has some common and unique terms that are used.  We are going to discuss some of the terms found in the revenue section of the income statement, also known as the operating statement.

  1. Market Rent Potential – Market unit rent times the number of units.
  2. Gain or Loss-to-Lease – Difference between market rent and actual lease rate.
  3. Vacancy – Number of vacant units times market rent
  4. Model/Employee Apartments – Units used for models or employees times market rent.
  5. Concessions – There are not any standard concessions as they vary by complex.  Some common concessions in the market include ½ month free or a reduction in the monthly rent for the terms of the lease.  Concessions maybe offered to both new residents and current residents that are renewing their leases.
  6. Rental Income – Total of market rent less deductions discussed in items 2-5.
  7. Other Income – Some of the common items include, but are not limited to: Late Fees, NSF Fees, Month to Month Charges, Vending Income, Early Termination Fees, Laundry Income and Cleaning Fees.
  8. Garage/Storage Income – Applies only to complexes that have garages or storage units.
  9. Total Income – Total of items 6, 7 & 8.  This is the only item that many owners want as this is usually the cash collected.

In the next issue, we will discuss the common expense categories.

One common question that is asked by owners is “Should I sell now or wait until I can increase rent”?  There is not one answer that is appropriate for every situation.  We do know that cap rates are at a historic low and I believe that cap rates will be higher a year from now.   One way to analyze this question is to estimate the rent increase and determine the amount the cap rate could increase without changing the estimated market value of your property.  Let’s assume the following:

Complex: 100 units
Avg Rent: $700
Occupancy: 95%
Expenses/Income: 40%
Current Operating Income: $478,800
Current Cap Rate: 8%
Proposed Rent Increase: 3%
Annual Increase in Total Income: $23,940
Annual Increase in Operating Income: $14,364
Estimated Current Market Value: $5,985,000
Projected Operating Income:
(after rent increase)
$493,164
Cap Rate @ price of $5,985,000 8.24%

We can now make a decision on whether to sell now or wait based on our perception of the direction of cap rates.  This is a very simplistic approach which does not consider other factors such as interest rates, new units being added, employment outlook, demographics, etc.

 

Larry Drinkard
Commercial Real Estate Agent
Macon Commercial Office
478-746-9421