Daniel Raupp, Managing Partner & Co-Founder of Fortitude Investment Group, recently had the chance to speak with our colleague and business partner, Ramin Kamfar, Chairman & CEO at Bluerock Real Estate. Bluerock is one of the national sponsors Fortitude partners with for our 1031 Exchange offerings.
In this interview, Ramin shares an overview of multifamily real estate properties, and why they work well in a rising interest rate environment. He also provides some insight into Bluerock’s strategy for acquiring such properties for DSTs and what investors should look for when considering a multifamily asset as part of their real estate investment.
DR: What draws Bluerock towards the multifamily assets they select?
RK: Bluerock principals have significant experience structuring and investing in apartment properties through multiple investment cycles with successful results. In just the past 11 years, we’ve invested in nearly 92 communities totaling more than $4 billion in capital with a footprint that covers 13 states. Our primary focus today is newer construction communities with high-end amenities in demographically attractive growth markets with high population and job growth, which are both positively correlated with increasing rental rates and high occupancy rates.
Our target markets typically exhibit robust infrastructures; diversity and growth of the economic base driven by the presence of major colleges, universities, technology, health care, trade, next-generation high value-add manufacturing and government industries; the presence of a younger, more educated demographic profile with a high proportion of renters-by-choice; high quality of life elements and favorable long-term supply and demand characteristic.
On a more local level, Bluerock seeks neighborhood catalysts that can drive higher rental rates and values. As such, our communities must possess strong “live/work/play/socialize/lifestyle” elements with great walkability to dining, shopping and entertainment and conveniently located with easy access to major employment hubs.
DR: Why does multifamily work well in a rising interest rate environment?
RK: Timely question considering the direction rates have gone over the past 2+ years. Rising rate environments typically signal inflation triggered by a strong economy and robust job creation. Job creation is positive fuel for household formation and apartment demand. While those conditions are beneficial for almost all property types, apartments are unique given their short duration leases, typically 12-months, which allows owners to strike rents more frequently and with virtually no cap on rents making it a great hedge to inflation and can lead to higher income potential for our investors as well as enhanced overall property value. Historically, all real estate sector returns have been quite strong in a rising rate environment.
DR: How does multifamily compare to retail in the current real estate market?
RK: Multifamily compares very favorably to retail in the current national real estate market. Systemic, non-cyclical forces in both sectors are driving pricing and development trends. The large influx of new households created by the large Millennial group, historically lower homeownership rates projected to continue through 2030, and renters by choice are creating strong demand for multifamily which is exhibiting high year-over-year rental rate increases and sustained high occupancy rates. On the other hand, the retail sector is being challenged by e-commerce and the “Amazon effect” and is facing systemic headwinds. Retail is a bifurcated sector with destination and experiential retail performing better and many other sub-sectors suffering. Single-tenant net lease retail, which has been popular in the DST structure, has the potential to provide for a highly predictable income stream but have little or no contractual rent increases, which could limit investor’s upside value creation and ability to meet or exceed inflation.
DR: How does investing in multifamily look in the future?
RK: The future of multifamily looks exceptionally bright as demand is expected to continue to outpace supply over the long-term. There are an estimated 4.6 million new renters expected by 2030 and even current supply trends are not expected to meet this new aggregate demand. Our population continues to grow, new household continues to form, and the demographic trends show a clear move towards lower homeownership rates. Even in the face of new supply, the multifamily market has continued to exhibit high occupancy rates and deliver strong rent growth, which shows the strength of these demand drivers.
The U.S. economy is entering its 10th year of expansion, continuing to provide a favorable backdrop for multifamily returns. Job growth remains broad-based, and labor markets are tight by historic standards, supporting further wage growth. U.S. real estate returns are now supported by income growth rather than cap rate compression. The NCREIF Property Index (NPI) reported a 6.7% total return in the trailing 12-months ending 12.31.2018, with approximately 69% derived from income as opposed to appreciation. We find income-driven returns to be a healthy indicator and in-line with long term trends. Income growth is being generated by solid property market fundamentals. We believe multifamily will provide the best risk-adjusted returns, providing investors with diversified credit risk, short-term leases to hedge inflation, low capital expenditures, and less historical impact from cyclical downturns.
DR: What strategy does Bluerock look to implement when acquiring properties for DST’s?
RK: Our strategy is providing 1031 replacement properties in a DST structure that provides an opportunity for sustained value creation. This doesn’t necessarily mean buying value-add properties; rather, we look to buy brand new communities directly from the developers in the late stages of lease-up which typically allows us to achieve a meaningful discount to appraisal value at the onset. Further, we seek unique neighborhood catalysts that are expected to drive higher rental rates and values over time. Examples of these catalysts include properties that are in the path of growth or redevelopment and centrally located in a corridor or area undergoing positive transformation, properties that have unique access to retail or recreational amenities or properties that will benefit from future complementary development, and immediate access to major employment nodes/corridors.
Investors considering a DST-structured investment typically have conservative investment objectives; thus, we focus on multifamily assets that we believe will provide for capital preservation and predictable income stability. To this end, we seek newer, Class A properties that offer modern amenities, no physical deterioration or functional obsolescence, and that require fewer capital reserves for maintenance and improvements. Additionally, we implement on-site institutional property management services with direct oversight by our experienced asset managers where we seek to maintain high community living standards, maintain high occupancy rates, maximize rental rates and mange down operating expenses and ownership costs. Since the properties are well located in high growth markets and have top-of-the-market amenities, they will also appeal to institutional-type buyers, creating an opportunity for a successful exit strategy with 5-7 years on average.
DR: What should an investor look for when reviewing multifamily assets?
RK: As with any real estate asset, a thorough analysis of the area’s economy and population trends as well as overall property specific demographic trends is critical. Supply and demand factors must be considered including an occupancy analysis and review of the comparable properties. Investors should ensure the property’s rents are in-line with similar peers based on locations, quality, and amenity package(s). Physical considerations are also important as future capital expenditures can impact returns. For somewhat older assets, investors should be aware of obsolescence and what unit and community upgrades may be necessary to remain competitive. Investors should be cognizant of overall underwriting assumptions and that they reasonably align with historical market conditions. Investors should also be aware of “yield -chasing”, a phenomenon where lesser quality assets and markets are sought for higher initial yields. Many times, higher initial yields carry higher risk and a challenging exit strategy.
DR: How is the current market able to support the new construction/class A multifamily?
RK: The historical 20+ year average for national apartment deliveries is approximately 300,000 units per year. The distribution of these deliveries is dictated by local market conditions and population/migration trends. Overall, the national picture for the multifamily market looks good with an approximate 95% occupancy rate. High occupancy rates drive higher rental rates due to lack of available space which then prompts new construction to meet this demand and capitalize on rising rents. Recent construction deliveries have pushed slightly above the 300,000 annual average primarily due to household formations, particularly among the Millennial cohort estimated 86 million. This group has a high propensity to rent given strained home affordability, and lifestyle and mobility preferences. The recent growth in Class A development reflects renter preferences of top amenities and custom home like features and finishes. It’s always important to evaluate each market and whether the new construction is justified. Nationally, the markets with high population and job growth have seen the most amount of new supply, but have also tended to quickly absorb the new supply maintaining stabilized occupancy rates. Our analysis confirms there is an 86% correlation between job growth and demand for apartments. If you focus on the job growth markets, especially those creating “knowledge” jobs, we believe investors will be better positioned for performance through the remainder of the new construction cycle.
Have more questions about investing in multifamily real estate? Feel free to contact our team!