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Economy And Apartment Outlook - May 2011
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Economy And Apartment Outlook - May 2011
1. Mixed Signals – Reading Between the Lines of Recovery The U.S. economy has evolved ﬁrmly from an extended recovery phase to the threshold of expansion, as U.S. Gross Domestic Product evidenced by improved momentum in private sector 10% job growth, GDP and retail sales. Although the economy Annualized Quarterly Change continues to record gains on the low side of expectations 5% and follow a ﬂatter trajectory, the question of whether 0% the U.S. truly has entered economic recovery largely has segued to a discussion of relative strength and -5% durability. The slow renewal of the credit expansion -10% cycle tempered the critical employment momentum 91 93 95 97 99 01 03 05 07 09 11* that typically follows a deep recession, but this is not * Through 1Q Sources: Marcus & Millichap Research Services, BEA unusual for a recession deepened by a ﬁnancial crisis. In addition, changes in global demand and exogenous events induced swings in commodity prices that resulted in an ongoing “surge and recede” pattern in important economic indicators such as trade, and corporate and consumer spending. Measured Progress and Tumultuous Recovery Slower global economic growth, ﬁrst quarter seasonality and inclement weather contributed in varying degrees to weaken ﬁrst quarter economic data, either because of outright declines or simply a deceleration in the pace of growth. Leading manufacturing and services indicators remain above pre-recession levels, signaling expansion, but some areas have recently decelerated. Slowing from outsized momentum is a natural progression from recovery to expansion; furthermore, declining productivity may signal increased hiring needs to meet rising demand. Softened First Quarter GDP Understates Economic Vitality. A steep decline in federal defense spending, cuts in federal, state and local government spending, and lower consumer and business investment spending resulted in a sharp downturn in the ﬁrst quarter GDP to 1.8 percent, from 3.1 percent in the previous quarter. Higher oil prices precipitated a strong upturn in oil imports, offsetting slower, but still solid export growth. Strength in manufacturing production and the strong upturn in inventory accumulation contributed positively to GDP growth, which is expected to continue. Sharp Decline in Fixed Investment Growth Masks Bifurcated Spending. Spending on nonresidential structures plunged nearly 22 percent in the ﬁrst quarter 2011, exacerbated by bad weather, and resulting in an overall slide to 1.8 percent growth from the fourth quarter’s 7.7 percent expansion. Equipment and software spending, however, surged nearly 12 percent, lending support to the emerging consensus that equipment and software expenditures are harbingers of improved real wages and corporate proﬁts, and will ultimately boost employment. Retail Sales Remain Well Above Pre-Recession Levels. The recent rise in gasoline and food prices of 30 percent and 5.1 percent, respectively, has clearly diverted expenditures from other industry segments. Total retail sales increased 7.6 percent in April on a year-over-year basis. Core retail sales, which excludes motor vehicle and gasoline sales, grew by 4.7 percent, the slowest year-over-year gain in months. Though growth rates have begun to slow, core retail remains 3.9 percent higher than its pre-recession peak, a level adequate to fuel broader economic growth in the coming months.For more information, contact John Chang, Vice President Research Services, at email@example.com. © Marcus & Millichap 2011
Residential Sector Remains Beleaguered. Single-family Existing Single-Family Home Sales home sales remain 30 percent below their 2005 peak while and Median Home Prices prices have fallen 28 percent. Bank-owned properties and 7 Home Sales Median Home Price $260 homes in some stage of foreclosure constituted more than Total Sales (millions, SAAR) Median Home Price (000s) a quarter of the homes sold in the ﬁrst quarter, placing a 6 $220 drag on the housing market and initiating a double-dip 5 $180 in home prices in many markets. These trends continue to reverberate throughout the economy, impairing sales 4 $140 of home-related products, depressing single-family 3 $100 starts and derailing construction employment. 00 01 02 03 04 05 06 07 08 09 10 11* * Through April Sources: Marcus & Millichap Research Services, National Association of Realtors ® Risks of Inﬂationary Pressure Rising but Still Contained. The Fed’s Quantitative Easing policies have held interest rates in check, but also led to a weakening of the dollar and fueled rising commodity prices. Strong global demand further contributed to a run-up in energy and food costs, which has stirred inﬂation concerns. Limited pricing power, easing oil prices, weak housing and still subdued wage growth, however, should contain short-term inﬂation. Private Sector Employment Continues to Advance but Momentum Waning. Powered by 15 months of continuous growth, private sector employers have contributed 2.1 million positions to the economy. However, May additions fell signiﬁcantly below recent trends to 83,000 private employer jobs as supply chain disruptions spawned in Japan combined with higher energy costs and severe weather in many parts of the country to erode hiring momentum. Nearly 85 percent of the positions created over the past 15 months have been concentrated in ﬁve sectors: Professional and Business Services, Education and Health Services, Trade Transportation and Utilities, Leisure & Hospitality, and Manufacturing. Meanwhile Construction, Financial Services and Information Services have ﬂoundered, with ﬂat or marginally negative employment trends. Though May’s weak showing could spark heightened caution among employers, resulting in lackluster ﬁgures through the summer months, employment trends should remain positive through the remainder of the year. Local Government Job Losses Hamper Growth. The government sector continues to act as a drag on the economy, with local and state governments retrenching due to falling income and property tax revenue. Over the past 19 months, 368,000 local government jobs have been eliminated including the 29,000 positions lost in May. The ongoing slump in existing home sales, and home construction together with diminished payroll taxes will further pressure local government ﬁnances in the months ahead, leading to additional layoffs. Private-Sector Employment Oil Prices vs. 10-Year Treasury Rate Crude Oil (WTI) 10-Year Treasury Rate 600 $160 16% Crude Oil (price per barrel) 10-Year Treasury Rate Monthly Change (000s) 300 $120 12% 0 $80 8% -300 Recessions -600 $40 4% -900 04 05 06 07 08 09 10 11* $0 0% 71 75 79 83 87 91 95 99 03 07 11* * Through May * Through June 7 Sources: Marcus & Millichap Research Services, BLS Sources: Marcus & Millichap Research Services, Federal Reserve, U.S. Department of EnergyFor more information, contact John Chang, Vice President Research Services, at firstname.lastname@example.org. © Marcus & Millichap 2011
Forecast: The unknown consequences of provisional monetary U.S. Public Debt as % of GDP policies, the large amount of liquidity in the banking 140% system, the withdrawal of ﬁscal stimulus and subsequent reduced demand from government, and inﬂation risk all 110% add complexity to the national economic outlook. Much % of GDP 80% of the money intended for quick distribution into the economy has just remained in the ﬁnancial system instead 50% of moving through the economy via lending. This has begun to change as lenders now appear poised to lend at 20% 40 56 72 79 83 87 91 95 99 03 07 11* attractive rates, and businesses appear conﬁdent enough * Through 1Q to take on new debt, although the hurdles remain quite Data pre-1976 represents 2Q of each year Sources: Marcus & Millichap Research Services, U.S. Bureau of Economic Analysis, Federal Reserve Board, U.S. Department of Treasury high. Only the most creditworthy borrowers have access to capital for small business and personal loans. The economy is forecast to add 2.0 million jobs by the end of 2011, reducing the unemployment rate to the high 8 percent range; GDP is forecast to average 3.2 percent in 2011 before trending up the following year. Still, the U.S. economy faces numerous challenges: The Fed’s QE2 Policy is Slated to Sunset in June 2011. Private investors must return to the Treasury market to replace the Fed’s direct purchases. Interest rates could rise quickly without continued government intervention and as a result of strengthening economic growth. The Fed must carefully calibrate monetary policy to promote economic growth and manage mounting inﬂationary pressures. Public Sector Debt Undermines Economic Growth and Consumer Conﬁdence. The withdrawal of government stimulus and higher levels of public sector debt will necessitate increased taxes and spending cuts, which could hamper the willingness of consumers and businesses to spend and invest, and thereby truncate promising economic growth. These actions, however, may be deferred until after the 2012 elections. Higher Savings Dampen Consumption Growth. That is, until wage growth reaches a level comfortable for consumers. Continued bank de-leveraging will remain a drag on attractive credit availability to a broader base of consumers and business. With expectations of strengthening economic growth, healthy corporate proﬁts, increasing demand and rising exports, business spending will power the recovery over the next year. The recent corporate rush to raise debt before the Fed ends the $600-billion Treasury-bond purchase program may indicate that companies ﬁnally are ready to invest rather than use the money to buy back stock, reﬁnance existing debt or hoard cash. This suggests an imminent increase in capital expenditures, a boost in employment and commensurate improvement in commercial real estate. Fundamentals for the industrial and ofﬁce sectors have moved into recovery, while the apartment and retail sectors shifted squarely into expansion territory, beneﬁting from short-term lease structures. Intense competition for core product and the availability of low-cost debt permits capital to ﬂow into a broader range of asset quality and market tiers to take advantage of real estate’s long-term stability, steady income and appreciation potential.For more information, contact John Chang, Vice President Research Services, at email@example.com. © Marcus & Millichap 2011
Apartments Enter Rapid Recovery; Convergence of Positive Factors Pushes the Sector Toward Equilibrium by Year-End 2011 Apartments Have Entered a Sweeping Expansion Cycle. The sector remains the beneﬁciary of important Quarterly Job Growth vs. Apartment Units Absorbed macro demand trends at work in both the economy and Job Growth Net Absorption capital markets. The housing market collapse ignited 3.0 100 a dramatic decline in the homeownership rate for 11 Units Absorbed (000s) Job Growth (millions) 1.5 50 consecutive months, retreating to 66.5 percent between 0.0 0 mid-2008 and this year’s opening quarter, ceding an additional 2.5 million households to rental housing. In -1.5 -50 addition, the prime renter age cohort of 20- to 34-year- -3.0 -100 olds staged a decisive rebound in employment, 00 01 02 03 04 05 06 07 08 09 10 11* capturing nearly 65 percent of job gains during 2010 *Through 1Q Sources: Marcus & Millichap Research Services, Reis, BLS and spurring a household “de-bundling” effect. The robust long-run demand trends and ready availability of agency and other debt sources offer apartments a competitive advantage relative to other commercial property sectors. That said, the spread between apartment cap rates and the 10-year Treasury is narrower than other sectors and the recent rise in long-term Treasury rates prompted concerns that cap rates may trend higher. Thus far, pricing has held ﬁrm in the face of moderately higher risk-free rates, although intense competition and pricing for core assets in top-tier markets has sparked investor interest in secondary markets. Renter Demand Swamps New Construction; Stellar Market Dynamics of 2010 Extend into 2011. The national vacancy rate plunged an unprecedented 180 basis points year over year to 6.2 percent in the ﬁrst quarter of 2011. Historically low stock additions coincided with the most substantial demand growth on record as nearly 242,000 units were absorbed over the past 12 months and only 74,000 units came online. Concessions continue to wane, averaging 7.1 percent of asking rents in the ﬁrst quarter, compared with 7.6 percent of asking rents in the ﬁrst quarter last year, driven by strong demand for top-tier rentals. Asking and effective rents grew 1.9 percent and 2.3 percent year over year through the ﬁrst quarter to $1,036 per month and $962 per month, respectively. Investors Undeterred by Competitive Pricing and Lower Cap Rates. Apartment sales of more than $1 million surpassed $8.5 billion in the ﬁrst quarter, a notable 18 percent increase from the corresponding period last year. Large deals dominated, with sales of more than $20 million more than doubling from a year ago and accounting for 13.1 percent of all transactions. Cap rate compression in primary markets has slowed as investors have started to explore opportunities for stronger return potential in secondary and tertiary markets. The spread between primary and secondary markets averaged 110 basis points in ﬁrst quarter, and may compel investors to increasingly seek arbitrage in once-overlooked markets in the months ahead. Cap rates in primary markets were 6.8 percent in the ﬁrst quarter; secondary markets averaged 7.9 percent, while ﬁrst-year returns in tertiary metros averaged about 8.8 percent.For more information, contact John Chang, Vice President Research Services, at firstname.lastname@example.org. © Marcus & Millichap 2011
Forecast: Homeownership Rate vs. Number of Renter Households Robust Demand Drivers Push Vacancy Close Homeownership Rate Renter Households 72% 40 To Equilibrium by Year-End 2011. Strengthening Number of Household (millions) economic conditions and demographic trends Homeownership Rate 69% 35 concurrent with minimal new supply should yield 66% 30 yet another notable decline in the national vacancy rate through 2011 to 5.6 percent. Asking rents are 63% 25 forecast to rise 3.5 percent to $1,068 per month; further 60% 20 reductions in concessions will support a 4.5 percent 66 71 76 81 86 91 96 01 06 11* * As of 1Q11 increase in effective rents to $1,000 per month. Class A Sources: Marcus & Millichap Research Services, U.S. Census Bureau and Class B+ properties will continue to outperform weaker, Class C properties, more at risk of falling into the “distress” category, due to rent collection challenges and cash ﬂow issues. The multifamily sector is the ﬁrst to start ramping up construction, likely led by public REITS due to available capital and healthy lines of low cost credit. Private sector ﬁnancing for apartment development may become more accessible this year as well. The outlook for 2011 calls for demand of approximately 150,000 units, three times the number of new units slated for delivery. The recent uptick in multifamily permit issuance will require another 12 to 18 months before new units come to market, creating another three- to four-year window before supply reaches a level considered risky, at least at the national level. Should interest rates rise, escalating all-in construction costs will require sustainable rent levels high enough to justify construction risk, which may naturally curb ﬁnancing and development. GSEs Remain Primary Source of Apartment Mortgage Originations, Although Heightened Competition Has Reduced Market Share. Agency lending accounted for 52 percent of mortgage originations, reﬂecting a downward trend in market share over the past year as regional and local banks, and life insurance companies expanded competitive lending efforts in the multifamily arena. Access to low-cost agency debt has long been a competitive advantage for the sector, but the possibility of privatizing or dissolving Fannie Mae and Freddie Mac places this beneﬁt at risk. The withdrawal of this government support, though unlikely, could result in higher borrowing costs and inﬂate cap rates over the forecast period. Any action may be years out but could occur within a ﬁve- to 10-year horizon. The Current Interest Rate Environment May Be Short-Lived. The expanding economy, growing deﬁcit, and the end of government initiatives and subsidies will exert upward pressure on interest rates. As cap rates fall, higher leverage will become somewhat more challenging as loan-to-value ratios become constrained by debt service coverage ratios. Stronger Investor Demand and Competitive Pricing Broaden the Quest for Investment Opportunities. Cap rates for top-quality, core Class A properties stand ﬁrmly between 4.5 percent and 5.5 percent. Further signiﬁcant cap rate compression in this category is unlikely to occur as concerns about inﬂation and termination of government support begin to weigh on investors’ yield expectations. In addition, stronger operational performance and low-cost debt have broadened buyer demand, leading to more sales of Class B and B- properties. Greater sales velocity in a broader spectrum of asset quality and markets in 2011 will create greater transparency and lend support to market pricing in the lower tiers, and secondary and tertiary markets.For more information, contact John Chang, Vice President Research Services, at email@example.com. © Marcus & Millichap 2011
Apartment Market Vital Signs Nonfarm Employment Trends Existing Single-Family and Condo Sales Single-Family Condo 70% Nonfarm Employment (Y-O-Y Chg.) 6% Year-Over-Year Change 3% 35% 0% 0% -3% -35% -6% -70% 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11* 03 04 05 06 07 08 09 10 11* * Through April * Forecast Sources: Marcus & Millichap Research Services, National Association of REALTORS® Sources: Marcus & Millichap Research Services, BLS Apartment Supply and Vacancy Trends Apartment Price and Cap Rate Trends Completions Vacancy Rate Average Price/Unit Average Cap Rate Average Price per Unit (thousands) 440 10% $120 10% Units Completed (thousands) $90 8% Average Cap Rate 330 8% Vacancy Rate $60 6% 220 6% $30 4% 110 4% $0 2% 0 2% 00 01 02 03 04 05 06 07 08 09 10 11* 81 83 85 87 89 91 93 95 97 99 01 03 05 07 0911* * As of 1Q11 Includes sales $1 million and greater * Forecast Sources: Marcus & Millichap Research Services, CoStar Group, Inc. Sources: Marcus & Millichap Research Services, Reis 1Q 2010 to 1Q 2011 Change in Apartment Vacancy Markets by Greatest Reduction in Vacancy Markets by Least Reduction in Vacancy 1Q Y-O-Y 1Q Y-O-Y Metro 2011 Chg. (bps) Metro 2011 Chg. (bps) Austin 6.3% -380 Denver 5.5% -100 Jacksonville 10.2% -360 Los Angeles 4.5% -100 Orlando 7.9% -360 Milwaukee 4.2% -100 Las Vegas 8.6% -320 Salt Lake City 6.0% -100 Phoenix 8.9% -320 San Diego 3.9% -100 Charlotte 7.5% -310 San Francisco 4.0% -100 Tampa-St. Petersburg 7.2% -290 Columbus 8.6% -90 Dallas-Ft. Worth 6.5% -280 Miami 5.6% -70 Kansas City 7.5% -280 New Jersey 4.5% -60 Houston 10.2% -270 New York 2.8% 0 U.S. Metro Average 6.2% -180 U.S. Metro Average 6.2% -180 Sources: Marcus & Millichap Research Services, ReisThe information in this report is deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no representation, warranty or guarantee, expressed or implied, maybe made as to the accuracy or reliability of the information contained herein. Sources: Marcus & Millichap Research Services, CoStar Group, Inc., DataQuick, Deutsche Bank, Economy.com, Federal Reserve,MBAA, NAR, Real Capital Analytics (RCA), Reis, U.S. Census Bureau.For more information, contact John Chang, Vice President Research Services, at firstname.lastname@example.org. © Marcus & Millichap 2011
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