The economy may be wobbly, but the outlook remains sound for multi-family properties, particularly B and C level apartments.

The multi-family housing market has largely avoided the pitfall of overbuilding, remaining in equilibrium for the last five years. While near-term demand may be weaker than expected earlier this year, long-term prospects look good, according to an analysis by Standard & Poor's (S&P).

Combine those factors with low interest rates and a slow economy that may be discouraging apartment dwellers from buying homes, and you have a recipe for a relatively strong return on investment.

"We have concluded that the majority of multi-family [real estate investment trust (REIT)] ratings and outlooks remain sound at this time," said Elizabeth Campbell, a director in S&P real estate finance group. "The ratings are supported by the expectation of fairly stable key credit measures, despite the likely possibility of potentially prolonged economic weakness in the U.S."

There are some pockets of oversupply that have been created by modest overbuilding. But in most markets, according to S&P, new supply should decline, while demand will remain relatively sound. After all, most apartment rental demand is nondiscretionary.

No markets are rated as strong, however. multi-family markets at equilibrium include Boston, Dallas, Denver, Houston, Washington, D.C., and Southern California. Chicago, South Florida and Tampa are weakening. Already weak markets are Atlanta, Austin, Charlotte, Las Vegas, Orlando, Phoenix, Seattle and San Francisco Bay.

Several large real estate concerns, however, are betting on apartments to serve as a stabilizing factor in their overall portfolios. For example, Grubb & Ellis Company (NYSE: GBE) has arranged the re-capitalization of a $181 million apartment portfolio. The portfolio of apartments owned and operated by Fifteen Group of Miami was re-capitalized this week by CMS, a Philadelphia based investment fund, which invested approximately $29 million, replacing the equity and mezzanine capital of Credit Suisse First Boston.

The portfolio included B and C level apartments located across the United States in major metropolitan markets.

"What we are seeing is that in times of economic volatility, like we are experiencing now, B and C apartment properties may prove to be a more stable investment," said Herb Chase, a senior vice president who helped broker the deal for Grubb & Ellis. "While B and C properties may not experience the rapid growth or command high rental rates, they do appear to have a more stable tenant base and offer less downside risk."

According to a report by the National Multi Housing Council, the national demand for apartments has grown steadily over the past few years and indications are that this trend will continue. And while the higher end of the apartment market may experience higher returns in key markets that are expanding, they can also feel the pinch when those markets collapse.

For instance, the recent collapse of the tech-heavy dot-com market in the San Francisco Bay Area is now affecting the higher-end apartment market, which is experiencing higher vacancy rates and rent reductions than compared to B and C communities.

"B and C level apartments usually have more blue-collar type residents who earn a modest, but steady income," said Keith Misner, managing director of the multi-housing investment group with Grubb & Ellis. "They tend to remain residents for longer periods of time, which keeps tenant turnover and vacancy rates down. Renters in B and C level properties may hold off planned home purchases and remain in cost-effective apartments longer, thus helping to strengthen demand."

According to Chase, very attractive "cash-on-cash" returns on investment for the B and C apartments are available, between 12 and 16 percent, due to high levels of liquidity and historically low interest rates.

For more articles by Lesley Hensell, please press here.

Published: November 21, 2001

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