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Las Vegas Multifamily – Trends, Fundamentals, Land Acquisition and Development – Summer 2015

Despite being one of the hottest commercial sectors over the past several years, interest in multifamily continues to be strong. Fundamentals have improved substantially since the recession, prompting new construction. In the prolonged low-yield environment, a search for yield has propelled many categories of investors into the space, including REITs, pension funds, high net-worth individuals and family office capital. There are simply not a lot of options in which to place money that are considered mild to intermediate risk. Similarly, the asset class is perceived favorably by many lenders ranging from community banks to commercial mortgage-backed securities originators, thus the cost of borrowing is relatively cheap, preserving some of the spreads despite compressed cap rates.

Mom and Pop investors continue to be interested in Class C structures but these deals have become even more sparse in the Las Vegas market with a widening bid/ask spread. Similarly, Class B properties are rarely coming on the market and the trades we see are often principal to principal, rather than using the traditional brokerage channels, and often those that are marketed are unpriced listings. Additionally, many of investors want value-add opportunities, however, many sellers of challenged buildings are pricing them as if they were stabilized. In Las Vegas, the lower-end segment of the market is largely broken with a drought in listings and many buyers, ranging from professional investors to the largely uniformed. We note only a handful of trades that have occurred within the Class C segment in Las Vegas for 2015.

Capitalization rates have been relatively low for several years, with cap rates for Class A Las Vegas properties in the low five percent range on average. Cap rates are so low in core markets that many investors are searching in second tier markets like Las Vegas. Cassidy Turley measured the lowest cap rates in New York at 3.5%, San Francisco at 4.3% and Orange County at 4.4%.1 While rental rates and occupancies have long been strong in these areas, Southern Nevada has registered strong improvement as well. Therefore it’s no surprise that investors have also shown interest in Las Vegas. Multifamilyexecutive.com notes that the cap rate spread between core and secondary markets has narrowed from 200 to 300 basis points and down to as low as 50 basis points. Similarly, we have seen Southern California investors priced out of their market and search in Las Vegas. 2

When we think in terms of historical spreads between cap rates and the “risk free” rate proxied by 10 year U.S. Treasury bonds, spreads are still wider than those observed in recent years. In 2006, when nearly everything in the real estate sector was in a bubble, spreads were only about 100 points. Spreads were probably widest in 2011 and 2012 and with current Treasury yields at 2.38%, that is still about 300 basis points for most Las Vegas Class A projects.

FUNDAMENTALS

The cap rate spread is only part of the story. Improving fundamentals in the Las Vegas region are also added to pro forma gains. Although the Las Vegas MSA has not yet returned to the employment high of 2007, job growth is rebounding and we observe some wage growth as well. Additionally, both single family rents and Class A and B apartment rents appear to be growing. Further, occupancies across the Class A segment are very strong with many buildings in the high 90’s. There is also some evidence that concessions have further burned off with ALN noting that apartments offering concessions dropped by 26.4% year-over-year (May 2015 data). The average concession package was 4.4%, down 16.4% from the same time last year.3 Furthermore, Las Vegas’ major sector, leisure and hospitality, is expected to grow further with the addition of Genting’s Resorts World Las Vegas, which broke ground in May. The project is anticipated to have 3,000 rooms in its initial phase, and is estimated to support more than 13,000 direct and indirect jobs.4 The Lucky Dragon, a boutique hotel near Allure Condos on Sahara, also recently began construction. The Las Vegas Convention and Visitors Authority is also expanding into what will ultimately be the $2.3 Billion Las Vegas Global Business District.

We anticipate that added construction on the Las Vegas Strip and Downtown will drive employment back to its 2007 high within a short period of time. Unemployment rates remain elevated at 6.6%, however year-over-year job growth is occurring at a faster rate than the U.S average and is 2.6% for the Las Vegas MSA, compared to 2.2% for the United States.5 Naturally, the area was hit disproportionately hard with a combination of a national recession and a deflating housing bubble. Currently, housing prices have returned to pre-bubble trends and distressed housing inventory is no longer a drag since the majority of closings are traditional sales. Additionally, visitor volume to Las Vegas has never been higher than it was in 2014 and that strength is continuing into 2015.

Gaming Revenue is not matching the trajectory of visitor volume, revealing a much more mild upward trend. Las Vegas has adapted well to changing consumer tastes, with a sizable nightclub scene and a greater focus on maximizing hotel and food and beverage revenues. As a result, gaming, while still important, is of less significance than in the past. For example, MGM Mirage Corporation, the largest single operator in Las Vegas and a good barometer for the region, has diversified on-property greatly. In 1994, gaming revenues were 59% of gross revenue compared to 2014, where gaming revenues were 38% of total revenues. Growing shares of revenue are food and beverage, hotel and entertainment and retail according to the company’s annual reports.

Total non-farm employment is now just 30,000 jobs short of its 2007 high. Measured from April 2014 to April 2015, job growth was 34,600 jobs and at the rate of job addition, at three percent to four percent per month, the region should return to pre-recession levels within 12-18 months.

In addition to major gaming projects like Resorts World Las Vegas, we are seeing non-gaming growth in the Valley with firms like SolarCity Corporation experiencing growth as well as new entrants like Asurion, which provides mobile phone and tablet protection insurance, Catamaran RX in the medical space and manufacturing, including Cannon Safe. Tony Hsieh’s affiliated VegasTechFund also continues to seed startups and continues to have investments in a large portfolio of companies, primarily in online sales, electronics and education.

Wage growth is not spread out over all employment sectors so Class C will continue to play an important role in workforce housing. There is still significant vacant supply in this category, so we don’t anticipate rent growth in the next couple of years. We have observed some owners over-improve for the area but this has not been reflected in stronger rents, implying that building quality is at best a minor premium if within a challenged area.

On the other side of the quality spectrum, Class A occupancies are best described as stellar and several of the newer builds have quality and amenities a step above traditional two-story walk-up buildings. There does appear to be a premium for quality in popular submarkets and those communities with strong walk-ability. Some traditional design projects are achieving rents as high as $1.38 per-square foot for 1-bedroom units. The Gramercy, which is a multi-story, amenity rich mixed-use project, is achieving rents up to $1.80 on 1-bedroom units. The Calida Group has been delivering amenity rich projects with interesting architectural elements and we understand that these recently delivered projects are performing well, indicating strength on the upper-end of the apartment rental market.

Many of the newer projects are built with the Millennials in mind. This cohort is generally described as those born between 1982 and 2000 and make up about 95 million Americans. They have demonstrated a high propensity to rent. Green Street Advisors estimates that individuals under the age of 35 have a 63% propensity to rent.6

Although it is challenging to define this age cohort, technology, quality gyms and open space appear to be attractive to many Millennials. In leasing, a strong online presence is important. All these features are expensive yet many Millennials are paying for it. While many lack downpayments or credit history to buy a home, high-quality Las Vegas apartments appear to remain in reach judging by the occupancy levels in many of the higher rent projects.

This age group is important because these individuals are the source of household formation for the next several years. The Millennial generation’s peak birth-rate occurred in 1990, many of whom are likely to be renters.7 The generation does have challenges. Household formations have been held back in recent years by slack in the labor market and likely student loans. A big unknown concerning Millenials is what occupations will be in the next ten years. For example, technology workers are used to moving often and may not like the burden of owning a home, which they would either have to sell or rent if they moved. Additionally, many Millenials recognize that homes can be illiquid and therefore fall into the “rent by choice” category, rather than renting because they lack the ability to finance a home.

The Urban Institute recently released a longitudinal of household formation and homeownership rates, predicting that the homeownership rate would decline through 2030 with the homeownership rate dropping from 63.7% in Q1 2015 to 61.3% by 2030. The study authors anticipate a rental surge of 13 million renters and renters will outpace new homeowners over the next 15 years.8 Projections can often be taken with a grain of salt, however, given that both government support for homeownership and lax lending in the early 2000’s contributed to an artificially high homeownership rate, the author’s forecasts may have merit.

An additional component of demand in Las Vegas is likely to remain former homeowners who lost their homes through foreclosure or still have tarnished credit profiles due to a short sale. We have observed that many prior homeowners choose to rent single family homes. In the past, single family rental homes were usually held by “mom and pop” owners. Some renters had fear of leasing from an absentee landlord and tended to gravitate towards apartments. Today, many homes are held by institutional investors or firms organized as REITs, or are privately owned homes managed professionally by property management firms, so there are many rental options within Las Vegas.

The degree to which higher-end apartments compete with single family rentals is unknown to us, however we suspect that there is mild crossover and that family size and age of householder remain the primary determinants of who lands in which rental category. Single family rentals are probably fringe competition for the two and three bedroom units in higher-end apartment projects.

Some prior homeowners may only be in the rental market for a transitional period and re-enter ownership after curing credit issues. These are the so-called “boomerang buyers”, of which it is estimated that 700,000 individuals nationally are now eligible for credit again this year according to TransUnion.9

The principal question is how many individuals are willing to buy or are aware that they can buy. Currently, the pendulum that swings between renting and owning is still swinging towards owning if you examine rent versus mortgage payments on an equivalently sized home. Ultimately, this will be sensitive to mortgage interest rate increases and in theory, renting could become financially equivalent to owning in an abrupt fashion. Many of these individuals and families are likely to be renters for an extended period, gradually trickling back into ownership if the labor market continues to strengthen.

DEVELOPMENT

Following the global financial crisis, both single family and multifamily construction dropped sharply. Multifamily construction almost died off completely while many developers focused on broken condominium projects and other distressed deals.

Recently, multifamily permits have been ticking higher but remain low relative to past observations. It is important to note where the activity is concentrated, since success of a particular project is largely determined at the submarket level rather than at the Valley level. Map 2 illustrates where a lot of the recent activity has been occurring geographically. Notice the concentration of projects along the southern portion of the 215, in Henderson near major corridors and on the South Strip. These areas tend to justify projects based on area incomes, proximity to employment centers and are attractive due to major arterial access.

One area that seems to have a major deficit in both recent and planned development is Downtown Las Vegas. Higher-end projects like Juhl, The Ogden, Soho Lofts and Newport Lofts are seeing strong demand for rentals. Of those four, Juhl is the only pure rental project, although originally conceived as a condominium. Both Juhl and The Ogden have had high occupancies and even waiting lists. The owners of The Ogden have been offering units for sale since late last year and are recently gaining some traction in sales. Soho Lofts and Newport Lofts are condominiums which often are used as rentals, so it is challenging to determine the size of the market for higher-quality rentals in the area but there does appear to be a shortage of quality rental units in the Downtown area. We understand that Juhl remains near full occupancy. We are also aware of a planned 300 unit apartment project near East Fremont which is very likely to be developed. Apartment vacancy rates within the redevelopment area are about 10%, which on its own doesn’t sound great. However, when you parse out what those buildings are, the picture becomes clearer. Many of the buildings in the area were built between the 1930’s and 60’s. If we look at some of the more recent buildings from the 1990’s and 2000’s, occupancy is extremely solid with several fully occupied and some hovering between two and six percent vacant. Towards the end of last year, we examined the financial reports of a renovated apartment project within the Arts District. The property was nearly 100% occupied and had an occasional waiting list. Given what we observe within Newport Lofts, Soho Lofts, Juhl, The Ogden and the Arts District Apartments, we expect that if a developer could deliver product geared towards urban millennials, it would fair very well. In some Las Vegas submarkets, we see apartment rents in amenity rich apartments as high as $1,600 for a two bedroom, with several between $900 and $1,200.

We are also aware of a proposed project near Main and Bonneville, however we don’t know how real the project is at this time (161 units are proposed). If the two proposed projects were built, it would help alleviate the strained occupancies in the area but we believe there is further demand on the horizon coming from employees at Resorts World Las Vegas (estimated to support more than 13,000 direct and indirect jobs.10) on the north strip, The Global Business District, The Federal Justice Tower which is under construction and potentially from Forest City’s planned Class A office campus named “The Grid” which will be located on 1st and Clark. If developed, this project would likely be the workplace of over 2,000 employees. Another potential source of renters are the current Zappos employees, many of whom do not currently live in the area but may have a desire to if they can find suitable housing.

The single most active submarkets are in the Southwest near the 215 curve and in Henderson near the 215 by both Stephanie St. and Gibson Rd. These areas boast strong incomes and favorable demographics and development is also a function of available land and there is still significant developable land in these areas.

Based on what we are seeing in escrow, we can expect significant development in the next few years and this may impact occupancy rates in some submarkets. Nevertheless, we believe that favorable demographics will be in play through most of this forward inventory. As with most projects, it really comes down to the skill of the developer and the leasing team.

PERFORMANCE

Map 1 in the introductory section illustrates the strong occupancies found in Class A projects throughout the Valley. With occupancies that strong and with rising rents, it makes sense for developers to move forward with several projects. Additionally, relatively low cap rates are generating more interest by developers, particularly in a national and regional context with both private equity monies and REITs engaging in ground-up development. Camden Properties Trust executives discussed their development pipeline at REITWeek 2015. They are planning 85% of their new pipeline to come from development and repositions rather than acquiring properties. In recent years, they have been selling properties in order to reallocate resources, such as the Oasis portfolio in Las Vegas, which they held an interest in and sold to The Wolff Company. On developments, they noted an expectation of a 7% yield which is substantially better than going out and buying the cap rate, with the exception of having to take both the construction and the lease-up risk.

Similarly, Lennar, long known for their single family product, has been developing apartments in recent years and listed 24 communities under construction in Q1, 2015 and sold their first two communities in 2014 and are expected to sell another five in 2015. In this space, Lennar acts as a merchant builder and uses third-party institutional capital on a deal specific basis. Lennar stated in their Q1 2015 earnings call that they were exploring financing structures that would allow them to hold leased communities in order to have a recurring income stream. To get a sense of the returns, Lennar stated that they expect IRRs exceeding 25% with cash multiples larger than two (Q2 2014 earnings transcript). We are not aware of any Lennar apartment projects in Las Vegas but this gives us an idea of what some builders may expect, particularly since Lennar has several projects in high cost California.

While Map 1 gives a sense of occupancies reported by Costar, there are several publicly traded operators which own projects in Las Vegas that provide a deeper sense of occupancies in the region. MAA Communities owns two buildings in North Las Vegas, both acquired through the Colonial Properties Trust acquisition. Camden Property Trust owns 15 Class A and Class B apartments in Las Vegas, each with a reported average occupancy near 95% for most of their buildings. This is probably a pretty good proxy for what a professional management company can expect. Examining the sale panel in Table 7 and in Figure 2, one can see a gradual decline in cap rates over the past several years. Presumably, even projects that traded in 2011 or 2012 may even be valued higher in the market of today. For example,The Croix Townhomes traded in December 2010 for a reported 6.5% capitalization rate and traded again in 2014 for 5.3%. There is an apparent slowdown in Class A and B transactions, perhaps indicating that owners are happy sitting on the cash flow or remain bullish on improving rents under continued strong occupancies.

RISKS AND REWARD

Some investors are beginning to question what happens to cap rates in a rising interest rate environment. First, despite verbal indications from the Federal Reserve about the likeliness of rate increases in 2015, many Fed observers only anticipate small increases in rates, although with the potential for volatility across debt markets. So, while many owners use 10-year Treasury rates as their performance benchmark, the relationship between Treasuries and capitalization rates is far from lockstep. Breaking it down further, cap rates are also a function of local supply and demand factors and a cyclical nature of building in many local markets, which don’t always integrate well into national models of cap rate and Treasury market trends.

Concerning interest rates, there are a few schools of thought on what needs to be done moving forward. Some market observers believe a prolonged period of easy money has lead to malinvestment, or the purchase or financing of projects that otherwise would not make sense under most other conditions. As such, they believe that the Fed should attempt rate hikes as part of a “normalization”, despite the potential for shaking out some of the weaker projects. Others believe that the Fed will respond to improving economic conditions, so higher rates will in part be a function of an improving economy. In any case, the natural question remains, will higher rates damage the commercial real estate sector? If indeed higher rates are a function of a better economy, the presumed higher cost of capital may be offset by strengthened demand in the commercial space market and for dwellings.

One cannot look at interest rates and capitalization rates in a vacuum and make broad conclusions. Another important factor is the overall performance of the debt market. John Duca and David Ling (2015) of the Dallas Federal Reserve find that cap rates are negatively related to the availability of credit (more credit availability leads to lower cap rates).11

As a result, commercial real estate prices can be vulnerable to shocks in the CMBS or other capital market channels and this was made more obvious by the global financial crisis. It may also make the case for using, if possible, assumable debt on a building.

Some believe that recent prices are the result more of maintaining reasonable spreads over the cost of capital or performance benchmarks, rather than from lower risk premiums. So while current cap rates may not be predicated on a herd mentality which leads to bubbles, financial market gyrations may lead to a bump in risk premiums built into required rates of return. However, again, if local market dynamics are favorable and investors expect rent increases, there may be an offset there. Additionally, multifamily projects tend to offer some inflation protection in the form of increasing rents, which is harder to achieve in office or industrial buildings which often feature long-term leases at pre-specified rents.

In the end, there are a many unknown causalities and non-linear relationships within the world of real estate so making simplified conclusions is challenging. However, examining some of the multifamily REITs that trade publicly, it doesn’t appear as though participants in the equity market are overy concerned about Federal Reserve Chair Janet Yellen’s recent language or the uptick in domestic bond yields.

Finally, much of what works in the commercial real estate world is derived from intimate knowledge of a particular trade area, along with strong execution in entitlements through construction and lease-up. In Las Vegas, the market seems to be crowded on the acquisition side with little play on the sell side. Additionally, there appears to be further room for well conceived projects in some submarkets, although several are beginning to get crowded.


1. http://news.theregistrysf.com/wp-content/uploads/2014/09/Cassidy_Turley_US_Multifamily_Report_2014_Review_2015_Forecast.pdf

2

. http://www.multifamilyexecutive.com/business-finance/debt-equity/chasing-yield-the-2015-dealmaking-outlook_o

3. alndata.com

4. http://lasvegassun.com/news/2015/may/05/group-says-new-las-vegas-strip-resort-casino-rise-/

5. nevadaworkforce.com, May 2015 data.

6. https://www.reit.com/news/reit-magazine/july-august-2014/millennials-move

7. http://www.forbes.com/sites/billgreiner/2015/02/25/how-a-lack-of-income-for-millennials-effects-household-formation/3/

8. http://www.urban.org/sites/default/files/alfresco/publication-pdfs/2000257-Headship-and-Homeownership-What-Does-the-Future-Hold.pdf

9. http://www.cnbc.com/id/102773427

10. http://lasvegassun.com/news/2015/may/05/group-says-new-las-vegas-strip-resort-casino-rise-/

11. http://www.dallasfed.org/assets/documents/research/papers/2015/wp1504.pdf

Figure 1

Relative Yields Across Asset Classes

Source: Costar, Fred II, Bloomberg, Yahoo!Finance.

YIELD PERSPECTIVES

Globally, yields remain far below historical levels. Many central banks continue to be accommodative in the face of weak GDP growth and little inflationary pressure. As a result, many of the lower risk dividend and interest rate instruments remain priced to a low yield.

To achieve high yields, one must either move abruptly on the risk spectrum (emerging markets or junk bonds for example) or accept lower liquidity (real estate). Given some of the vanilla choices, it’s not surprising commercial real estate has been receiving a lot of interest.

Figure 2

Class A and High Quality Class B Going-in Cap Rates

Source: Costar, Power Broker Confidential, First American Title, Coldwell Banker Premier Realty, Fred II.

Figure 3

Las Vegas Apartment Average Asking Rent

Source: Lied Institute for Real Estate Studies, Costar.

FUNDAMENTALS

The leasing market is bifurcated between lower quality and higher quality projects. Figure 4 illustrates that significant difference between occupancies in the overall market, which includes a significant amount of Class C projects. If we could invent a new category “D” would also be in there in the form of smaller and older buildings. We know of at least 300 buildings in the urban core that were built before 1970. If we analyze Class A buildings or high-quality Class B (which we consider to be those built after 1990, have more than 200 units and achieve rents of at least $0.85/sq.ft) buildings separately from the overall market, vacancy rates are as low as they were during the boom days of 2005.

Map 1

Class A Apartment Occupancy

June 2015 snapshot.

Source: Costar.

Figure 4

Las Vegas Apartment Vacancy Rate

Source: Lied Institute for Real Estate Studies, Costar.

Figure 5

Visitor Volume – Clark County NV

Figure 6

Non-Farm Employment – Clark County NV

Source: LVCVA.

Source: Nevadaworkforce.com.

Figure 7

Homeownership Rate – Las Vegas-Paradise MSA

Source: Census.gov

Map 2

Las Vegas Area Planned, Under Construction and Recently Built Apartments

June 2015 snapshot.

Source: Costar, Clark County, City of Henderson.

Figure 8

Multifamily Permits – Clark County NV

Source: LIED, Census.gov

Juhl is one of the more sought after residential rentals downtown.

Newport Lofts are individually owned condos, however some occasionally become available for rent. Sale prices have been gradually climbing within the project.

The Ogden has made up a large portion of the Downtown rental pool. Currently the owner is actively marketing these condominiums on an individual basis.

Table 1

Rent Price Per Square Foot in Downtown

Source: GLVAR multiple listing service.

Table 3

Proposed Apartment Projects

PROPOSED PROJECTS

The table above notes some of the projects that we understand are possible to be delivered in the next three years. We are aware of several parcels that are in escrow that are extremely likely to become either traditional apartments or senior apartments, however we cannot mention them publicly at this time. As such, we should not consider the above table to be representative of the entire universe of proposed projects.

Map 3

Class A Apartment Average Rent Per-Square Foot & Median Household Income

Table 2

Apartment Land Purchases in the past 12 months

June 2015 snapshot of rental data. 2014 ESRI income estimates.

Source: Costar, ESRI.

LAND PURCHASES

Based on price per door or price per acre, it is clear that there is broad variation in pricing. It should be noted that most of the high dollar land purchases were by luxury apartment developers, a largely new category in the market.

Table 5

Recently Completed Projects

Source: Costar, City of Henderson, Clark County, Coldwell Banker Premier Realty.

Map 4

Apartment Land Sales

Source: Clark County.

Table 4

Under Construction Projects

Source: Costar, City of Henderson, Clark County, Coldwell Banker Premier Realty.

Some developers have departed from the traditional two story walk-up/garden style apartments and are building true luxury apartments with a greater variation in architecture, amenities and finishes. Shown under construction is Calida Group’s Elysian at The District and DG Development/Fore Property Company’s Volare project.

* Average Physical Occupancy. MAA reports occupancy at December 2014 and Camden provides the 2014 average.

Source: MAA Communities,Camden Property Trust 10-K.

Table 7

Sale Panel of Class A and higher quality Class B Apartments 2011 – 2015 YTD

Table 6

Public Apartment REIT Las Vegas Buildings

Source: Clark County, First American Title, Ticor Title, Costar, Power Broker Confidential, Coldwell Banker Premier Realty, REIT.com, MAA.

Source: Clark County, First American Title, Ticor Title, Costar, Power Broker Confidential, Coldwell Banker Premier Realty, REIT.com, MAA.

Map 5

Class A and higher quality Class B Apartments 2011 – 2015 YTD (see also Table 7)

Illustrates Price Per Door and Cap Rate at Acquisition

Market IQ

Authors:

John McClelland

Vice President, Research

702.938.1375

Brian Krueger

Senior Vice President, Strategic Services

702.939.5128

8290 West Sahara Avenue, Suite 200

Las Vegas, Nevada 89117

www.commercialrealestatevegas.com

The information contained in this report is deemed reliable but is not guaranteed.

The information and opinions expressed in this document do not constitute investmnt advice.

 

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