Apartments Are Pricey Today

Implications: Apartment rents will be difficult on the average to raise in light of the significant increases last year.  There is no shortage of rentals in the average market to cause a different result.  Strained household incomes will be difficult to stretch to higher levels across the markets. 

Analysis: The article notes growing demand for apartments has not been alleviated in total by the shadow market – those residential properties that have been added to the rental pool when they didn’t receive a suitable offer on the re-sale market.

In contrast, Bloomberg notes that others say rents are flat in most areas with accelerating vacancies. Vacancies are now at 6.1% nationally with an average rent of $ 991. With the exception of New York City, its source, McCabe Research, says rents may not increase in the next year. A second source, Reis, Inc, says vacancies will continue to rise in 2007. The Census Department says 2.8% of houses for sale in the first quarter were unoccupied. There’s more here and you probably should read Rents Peak in Housing Glut; New York Escapes Decline (Update 3) http://bloomberg.com in tandem with the subject MarketWatch article.

The Bloomberg article mentions Equity Residential, noting that it is the country’s biggest apartment owner. In the market with which I am most current, the Phoenix metro area, Equity is a substantial player. Most of their properties in this market are clever acquisitions worthy of the grave digger moniker. Just reviewing them in my mind, the acquisitions have monetized others’ mistakes. They are a mix of older properties in big name markets (like Scottsdale) but sometimes off-speed locations, too big for their market, previously rundown from lack of financially capable ownership at acquisition, strange conversions back from condominiums, the best property in in-fill but spotty locations, perimeter properties that entered the market slowly creating financial problems and the like. Some problems can be handled by large on-site staffs constantly recruited for both sales and maintenance issues. Phoenix is a transient market as you know and there is plenty of work for the staff to do. Further, when you are the grave digger, some properties are beyond your restorative capabilities and they remain problems during your ownership. Equity does a nice job of redecorating and maintaining so their properties are visually appealing – various shades of cocoa brown do for undistinguished architectural elevations what waxed paint and chrome do for ordinary automotive design. But Phoenix is a harsh environment. Glazing facing west/south and inadequate HVAC combined with the intense desert sun, for instance, cannot be adequately overcome with maintenance. As a result, I believe Equity’s turnover may be higher than the average in the market. In general, I would characterize the physical plants as Class “B” with a Class “A” attitude.

The Phoenix metro area is a community of haves and have-nots like many other U.S. communities. Of the 3.8 million in the metro area, some 113,000 plus are millionaires – 4^th highest in the country. The county median household income ought to be around $ 52,000. If it’s reasonable to say that the average millionaire has an annual gross income of say $ 250,000, the residual average might be say something just less than $ 46,000 annually. Assuming that for the most part the capable are among the say 2/3 that are homeowners, the renter pool is for the most part working class folks with limited means under say $ 30,000 annually. The average rent in the Phoenix metro area is about $ 800 monthly. With $ 800 coming out of $ 2,500 monthly and community charges plus utilities plus lease extras, the average budget is close to the bone. The result is high turnover. The parallel in the home ownership market puts Phoenix 24^th highest in the nation in foreclosures. I think Equity’s renters approximate the income numbers shown above.

Equity presses the rent envelope. No $ 800 average rents here – you’re lucky to rent a one bedroom apartment for $ 800 monthly. The Equity rental agreement is somewhat normal to the market with a twelve month standard lease and multi-month rent interim cancellation charges. No doubt that Equity’s income stream profits mightily from imposition of these cancellation charges as a large immigrant and young population have needs or perceived needs to move during the term of a lease. There are other and varied charges at the onset which might add up to say ½ of or a months additional rent – just like the escrow closing statement with a sub-prime loan. I believe the standard/base rental quoted is usually as much as say ten percent over the competitors anyway. That additional charges are competitive and warranted in many cases as comparison with comparable tired properties elevates a renter’s spirits.

I believe Equity has abandoned the Midwest with the exception of a few properties in Chicago - they have been the largest recent seller in those markets. Equity has the choice like other apartment investors of the coastal markets or the sunbelt growth markets as places to make money. The investment hope is that coastal supply constraints allow time to permit the market population to grow and rents to increase with a resulting shortage. The sunbelt markets are easier to enter but obtaining a sufficient income stream is difficult.

If this business sounds like hard work, it is. The Equity management and Mr. Zell are masterful at grinding it out through thick and thin. Most of their endeavors have been successful, but not all. Remember Broadway Department Stores. The timing of the Equity Office Properties sale appears to have been masterful for EOP as Blackstone is selling for a 7% premium over acquisition costs. At least, that’s what Mr. Zell says and, if so, isn’t much of a premium for all that risk and work. Mr. Zell also has his hands full with the Chicago Tribune, RV Parks, Senior Housing, investments in Mexico, Brazil and Egypt, so you better believe he can do it all and ride his Ducati too if you’re going to travel with this posse.