Apartments are Hot, Hot, Hot!

 

The apartment market is HOT, and everyone wants to be in it.  The decline in home ownership is causing a boom in rental housing, and construction starts for the multifamily sector in November 2011 grew over 25% from the previous month.  If you’re an office or retail developer, with little or nothing in your pipeline, this growing residential market is very attractive, and many of the nation’s largest office and retail developers are moving into residential apartment developments for the first time.

Well-known commercial developers such as Boston Properties, Inc., Mack-Cali Realty Corp, SL Green Realty Corp, Simon Property Group and Macerich Co have all either acquired, completed or broken ground on apartment building in recent months, or have apartment projects in their pipeline for 2012.  For example, Macerich, a high-end mall developer with holdings such as Scottsdale Fashion Square in Arizona and Queens Center in New York, has a 430-unit apartment project under construction near its Tyson’s Corner Mall in Northern Virginia.  SL Green, the largest owner of Manhattan office buildings, has never owned or operated apartment buildings before, but in October, the company announced that it was joining Stonehenge Partners to purchase eight apartment and retail buildings in New York.

Some investors are questioning the move by these retail and office giants into a field where they have little experience.  Jay Leupp, a portfolio manager on Lazard Asset Management’s global real estate securities team, which invests in SL Green and Boston Properties, has indicated that he doesn’t want these companies to hold more than 10% of net operating income coming from non-core operations.  However, the retail and office developers believe that moving into the residential market can be complimentary to their core products.  Macerich Chief Executive, Art Coppola, was recently quoted in the Wall Street Journal.   “I see our residential strategy as being an ornament on a great retail town center.  I don’t see it as a separate business,” Coppola said.  “It’s complimentary and subservient” to the company’s mall business.

Most major real estate companies tend to stick to what they do best.  Those who have strayed into new sectors have done so with mixed results.  For example, in 1997 Vornado Realty Trust, traditionally an office developer, purchased the nation’s largest supplier of cold-storage space in a deal valued at close to $1 billion.  Although Vornado ended up making a profit on the purchase, Michael Knott, an analyst at Green Street Advisors quoted in the Wall Street Journal, says that Vornado would have done significantly better if it had stuck with its core expertise and purchased New York office buildings instead.

As more Americans opt to rent instead of owning a traditional home, the apartment sector is the fastest growing segment in the real estate industry.  But will this rush become just another real estate bubble?  More than 225,000 units are expected to be started this year, with another 280,000 on the planning board for 2013, according to Zelman & Associates.  Once lending restrictions ease on single family residential housing, will prospective tenants move back into traditional housing, leaving a glut of see-through apartment buildings?  If so, how long do the developers have to enjoy profits from these developments before they start losing money?  In this economy, who knows?

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