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REMAIN CALM!

Doug Imber



I’m reminded lately of the final scene in Animal House after the Deltas caused a riot and Kevin Bacon’s character keeps feebly shouting “Remain Calm!!… All is Well!!” Then he’s flattened by a stampede of parade goers.

At the risk of being flattened, and despite the noise and tumult all around… my advice: REMAIN CALM!

I realize that, if we’re looking for things to fear, there is plenty of fear to be found. Rent control, trade wars, interest rate hikes, new supply, and pension defi-city™. (I haven’t really trade-marked this word but, if it catches on, I call dibs.)

These are serious issues and I’m not trying to diminish them or their potential impact on each one of us. But there’s rarely been a time in my career when there haven’t been looming concerns. Sadly, in the past 30 years, we’ve experienced multiple wars, terrorist attacks, recessions, tax reform, condo-booms, condo-busts and deficits. For those like me who are hyper-vigilant (that’s my euphemism for worrying too much), there is always something to keep us awake at night. But fear can become a self-fulfilling prophecy. Or at a minimum, the fear of something is often worse than the actual something. This isn’t just fortune cookie wisdom; it’s how investment markets often function.

The collective something these days is whether the apartment market is at a peak? The obvious answer is that none of us knows. But the underlying answer is that markets frequently reset or correct. For example, the DJIA regularly experiences declines of 10% or more. Going back to 1928, Bespoke Investment Group calculates that this occurs a little more than once a year. Markets have corrections, catch their breath, and then frequently rally again. The nose-bleed peak that condominium converters paid for apartments in 2007 seems cheap today. What might a 2027 peak look like?

We have all enjoyed feasting on 98% occupancies and 4% rent bumps. Like eating too many huge meals, it’s likely not sustainable. 95% occupancies and 2% rent bumps can still be considered part of a balanced diet but maintaining this may require some additional exercise.

So, is the collective fear that the apartment market is due for a correction? Or is the fear that the sky is falling, we should sell everything, and go buy a bunch of Bitcoin? Or is the fear misplaced and all is well? I think you see where I’m going with this. “Was it over when the Germans bombed Pearl Harbor? No!”

 

 

Arguably, since mid-2010, this has been the Golden Age of Chicago’s Apartment market. In 2009, a “typical” one bedroom in Rogers Park rented for $800. Today, that same apartment rents for $1,100 or more, nearly a 40% increase in less than a decade. During that time, property taxes as a percentage of income have been chopped in half; interest rates have remained low by historic standards, troughing in the mid 3% range but increasing steadily this past year to the mid-to-upper 4% range; and cap rates, which compressed commensurately with the rate decreases, have been slow to expand with the recent rate increases. During this Golden Age, Rogers Park has continued to evolve not merely as a bedroom community, but also as a vibrant commercial and investment market.

While there are certainly some potential headwinds, there are also many strong tailwinds pushing the market along. According to the Bureau of Labor Statistics, the area’s unemployment rate is now at 4.5%, a level not seen since 2000. The Chicago MSA added 38,000 jobs for the year between May 2017 and May 2018, and the city added 168,000 jobs in the past seven years. Anecdotally, there seems to be some real wage growth occurring after years of little to none. These are the hallmarks of a very healthy economy. Toga! Toga!

Similarly, while apartment supply is a source of concern for all multi-family investors, according to Integra Appraisal, 2017 saw a record level of absorption (the change in the number of occupied units) of 3,500 units downtown, offsetting most of the 4,500 units of new inventory. That record may be broken again this year, with 2018 absorption already at 2,600 units. Surprising to many, the suburban market remains strong, with occupancy at 95.1%, down only slightly from the prior year’s 95.3%.

According to the US Census Bureau, the home ownership rate in the country has declined sharply since its peak more than a dozen years ago, adding even more strength to the rental market. The home ownership rate in April stood at 64.4%, roughly on par with levels from the mid-1980s and mid-1990s, before a decade-long home-buying boom drove the rate to a peak of 69.4% in April 2004. As Flounder insightfully observed, “Oh boy, this is great!!”

 

 

In my opinion, the strongest tail wind of all is the country’s demographics. According to 2017 Census estimates, the Baby Boom Generation, which shaped our country for decades, was comprised of 71.4 million people. By comparison, the Millennial Generation, which is reshaping the apartment rental landscape, is even larger at 84.7 million people. Furthermore, the Gen Z’s (born after 1998) now make up 25% of the US population and is a larger cohort than either the Boomers or Millennials. This last group hasn’t even entered the apartment market yet! “Thank you, Sir. May I have another?”

I don’t believe there are any silver bullets, but I would offer the following simple suggestions. First, if you think you might like to sell in the next few years, now is as good a time as any. There are plenty of buyers and debt is relatively cheap. Conversely, if you’d like to buy, being a market timer is super challenging. Instead, I’d recommend finding the right property for your portfolio, not over-leveraging it, and being an attentive manager. And most importantly, keep your eye on the next peak, not the last one.

There are always problems to contend with. Some of these are within our control and others are not. But we shouldn’t conflate the fear of the unknown and market corrections with the end of the world. And in a final effort to beat this metaphor to death, I believe there’s room in the apartment investors’ mindset for Otter’s enduring philosophy… “Don’t think of it as work. The whole point is just to enjoy yourself.”

 

 

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