Rental Apartment Developer’s Strategy Outlook Landscape

The market banter at the onset of 2017 provides contradictory guidance for the shrewd developer or investor in multifamily housing construction
By Adam Ducker

The market banter at the onset of 2017 provides contradictory guidance for the shrewd developer or investor in multifamily housing construction.
At the macro level, the “Trump Effect” seems quiet real – even with the threat of escalating interest rates, equities markets and other leading indicators are positive, with many economists and RCLCO’s own 1Q Sentiment Survey showing more near-term confidence in the underlying economy than during 2016.

We believe the most likely scenario is that we will enjoy another two to three years of perhaps modest, but nonetheless positive economic growth.

We believe the most likely scenario is that we will enjoy another two to three years of perhaps modest, but nonetheless positive economic growth.
The buzz around the Class A multifamily market has been more cautious this year – with a Wall Street Journal article the first week of the year ringing the alarm bell regarding the impact of new supply and banks cramping down on their multifamily lending pipelines. The questions to be grappled with are: (1) Are we headed for a correction in the multifamily markets and what is the likely nature of that correction and (2) even if we are, or we think we might be, what is the enlightened developer to do about it?

RCLCO perceives a better-than-average likelihood that new rental housing deliveries in some submarkets and in some metros will need to stabilize through a soft market likely materializing in 2017 and continuing into 2018. Critically, however, we believe that this malaise in the markets will not be uniformly felt across geographies and asset classes, and that the market interruption will be characterized as “squishy” rather than truly recessionary, with slow leasing and no to marginally negative rental rate growth in most markets, rather than the profound interruption in demand and revaluations we saw in the last cycle.

So what to do about it? While there is always an allure to outsmart the market cycle, or at least the gnawing urge to temporarily roll up the “open for business” flag, the reality is that timing of this type is really neither feasible nor practical for most developers. The optimal strategy is to manage the enterprise to muddle through such weak periods, painful though that may be.
Five lessons in doing so:

1. The risk is most significant for merchant builders, as the primary risk is illiquidity or poor valuations at stabilization. Even if it’s not your or your capital’s strategy, now is the time to put in place a contingent extended hold strategy, which is largely comprised of the following action items. This strategy should be explicit, written down and discussed with your key financial partners

2. Re-underwrite deals in the pipeline and prioritize those with the most defensible supply-demand fundamentals, and ice or exit those that appear more at risk or are too expensive to carry. There are contrarian positions that we believe have the best potential to perform, even if we have a period of broader market weakness, in the coming year – suburban/garden deals; smaller markets with strong job bases where the pipeline has remained constrained; value-oriented product; family housing and other niches.

3. Begin to increase cash reserves; lower project leverage and secure lines of credit. While it is extremely difficult to sit on actual cash or even leave potential lending lines undrawn, this is effectively teeing up the lifeline you may need at some point in the next few years.

4. Double down now on marketing effectiveness and customer knowledge tools. When the markets get competitive it is too late to up your game. Rather, invest in this potential now when cash flow is healthy and equity partners are open to it rather than when the contest for customers gets fierce, at which point it will be too late.

5. Manage your organization for long-term stability. One of the most painful outcomes of the last cycle, and the one that made responding to the rebound most difficult, was the need to rationalize company size. Solidify your team now, don’t overhire, but do work to promote long-term loyalty and buy-in among your most talented professionals.

Adam Ducker is the Managing Director And Director of Urban Real Estate for RCLCO, specializing in mixed-use development, market and financial advisory, and economic development strategy. He may be reached at aducker@rclco.com.

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