REITs rise, but will apartments?

Investors are positioning themselves for a recovery in the moribund multifamily housing market. Real estate investment trusts (REITs) that specialize in apartments are raising billions of dollars in equity to answer pent-up demand from "Echo-Boomers" eager to leave their parents' homes -- and vice versa, no doubt.

Commercial real estate REITs of all types are being bid up by investors who are sensing the first green shoots of a recovery and want to get in on the ground floor. About $17 billion in capital was raised by such trusts last year, according to Milwaukee-based investment bank Robert W. Baird & Co.

But whether the investor optimism will be translated into new apartments and much-needed construction jobs is another matter, industry observers say. In the Twin Cities apartment market, which is dominated by smaller local players rather than national REITs, multifamily deal flow decreased to a trickle during the recession and is likely to take longer to rebound.

Yet there are positive signs in the multifamily sector, which is strongly linked to the labor market. The U.S. Department of Commerce reported last month that seasonally adjusted construction starts for multifamily dwellings with five units or more jumped 17 percent from December to January, to 100,000 buildings.

Apartment REIT analysts Green Street Advisors wrote last month that fundamentals for the multifamily market are strengthening: Homeownership rates are falling, thus boosting demand for apartments, and the falling of rents is bottoming out.

"If you look at how the labor market recovered after previous recessions, you see increasing lag times, and we're expecting a 24-month gap this time, putting it in the third quarter of 2011," said Paula Poskon, a real estate industry analyst with Baird. "But what is ultimately driving this optimism is that by the time we get to 2011-12, there will be a significant unleashing of pent-up demand from young people who have been unemployed and underemployed and living at home with parents. At the same time, because there has been no construction in the past few years, there will be a very short supply of new multifamily housing."

Still, she added, "two years is a long way off," and many things could happen in the meantime to scuttle the actual building of new units.

"There are reasons for optimism, and I think the fact that we're going to be delivering apartments later this year shows it can be done, given the right product in the right location with the help of a creative lender and city officials who want to work with you.

"But," Holtzman added, "there are still significant disconnects in the market. For Mill City to be the only project all year in a great city like Minneapolis is sad and ridiculous. We still need banks to be banks, we still need mortgage companies to be mortgage companies and investors to be investors."

Holtzman said there's plenty of capital available to be deployed, but rather than being put to use to build new units and address the coming supply crunch, that capital will probably instead be used to snap up existing distressed properties at bargain prices.

"That will delay building the new apartments that will clearly be needed in 2011, 2012 and 2013," he said.

Scott Pollack, senior vice president of investment services for Minneapolis-based Northmarq, said: "There are not many properties on the market right now and it's tough to find sellers who will sell. There's still not much lending activity going on. Sellers can't refinance their previous loan balances and are reluctant to put additional equity in."

"It's generally hard to build in the Twin Cities market and make new development projects work because our costs are high and our rent structures are not at the levels that can support new construction," he said.