High-Yield Buyers Eye Core Phoenix Rentals
Competition for value-added apartment properties has grown so intense in the Phoenix area that some investors are widening their scope to include core plays.
The higher risk involved in buying properties that are ripe for renovation is typically balanced by a higher initial annual yield. But in Arizona’s white-hot multi-family market, the line between core and value-added pricing has become blurred.
“When you look at pure capitalization rates, you see core and value-added properties trading within the same band,” said Matt Pesch, executive vice president in CBRE’s Phoenix multi-family institutional properties group. “There are some investors who have looked at those spreads and overall returns and are pivoting their strategy, because on a risk-adjusted basis, it seems to make sense to them.’”
Phoenix-area apartment sales in the first half were up 15% to $3 billion, according to Real Estate Alert’s Deal Database, which counts trades of $25 million and up. That was the highest total ever for a first half and put the market on track to surpass the $5.9 billion annual record set last year. Strong job growth, rapidly rising rents and tight supply have investors flocking to the city and its suburbs.
Market pros say that demand has been especially hot for value-added properties — with listings often attracting 15-20 initial offers, and sometimes more. As a result, cap rates on those acquisitions are shrinking and getting close to those on core deals.
“You have a ton of capital putting downward pressure on the value-added space,” said Pesch. CBRE data for the first half shows initial annual yields on Class-B rental properties have dipped to 4.25-5% — the same as Class-A — with Class-C cap rates only slightly wider, at 4.75-5.25%.
The narrow gap is prompting some nimble investors to jump across, noted Steve Gebing, senior managing director and multi-family investment specialist in the Phoenix office of Marcus & Millichap’s Institutional Property Advisors unit. “In many cases, given the sheer imbalance of liquidity in the market offset by limited 1990s- and 2000s-built value-add assets for sale, cap rates are blurring between the core asset class and value-add market segment,” he said.
That’s what prompted Chicago-based Redwood Capital to pivot this year, according to Field Stern, its director of acquisitions. Redwood’s bread-and-butter has long been suburban workforce housing, specifically garden-style apartments built in the 1980s and 1990s. But in June, it snapped up a brand-new complex in Scottsdale, Ariz. Redwood paid $117.8 million, or $323,000/unit, for the 365-unit Carter, at 3300 North Scottsdale Road, for an initial annual yield of about 5%.
“I’m getting a premium cap rate with less execution risk, no deferred maintenance, and a stronger demographic profile,” Stern said. It was Redwood’s first foray into the Phoenix-area core market, but Stern said it won’t be its last. “That was our first flag, and we’re going to look to expand our footprint there — and candidly, we’re looking at a lot more new construction in Phoenix right now.”
Compared to core investments, value-added opportunities typically require more capital to conduct improvements, re-stabilize the property after construction downtime and then market the apartments to higher-paying tenants. The aim is to raise rents and boost the yield.
But amid strong rent growth, value-added investors can come close to their yield targets without those costs. With market-wide occupancy at 96% and absorption outpacing development, rents rose 8.1% to an average $1,160 in the third quarter from a year earlier, according to Marcus & Millichap.
Matt Ferrari, co-chief investment officer and head of acquisitions at TruAmerica Multifamily, said the prices currently commanded for Phoenix properties with upside potential leave little room for error. “Deals are definitely priced for perfection,” he said. “You have some groups who have concluded that they can’t play in the value-add space, and they’re willing to pursue core and core-plus real estate opportunities.”
Ferrari said his firm has been both a buyer and a seller in the Phoenix area this year. Unlike other metropolitan areas, he said, TruAmerica reviews every Phoenix opportunity that comes along. “The box is probably bigger in a market like Phoenix as to what we would buy,” he said. “We would be open to buying good value-add or core-plus deals.”
Investors and brokers said the Arizona economy is firing on all cylinders, with strong job and population growth that bodes well for continued rent increases. Apartment absorption totaled 6,137 units in the first nine months of the year, far outstripping deliveries of 4,238 units in the same period last year.
“It’s the perfect storm,” said Gebing at Institutional Property Advisors. “Across the board — whether we’re talking about the underlying economic fundamentals, operational momentum in the sector, escalating investor demand or soaring liquidity in the market — everything is coming together at the same time.”
Source: Real Estate Alert