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More Multifamily REITs Looking Beyond Primary Markets

As Competition Remains Fierce in Major Metro Apartment Markets, Some REITs Are Finding Better Opportunities in Outlying and Smaller Markets
November 28, 2012
When deciding whether to let their money ride on Washington, DC, or Baltimore, MD, Home Properties is going with Baltimore.

When deciding whether job growth will be stronger in larger or smaller markets, Mid-America Apartment Communities is seeing the secondary markets doing better.

And in the New York City MSA, AvalonBay Communities increasingly sees better investment opportunities in the outlying markets in Connecticut, Westchester County, NY, New Jersey, and Long Island that haven’t been available for years.

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The strategies pursued by the three REITs are indicative of the changing dynamic in the multifamily investment market. With numerous investors bidding up prices for higher quality properties in the top markets, many of the nation’s apartment REITs are increasingly putting their propoerties in core markets up for sale and looking to invest in secondary markets outside of the major urban cores.

Home Properties Inc.

While Home properties does have two properties under contract for sale in Baltimore, Edward J. Pettinella, president and CEO, told investors on the firm's third quarter earnings call the REIT is aggressively marketing for sale its 450-unit Falkland Chase property in the Washington, DC, suburb of Silver Spring, MD.

“We have had huge interest from potential buyers,” Pettinella said. “Selling Falkland will have a number of positive effects for Home. It will lighten our DC concentration which we are targeting to get under 30%. It also lightens our future development exposure and monetizes the tremendous value added from entitlements to increase the density on the north parcel of this property. Final offers are due in the coming week and while there still may be some due diligence, contracts, et cetera to get through we are very optimistic about the very profitable sale of this property.”

“The fact that our DC portfolio is the highest [in number of units owned], not only among ourselves, but on a national basis among the 12, we decided to scale that down a number … over the next month, but [in] Baltimore, we feel pretty comfortable,” Pettinella said.

Baltimore is Home’s second biggest market and has performed well.

“Economically, it may not be quite in the same league as Boston and Philly at the moment, but I feel very confident over the next full cycle or two, Baltimore is going to perform well,” Pettinella said. “There is no movement on our part to scale down Baltimore… We’ll be doing some pruning. We sold one property in the third quarter. We may do a little bit more of that but overall, we’re very comfortable with our suburban footprint in the Baltimore region.”

Mid-America Apartment Communities

When H. Eric Bolton Jr., chairman and CEO of Mid-America Apartment Communities, looks at new supply of apartments across his markets, he also likes what he sees in the secondary markets.

“Within our large market segment of the portfolio, latest projections suggest a ratio of just over eight jobs to each new unit expected to be delivered next year, which is stronger than the last up-cycle we had over the 2004 to 2007 timeframe,” Bolton told investors in his firm's quarterly conference call. “Within our secondary market segment, the story is even better, with a job growth to new supply ratio projected to be just over 10-to-one in 2013.”

In large markets, Bolton said it's important to drill down into sub-market analysis in order to understand the threats presented by emerging new supply is likely to have at specific locations. He added in a number of the larger markets, new supply is more likely to create pressure on locations in more of the urban or core CBD submarkets.

“Within the secondary markets in general, we just don’t see much new permitting activity taking place and would expect that this segment of our portfolio is more likely to capture improving performance as compared to our large market segment towards the second half of next year,” he added.

As part of a strategy targeting sdecondary markets, Mid-America made its first move into the Kansas City, MO, market over the past year.

“As a consequence of our stepped-up efforts of recycling capital out of some lower margin older investments into higher margin newer investments it just so happens that a lot of our older properties are in some of our secondary and more tertiary markets, and so you’ll be seeing much more active recycling taking place in that particular component of the portfolio. Markets such as Kansas City, San Antonio, Charleston and Savannah, those are some of the secondary markets that we would like to continue to fill out.”

On the development side, Mid-America said it will be deploying capital in Little Rock,AR, Charleston, SC and Jacksonville, FL.

“You’re not going to see us do development in Dallas and Atlanta,” Bolton said. “We’ll let others do that... To the extent that we deploy capital for development, it will be a secondary market focus.”

AvalonBay Communities Inc.

AvalonBay Communities made headlines this week by teaming with fellow REIT Equity Residential in a deal to acquire Archstone's U.S. portfolio. The firm has a historically strong major market presence, with apartments concentrated in Northern and Southern California, Seattle, the Mid-Atlantic, New York and Boston.

However, lately it has been looking more closely at the 'exurbs' in its major markets.

“We’ve always been relatively agnostic between urban and suburban investment,” said Timothy J. Naughton, president of AvalonBay. “Clearly over the last 10 years, urban has outperformed suburban. On the other hand, that hasn’t gone unnoticed by the market and that’s been reflected certainly in asset pricing and in land pricing. So, our view is to pursue more of a mixed strategy... Hedging your bets is probably the right approach to our markets and particularly when you look into the New York area, when you look at places like Connecticut and Westchester, New Jersey, and Long Island, we are seeing opportunities (for rental apartments) there that we have never seen really -- that would have (in the past) gone condominium.”

Naughton said, in those outlying markets, his firm can build wood frame construction at relatively close-in locations that serve as very high-end bedroom communities and generate outstanding economics, with yields of more than 7%.

"Manhattan certainly doesn’t give you those kinds of initial economics, but perhaps gives you a little bit stronger growth over the long run. So we think a mixed strategy with respect to urban and suburban across all markets probably makes the most sense, New York included,” Naughton said.

Keep up weekly on national news, trends and property leads with the Watch List Newsletter, a weekly pdf that includes other news and leads not found on the CoStar Group web news pages. Sign up for the Watch List E-Mail Alert. A new issue is published late each Wednesday.

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