Suburban multifamily investment shows few signs of cooling
When people ask me whether it's too late to get in on the suburban multifamily investment boom, I assure them it is not.
When I advise investors looking to acquire properties throughout inner-ring suburbs, I emphasize fundamentals that help ensure ongoing demand -- that is, properties in near-transit locations that offer connectivity to downtown, as well as easy access to quality schools, retail, restaurants and other amenities that promote a walkable, suburban lifestyle.
Although uncertainty about the economy, interest rates and local property taxes dampened activity in first- and second-quarter 2019, we are seeing a pickup again and believe the third quarter will be very strong for multifamily property sales in the suburbs. Why? There are several reasons:
Coastal cash. Chicago and suburban multifamily properties are among the most attractive in the country right now to investors. Compared with coastal cities like Los Angeles or New York City, multifamily properties in Chicago are affordable, especially in the suburbs, which offer higher cap rates than the city. Increasingly, we're seeing more buyers from the East and West coasts touring, bidding on and buying multifamily properties here.
Strong Demand. Suburban multifamily occupancy is strong, with vacancy rates typically around 5% and as low as 3% in stronger locations, even as thousands of units are added to the market. With virtually all of the new construction priced at or near the top of the market, older communities have become increasingly attractive to renters and, therefore, investors in search of value-add opportunities.
Low Interest Rates. In the second quarter of 2019, the Fed cut interest rates for the first time since 2008. The interest rates are back near historic lows, and many investors are taking advantage of the low cost to borrow.
End-of-cycle appeal. With some economists forecasting a recession in 2020, multifamily properties are ever more appealing because they are considered "defensive investments." This is partially because they fill a fundamental need -- housing -- unlike, say, a shopping center or hotel that relies more on disposable income. Apartments also offer cash flow diversification compared with other types of investments in that if one or more tenants does not pay, the owner has plenty of others who will. This is not the case with commercial leases if the tenant goes out of business entirely. Additionally, with the unpredictability of the stock market, some investors see an apartment investment as a safer alternative. It is an investment they can physically see and touch. For more hands-on owners, it's an investment they feel they can control the operations and performance of.
My company, Interra Realty, brokers middle-market transactions throughout the metro area, helping buyers and sellers maximize value by analyzing market data and leveraging our own boots-on-the-ground expertise. If you're among those looking to expand your multifamily holdings in the Chicago area, there are several questions you should ask before beginning your search:
What type of buildings are we talking about? It depends. We've seen recently developed Class A properties trade hands as developers capitalize on
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on strong occupancies and rents. There's also an appetite for older Class B and C communities -- some of them garden-style properties with hundreds of units -- that offer upside through renovation. But activity hasn't been limited to larger deals. There's plenty of opportunity for small- and mid-size investors, too, especially in municipalities that have been reluctant to green light new projects. Many of the deals my team brokers range in size from six to 40 units and are priced between $1 million and $5 million, although we also have brokered properties up to $20 million.
Are renovations required? While some investors target core assets, which have become easier to find amid the suburban market's ongoing construction boom, others pursue value-add opportunities that, while riskier, offer higher returns. By renovating units and/or common areas, investors can push rents while keeping them below new construction -- $1.67 per square foot for suburban Class A vs. $1.47 for Class B and $1.33 for Class C, according to data from Integra Realty Resources. The benefits of this strategy are twofold: the investor helps meet growing demand for middle-income or workforce housing and, in doing so, increases their own profitability by keeping their buildings full.
Where should I look? Again, it depends on what you're looking for in an investment. For example, the core parts of Oak Park and Evanston are always hot and, therefore, safer investments. Both offer the good schools, transportation and proximity to Chicago that investors seek.
When comparing assets in different submarkets, it's important to look beyond price and relative value. For example, a multifamily property in Berwyn may be half the cost of a similar property in Oak Park, offering a cap rate that's 3 or 4 percentage points higher. But lower-cost properties can translate to lower returns if they're not located in areas where prices will appreciate. Some assets can also be more labor-intensive in terms of management.
Whether you're looking to make your first multifamily investment or expand your existing holdings, now is an excellent time to take a closer look at the suburban Chicago multifamily market. There's still plenty of capital waiting on the sidelines, and well-located rental communities that offer downtown-inspired finishes and amenities at suburban prices are solid investments that fill a need and face less competition -- both attributes that bode well for the market even if broader economic conditions change.
•Pat Kennelly is managing partner of Interra Realty in Chicago.