Despite pandemic, suburban Chicago multifamily still a great bet for investors

  • Patrick Kennelly

    Patrick Kennelly

 
By Patrick Kennelly
Interra Realty
Posted11/10/2021 2:00 AM

Two years ago I wrote an article in these pages explaining that it was not too late to get into the suburban multifamily investment boom.

What about now, after 18-plus months of living with a pandemic, recession and unemployment?

 

Turns out, multifamily is still one of the hottest sectors in commercial real estate right now. In fact, multifamily investment in the second quarter of 2021 was $52.7 billion, compared to $43.2 billion in Q2 2019, per CBRE research.

With the pandemic accelerating migration out of the city, suburban multifamily has been especially strong. Not only are new Class A apartments leasing up quickly, experiencing rent increases and attracting top dollar when they go on the market, but smaller, older properties are also in demand among renters and investors.

While demographics and preference for rentals are pushing up demand and prices nationally, there are still plenty of opportunities for investing in this hot sector in Chicago's suburbs.

A changing preference for rentals

Despite headlines about the active market for suburban houses, many U.S. suburbs are now majority-renter. According to a recent report by RentCafe, over the past decade, more than 100 suburbs became majority-renter, including suburbs of Los Angeles, Miami and Washington, D.C. Suburbs in the nation's 50 largest metro areas have gained 4.7 million people since 2010, 79% renters, per U.S. Census data. More than half are under age 45, with a median household income of about $50,000.

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Over the next five years, even more suburbs are expected to become majority-renter, including Melrose Park, Riverdale and Justice.

As The Wall Street Journal reported this summer, the pandemic only accelerated changes in how and where Americans live, with suburbs emerging as the winner. The WSJ analyzed U.S. Post Office data and found that New York, Chicago, San Francisco and Boston saw hundreds of thousands more people move out than move in -- a net loss of 71% in 2020, versus a 43% net gain in new suburban households compared with 2019.

While some of the moves may be temporary, the pandemic seems to have sped up a trend already under way before 2020 of Millennials and Gen Z relocating to the suburbs. Whether it's the work-from-home or hybrid work model many offices have adopted giving them more freedom in where to live -- including the suburbs, where it's often cheaper to rent than in the city -- or other factors at play, more young people are saying yes to suburban life.

As David Beyel of Walker & Dunlop recently observed, about 23% of young people aged 20 to 39 live with their parents, compared with 20% in 2010. If 3% of those currently living with mom and dad come into the rental market in the next couple of years, that's an additional 2.1 million people.

Demand for well-located suburban assets has never been stronger

Integra Realty Resources recently reported that suburban Chicago multifamily apartments had a 97% occupancy rate in Q2 2021, the highest in four years, versus 95.1% in Q2 2020. Rents were up an average of 7% from the previous quarter, and up 8.7% from Q2 2019; in the Naperville area, rents increased as much as 14% from Q2 2019 to Q2 2021.

                                                                                                                                                                                                                       
 

New Class A properties, like Panton Mill Station in South Elgin, brokered by my company, Interra Realty, sold for record-breaking prices in 2021, with many fully or almost fully leased. Chicagoland's Class B and C properties also held appeal as options for renters unwilling or unable to pay for Class A, some with great value-add opportunities for investors.

Reflecting demand, nationally, cap rates are down and prices are up for multifamily. A cap rate or capitalization rate is the property's expected net operating income divided by current market value. It helps indicate what the rate of return will be and therefore if the investors should buy the property; a good cap rate is usually higher than 4%.

Per CBRE, investor demand is pushing cap rates down -- to an average of 5.04% in Q2 2021 versus 5.29% in Q1 2021, and from 6.93% in Q2 2021; in the Midwest, it was 5.97% in Q2 2021 -- and driving prices up, increasing 12% nationally between June 2020 and June 2021. In Chicago's suburbs, Class B and C apartments under 100 units have cap rates from 5.5% to 7%.

What to look for now

According to a 2009 study from the U.S. Department of Agriculture, there are 119 suburbs in Cook County alone, so investors have no shortage of options. That said, when it comes to investing in multifamily properties, the fundamentals of buying real estate continue to apply, including, location, location, location.

Look for properties near transit, with access to downtown and near good schools, stores, restaurants, entertainment and other amenities for a walkable suburban lifestyle.

Work with a broker who knows the submarkets and available property/housing stock or has access to off-market sales, an increasingly popular approach.

Many factors in place two years ago continue to help spur demand. This includes "coastal cash," or people from the coasts seeking Midwestern multifamily properties because of their good cap rates and prices and generally strong rent collection.

It also includes continued low interest rates and the "flight to quality," or investors selling retail or other more troubled investment types and moving to multifamily.

Locally, investors are watching increases in property taxes, but so far, they have not dampened investor interest.

As a result of rising investor demand for multifamily, funding sources also are increasing for the sector -- from private sources to Freddie Mac and Fannie Mae. Keep in mind, assets with higher vacancies or rent collection issues will face a tougher time finding financing.

In short, it's not too late to get in on the suburban multifamily boom. In fact, the pandemic has probably only accelerated a wave of moves to the suburbs -- and to rentals, making this a great time to buy or add to your portfolio.

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