Apartment Owners & Operators Are Facing Rising Costs, But Staying Ahead in NOI

Last modified on March 3rd, 2022
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The buzz about apartment industry property transactions is nationwide and there’s no signs of it slowing.

The low-interest rate environment and exploding demand for rental living can be found in all asset classes and in nearly every market.

Sure, some caution is creeping in as investors await the imminent decisions from the U.S. Federal Reserve about its playbook on dealing with inflation that hit 40-year highs in February while it and many others have their eyes on rising geopolitical tensions in Ukraine.

And while the supply chain woes may have recovered slightly, they are certainly not over. Order backups for construction materials and many items from appliances to flooring are causing delays and kinks for development and value-add players.

Fortunately, rent growth has followed and continues to climb. A majority of markets are seeing at least double-digit year-over-year gains and many in the most desirable sunbelt areas are experiencing unprecedented boosts of more than 30 percent.

As for available capital, “there was too much even before the pandemic,” one said, “and there’s even more now.” Simply put, there is way too much money chasing way too few deals.

Technology, New Strategy Makes a Difference

Apartment operators are busy adjusting their strategy, considering new investment strategies such as building types and are taking better advantage of technology that can streamline and improve their operations. Small- and medium-sized operators spoke to us about what they are experiencing.

In what always seems like one of the most volatile areas for housing, Vince Korta, COO and CFO, 2B Living Property Management, operates 3,000 units in the San Francisco Bay area.

Oakland had been building a lot before COVID, but then it hit and created a perfect storm and pricing is not as strong as it is in San Francisco, he said.

“During the height of the pandemic, pricing wasn’t hit that hard, but transaction volume was lower,” Korta said. “It was a bit odd that rents took a hit, but not pricing.”

Labor and materials costs are up, “but they don’t play a large role in pricing unless it’s for new development,” he said. “Most properties we’re involved with are existing properties where those costs aren’t a big factor.

Rushing to Get Deals Done

Driving prices in the Bay Area is demand, and a strong economy and good jobs numbers. There’s also a lot of capital available – the twin drivers of real estate pricing, Korta said.

“Everyone is looking toward the Fed and its soon raising interest rates,” he said. “Buyers and sellers now are rushing to get deals done, which is driving prices up for the short term. This will continue in Q1 and maybe Q2. It’s actually the opposite of what you’d think would be happening given the rising-rate environment we feel like we’re in.”

Korta said he’s seeing some greater focus for investors on student housing and single-family rental homes. “Funds are simply chasing yield and they are seeing more yield on properties that are near tier 1 universities compared to multifamily.

“The current climate is certainly helping the sellers, but it’s also benefiting those who have knowledge of the market and strong relationships. Sellers are probably not going to reinvest their money in this market. So, they will need to find another market, and there, they’ll need to establish new, strong relationships with the operators there.”

Concessions are Burning Off

New revenue streams in multifamily are few and far between, Korta said. “Concessions are burning off and owners are trying to get ahead of that,” he said. “To improve revenue, simply being a good landlord makes a big difference when it comes to retaining residents and keeping collections high. 

“A year or so ago, we saw this in spades when the work-from-home craze hit and people moved out of the Bay Area. You’ve got to get the blocking and tackling right. For so long, owners here always knew there’d be another person to take the place of a renter who was leaving.”

But then, it wasn’t necessarily the case, he said. “Now your marketing and advertising have to be top notch and your online presence/reputation matters as renters have become savvier,” Korta said. 

He said that today, he’s mostly back to pre-pandemic rents, except maybe in parts of Oakland, given the greater, newer supply.

Tech Making a Difference

Technology is definitely helping us operate more efficiently, Korta said. “Tools such as revenue management have been around for a good while, and proptech today is proliferating our area. 

“If you aren’t using advancements in tech, you’ll be left behind. Technology is our backbone so that we’re able to do more analysis in our decision-making about work-order flow, the time it takes to turn a unit, time a unit sits vacant. Having these abilities that help our staff work more efficiently is huge, given the rising cost of labor in general.”

Daniel Morgan is Managing Principal, Real Estate, at Marterra Real Estate. In Southern California, multifamily sale prices have risen dramatically, he said.

Pre-COVID, a four-unit property in a neighborhood Marterra has a large presence in sold for $335K per unit. A similar building in the same neighborhood just sold for $465K per unit.

Material and labor costs are up significantly in the past two years as well.

He renovated a unit three years ago, in that same neighborhood, for $18,000 and did the same scope on a model match unit recently for $35,000. That’s a 94 percent increase. 

“I believe the differential is due to supply chain issues, which causes price increases that are outside of typical inflation,” Morgan said. “Unfortunately, the costs associated with supply shocks are likely going to be pretty sticky, even once supply chain issues are resolved. I think if supply chain issues weren’t a factor, we would likely still be paying about $28,000 for the same renovation.”

Remodeling Costs Spiking

However, when Marterra remodeled this unit three years ago, it was able to lease the unit for $2,600. Today, it is renting the same unit for $3,250 – up 25 percent in just 3 years.

“We are having a hard time buying fully marketed properties these days, as other buyers appear to have exchange money or to be underwriting substantial further rent growth,” Morgan said.

Despite raising interest rates, cap rates are staying low, likely due to the fact rent increases are outpacing operating cost increases, he said.

One way he has been able to make properties work is through buying properties that have an opportunity to build Accessory Dwelling Units or ADUs on excess land. 

“We can typically build ground-up, new units with a one car garage for about $200,000, which old value-add units are selling for $450,000; that is a pretty healthy spread,” he said. “We are building to mid-teen return on cost.”

Other than executing on ADUs, some of our best returns are coming from improving operational efficiency more than anything else, Morgan said.

Marterra is adding new revenue streams (pet rent, RUBs and laundry) as well as finding savings in the operating expenses.

Even in these sometimes unsteady financial times, apartment operators who use technology to help crunch their numbers and who seek alternative strategies are staying ahead in the real estate game.

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