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1031 Tenants in Common Apartment Investing
A popular choice among real estate investors seeking replacement property for a 1031 exchange is apartment properties owned as Tenant-in-Common. As a Tenant in Common apartment owner you own an undivided fractional interest in a property and share proportionally of the net income, depreciation write-offs, and potential growth. Tenant-in-Common interests allow the smaller real estate investor to buy interests in institutional quality, apartment properties with a minimum investment as low as $100,000 on some properties.
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The outlook for apartments
Why Apartments can Provide Steady Rent
The Cyclical Outlook for Apartments
Implications of "Generation Y" (twenty somethings) on Apartments
Impact of Recent and New Immigrant on Apartments
TIC Advisors is a 1031 exchange Company specializing in 1031 exchanges into tenants in common replacement properties. It is our commitment to empower accredited investors with valuable information to educate and assist them with making informed 1031 exchange investment decisions.
The outlook for apartments
Three major demand drivers are possibly turning around as the economy improves: job growth appears to be accelerating; the number of twenty-somethings, the prime renter age group, is growing; and, interest rates may be finally heading up, making it more difficult for renters to move into homeownership.
Apartments: Steady Rent Growth Potential
Apartment rents are the only one of the four property types to grow in real terms over time. They are also appear to be the least volatile. They're income generators, with relatively little year-to-year variation, and property values tend to rise gradually but consistently. This makes apartments core portfolio investments.
Structural trends point to continued long-term performance for apartments. The "echo boom" or "Generation Y" (the children of the baby boomers) are just entering the prime renter age group. The urban renaissance in several central cities is attracting many young professionals and empty nesters to these locations.
The downsides to investing in apartments are more cyclical in nature. First of all, current pricing is high. Apartments have had the biggest cap rate compression over the past few years, and there are no shortages of buyers. Finding attractive yields in strong markets is challenging. Second,
supply is a concern in many - generally non-coastal -markets with weak fundamentals. Even vacancy rates in the double digits in some markets aren't enough to squelch development capital. Higher interest rates will hopefully tamp down some of this construction and allow imbalanced markets to find their footing, but until that occurs, new building will prolong the period of soft rental rates and subpar occupancies.
The Cyclical Outlook for Apartments
Since early 2001, apartment demand has been negatively impacted by two major factors. First, it had to contend with major job losses.
When people lose their job, they eventually end up moving back home or doubling up with friends. Second, generational low mortgage rates enticed higher-end apartment dwellers to finally move-up to homeownership.
In addition, apartments have had to deal with long-term unfavorable demographic trends, with the prime renter age group (age 20-29) having shrunk over the past two decades. All three of these forces now may be poised for turnarounds as the economy rebounds, interest rates begin to head up, and the echo boomers come of age.
The poor economy and low interest rates caused apartment demand to turn negative in 2001 and 2002, the only down years since 1980. This negative absorption, along with continued construction, drove the apartment vacancy rate up from a very low 3.1% at year-end 2000 to a peak of 7.1% in the first quarter of 2004. However, it looks like conditions may be changing. Absorption was 37,000 units in the second quarter of 2004 and 33,000 units in the third quarter. As a result, the vacancy rate fell to 6.6%.
This recent reversal is due to a rebound in the drivers of apartment absorption. In the last three quarters, the nation finally experienced sustained employment growth, following ten quarters of job losses. Job gains quickly translate into increased apartment demand, as evidenced by absorption in the second quarter. Interest rates are also higher than they were a year ago, although the upward trend has been more volatile than expected.. If interest rates rise, it will slow the transition to homeownership. It should also eventually slow the construction of new units.
The turnaround in the key drivers of apartment demand will effect absorption in 2005 and beyond. Construction may also begin to slow. Major metropolitan areaswith supply constraints and low housing affordability are still the best long-term bets for multi-family housing.
Implications of Generation Y on Apartments
2004 population distribution has two bulges, the Baby Boomers (born 1946 to 1964) who are currently between the ages of 40 and 60 and their children who make-up Generation Y (born 1980 to 2000), currently between the ages of 5 and 24. To put this in perspective the size of the Generation Y cohort is 82.3 million people, which are larger in current size than their Baby Boomer parent's cohort, at 81.0 million. In addition, Generation Y is 35.8% or 21.6 million people larger than Generation X (born 1965 and 1979) the 60.6 million person cohort born between Generation Y and the Baby Boomers.
Assuming the average age of a person entering the workforce is twenty-two (22), the leading edge of the 82.3 million people in Generation Y moved into the labor force in 2002 and will continue through 2022. More specifically, over the next five years, 33.3 million people from Generation Y will start working, which in turn will create approximately 10 million new RENTER households! Households where the head of the household head is between the ages of 15 and 34 have a much higher propensity to rent housing. To put into perspective the magnitude Generation Y's impact on apartment, the approximately 10 million renter households Generation Y will create over the next five years, nearly equal to all of the renter households Generation X generated during the ten years ended 2000.
What does Generation Y mean for the multifamily sector? First and foremost, Generation Y may possibly produce demand for apartments comparable to that experienced in the 1970 and 1980's. In addition, based on purely anecdotal evidence, it appears that Generation Y will live in apartments longer than their predecessor generations. Because of financial constraints and to a lesser degree fiscal conservatism, they may be less likely to choose apartments at the upper end of the rental spectrum. Finally, they will focus on quality of life rather than quantity of life, choosing to live in technology friendly apartments closer to urban and employment centers in more ethically diverse neighborhoods.
Impact of Recent and New Immigrant on Apartments
Immigration into the US has in many ways been responsible for supporting the multifamily sector over the past ten years. Generation X, the source for traditional twenty-something apartment residents through the late '80's and 90's was more than twenty million people smaller than either the Baby Boomers or Generation X. As a result, it has largely been the 15.8 million immigrants who have come to the US during the past twelve years that permitted the multifamily business to flourish. According the Center on Immigration Studies, during the 90's, 86.7% of the United States' population growth in any given year resulted from mass immigration and the children born to U.S. immigrants. Looking forward, this demographic continues to be of the utmost importance for the multifamily sector. Often underestimated, the immigrant population is rarely catered to by institutional multifamily owners, yet immigrants hold perhaps the single largest opportunity anduntapped market for apartment owners.
According to the US Census, in 2002 32 million people, or 12% of the US population were foreign born.
Recent immigrants, those who have arrived in the US since 1990 ("Recent Immigrants") present some potentially favorable demand characteristics for apartments. Recent Immigrants represent 49% of all US immigrants and arrived at an annual rate of 1.3 million per year. This represents 5.1 million households over the past twelve years, approximately 3.3 million of whom live in apartments. During the 1990s, the United States admitted the largest number of immigrants in its history.
The Census data indicates that over the longer term, US immigrants tend to assimilate into the larger population and within twenty years of arriving in the US, have home ownership rates that are comparable to the US population as a whole. According to the US Census Bureau, baseline immigration for the next ten (10) year ranges from 1.3 million to 1.7 million per annum on the high side. An estimated 1.65 million new immigrants per year, which translates into approximately 1.75 million renter households over the next five (5) years. Given George W. Bush's current policy initative, the "guest worker plan", new immigration into the United States, legal or otherwise may increase. Bush's plan may be attractive for businesses because it allows employers to hire workers for low-wage jobs without having to break the law or worry about the INS. In addition, it would allow many recent immigrants to pay taxes, and more importantly for apartment owners demonstrate and report actual income. In the event that Bush is not re-elected, US immigration policy is not anticipated to markedly change because historically minorities represent a very large voting block for the Democrats. Regardless, the profile of these new immigrants will be very similar to recent immigrants, with the vast majority being renters.
What does this mean for the multifamily sector? For the most part, Recent Immigrants are Necessity Renters, rather than by choice. Statistically, they stay in apartments significantly longer than the average US apartment renter, which reduces the cost of turnover. Given income levels, they are not typically drawn to Class A, luxury properties, but instead B and C properties in established infill neighborhoods. Because they come from urbanized metropolitan areas, this is where they prefer to live upon arrival in the US.
They look for value in housing, focused primarily on nominal rents. They have larger families and need more bedrooms and larger units. Given their higher average number of children, they need more family oriented communities. Finally, Recent Immigrants are community-oriented and are more likely to cluster in areas with people of similar culture and background. For owners of properties in submarkets with a high percentage of Recent Immigrants, this presents apossibility to attract and retain this demographic through activities targeting their interests.
Sources:
Edited National Apartment Overview; Finlay Partners June 2004
U.S. Real Estate Investment Outlook 2005; CB Richard Ellis Investors/US Advisor, LLC:
