Will This Year See Continued Apartment Success?
Published Expert Article
by Andrew Monette
Senior Advisor at Pinnacle Real Estate Advisors
Over the past few years, the statement heard at nearly every real estate conference was, “We’re somewhere in the ninth inning, and we’re not sure how many extra innings there will be.” This thought was on everyone’s mind following the tremendous growth the Colorado real estate market experienced following the Great Recession. After a record year in 2016, many real estate professionals thought it would not be possible to continue the trajectory, and a large majority of professionals felt 2017 was destined to be the year of normalization. To a degree, that theory was correct as sales volume in 2017 was slightly less than 2016. However, 2018 proved to be the big year where multifamily investments would cool down. According to CoStar, when searching multifamily properties in the five-county metro Denver area between five and 200 units, there were 212 sales in 2018 compared to 280 sales in 2016. With 241 sales recorded, 2019 was a year that saw a rebound in transaction volume and Denver yet again was attracting a wave of investors ready to place capital.
Favorable interest rates impacted steady transaction volume during the last year. Looking back, we now are able to identify a direct correlation between volume and the Federal Funds Rate, which has declined for the past three quarters. Although the Federal Funds Rate sat at 1.51% during the first-quarter 2018 and real estate investing was strong in Colorado, it was apparent that no one knew when the wave would start to break. Starting in second-quarter 2018, there were five consecutive quarters of rate increases, which directly impacted the sales volume for multifamily properties five to 200 units in the five-county metro Denver area. As rates increased throughout 2018, transaction volume in the third and fourth quarters dropped 33% and 18%, respectively, compared to the second quarter. As rates increased, lenders and buyers became more scrutinous, and deals were becoming harder to pencilout. Although sales volume (in dollars) was up, transaction volume stayed relatively stagnant between third-quarter 2018 and second quarter 2019.
Contrary to many professionals’ projections, the Federal Funds Rate began to decrease during the second-quarter 2019. The preceding three Federal Reserve meetings concluded with repeated rate cuts, dropping the Fed Funds Rate back to levels seen in 2018, and investment activity rebounded. Fueled by incredibly low interest rates and the typical end-of-the-year rush, there were 70 recorded transactions in the fourth quarter, according to CoStar. The impact of low interest rates on transactions is two-fold: as buyers’ returns improve, the ability to be more aggressive on purchase price entices sellers to look harder at offers. When considering what to do next, sellers now are better positioned to take advantage of low interest rates when they are in a buyer’s position.
Looking back, we all knew the change in the market would come, it was just a matter of time. It seems that whether you agreed or disagreed with the Federal Reserve’s actions, the rate drops that took place over the past year had a positive impact on the Denver multifamily real estate industry. Looking at the data, confidence seems to be restored in many people’s minds. Buyer competition is high, and it seems we have entered the realm of a seller’s market again. With so much capital waiting to be deployed and with interest rates at relatively historic low levels, many anticipate 2020 to surpass the transaction volume of 2019. If the theory holds true, we should see a healthy volume of sales throughout the year and, with record prices continuing to be set, 2020 could be the best year of real estate since 2016.
Although this sounds like a great scenario, we undoubtedly have entered uncharted territory regarding interest rates. We can all identify the short-term benefit of having another banner year in terms of real estate transactions but looking forward, there likely will be long-term unknown repercussions that remain to be seen.
Featured in CREJ’s February 2020 Multifamily Properties Quarterly