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Investors Eyeing Secondary Markets, Workforce-Level Apartments As Downtowns Overbuild

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The high-end apartment markets in the downtown cores of many major U.S. cities are experiencing an oversupply that makes it difficult to raise rents, and several top investors are now shifting their money to secondary cities, suburban areas and the workforce housing segment to find opportunities for growth. 

Greystar's Bob Faith, Walker & Dunlop's Willy Walker and Starwood's Barry Sternlicht
Greystar CEO Bob Faith, Walker & Dunlop CEO Willy Walker and Starwood CEO Barry Sternlicht

"We focus on [Class-]B's not A's," said Starwood Capital CEO Barry Sternlicht, speaking Wednesday at Bisnow's Multifamily Annual Conference East. "We don't own anything in New York, Los Angeles or San Francisco. We bought into markets where we thought rents would grow." 

Starwood is one of many top investment firms shying away from the nation's priciest cities and passing on the Class-A segment in favor of more affordable apartment markets. 

PGIM Real Estate, the investment arm of Prudential Financial, announced Tuesday it acquired three multifamily portfolios in Raleigh-Durham, North Carolina, Charleston, South Carolina, and Ponte Vedra Beach, Florida, for nearly $600M. The portfolios, bought in partnership with Atlanta-based Carroll Organization, consist of workforce-level housing properties, part of a strategy the JV is pursuing.

Aronson's Chris Vasquez, PGIM Real Estate's Susan Mello, Freddie Mac's David Brickman, Pender Capital's Zach Murphy, Broadstone's Chris Czarnecki and LGA Capital's Jason Gerstein
Aronson's Chris Vasquez, PGIM Real Estate's Susan Mello, Freddie Mac's David Brickman, Pender Capital's Zach Murphy, Broadstone's Chris Czarnecki and LGA Capital's Jason Gerstein

The PGIM-Carroll JV has acquired more than $2B of workforce housing in the southeast U.S. and Texas since December 2017. PGIM Managing Director Susan Mello said the acquisitions show that investors see more opportunity in the value-add Class-B space than in ground-up apartment development. 

"We're going to be opportunistic on the development side, though it's gotten expensive with construction costs rising and labor shortages and interest rates going up," Mello said. "It is driving capital to look for new opportunities, maybe new niche strategies that they haven't been going to previously ... It's going to go into value-add renovation plays or workforce housing or things like that."

LGA Capital Managing Principal Jason Gerstein also said rising construction costs and interest rates have made ground-up development harder to pencil. He said development is most difficult in downtown markets where new projects have the most competition from a large amount of supply delivering, so he is looking elsewhere.

"There's a concern about overbuilding in the urban core," Gerstein said. "We're looking to invest in ground-up construction in that first or second ring outside the urban core where you're still seeing the demand drivers and job growth and you can build without competing with all the cranes. That's something the investors are looking for, and it's still financeable and produces cash flow." 

Freddie Mac President David Brickman said he has seen a shift of investors across the U.S. placing more attention on the workforce housing space, rather than Class-A apartments. 

"We take a lot of pride in seeing how much money has moved into workforce housing," Brickman said. "That's something that we've particularly focused on and tried to help incent capital to move to, because we see strong opportunities there." 

CBRE's David Webb, Bridge Investment Group's Jonathan Slager,  TruAmerica Multifamily's Matt Ferrari, Pantzer Properties' Jason Pantzer, Boland's Dave Pirkey and FCP's Jason Bonderenko
CBRE's David Webb, Bridge Investment Group's Jonathan Slager, TruAmerica Multifamily's Matt Ferrari, Pantzer Properties' Jason Pantzer, Boland's Dave Pirkey and FCP's Jason Bonderenko

Pantzer Properties co-President Jason Pantzer said institutional investors have become more interested in multifamily as an anchor to a real estate portfolio, providing a more stable cash flow than other asset classes. 

"Capital flows have increased dramatically," Pantzer said. "I think multifamily — particularly Class-B and C apartments, which is the workforce housing sector — has gotten an extraordinary amount of attention."

But as more investment flows into the workforce sector, deals get more competitive and it it can be harder to generate the same returns on projects. 

"A couple years ago, the value-add deals were in the mid-to-high teens, it's more in the low-to-mid teens now," said FCP Senior Vice President Jason Bonderenko, referring to the percentage of returns. "As more capital comes into the space, to stay competitive while still underwriting reasonable assumptions, you've had to lower your return expectations if you want to continue investing."