Apartments in 2024: A Critical Turning Point

In 2024, many apartment investors will grapple with high costs, leading to a mix of property retention and potential sales. The rise in interest rates since March 2022 has unsettled investment plans, with a decrease in buyers willing to pay previous high prices and sellers reluctant to lower their prices due to ongoing high interest rates.

A shift may occur in 2024 as numerous owners with short-term loans approach their maturity dates. Difficulty in securing new loans to cover existing debts could force many to sell, while some companies are eyeing investments in distressed apartments.

Brennen Degner, CEO of DB Capital Management, warns of challenges for those facing imminent capital events or loan maturities. Meanwhile, other investors are bracing for a tough year, hoping to manage with limited damage, even as rent growth struggles to match escalating operational costs.

Survival Mode Until 2025?

Investors Management Group isn’t actively looking to buy or sell apartment properties in 2024 but remains alert for unexpected opportunities. Neil Schimmel, CEO, doesn’t expect much transaction activity in the next 6-12 months. Instead, he’s focused on boosting income from his 22-property portfolio through resident retention, emphasizing capital preservation.

In 2023, U.S. apartment property investments fell to $97.4 billion, down 64% from the previous year. With the average cap rate at 5.2% and most investors seeking rates above 6%, transactions have slowed, especially due to high permanent financing interest rates.

Meanwhile, DB Capital Management made progress in October, intending to acquire properties in Texas, Colorado, and Utah, with cap rates of 5.25% to 5.5%. These plans, however, faced setbacks due to rising long-term interest rates.

The yield on 10-year treasury bonds hit over 5% on October 19, a significant increase from 4.4% the previous month and a substantial jump from less than 2% in March 2022, before the Federal Reserve’s interest rate hikes to combat inflation.

The deals DB Capital Management had lined up collapsed. The firm still aims to acquire properties in 2024 but is waiting for sellers to agree to cap rates between 6% and 6.5%, despite a recent moderation in long-term interest rates. “The inherent risk and volatility need to be factored into the deal,” notes Brennen Degner of DB Capital.

Revitate Buys Off-Market

Revitate Cherry Tree focuses on acquiring apartment properties in the Midwest with cap rates around 6%, favoring off-market deals with motivated sellers. As of December, they were planning to purchase three to four properties, reviewing roughly 100 to select six to eight viable options, according to Chris Marsh, a general partner at the firm.

Their target properties are often older and smaller, like the 96-unit Tuscany Bay in Lawrenceburg, Indiana, which they acquired at a nearly 6% cap rate. Revitate aims to buy properties at cap rates similar to its low-interest rates from Fannie Mae and Freddie Mac lenders.

Meanwhile, other investors like Excelsa Properties are also adapting their strategies. Excelsa, for instance, purchased Concord Park at Russett in Maryland by assuming an existing low-rate loan. They plan to be more active in 2024, focusing on buying rather than development due to the high cost of land and materials.

Challenges in refinancing are leading to opportunities for firms like Asland Capital Partners, which is looking out for undervalued properties. As of late 2023, MSCI classified $7.5 billion worth of apartments as distressed, with an additional $65.7 billion potentially at risk. This situation might open up chances for partnerships to alleviate debt, despite some banks’ reluctance to enforce sales.

Gray Capital Prepares for Distressed Property Investments

In December, Gray Capital was gearing up to make its initial investments in distressed apartment properties. CEO and co-founder Spencer Gray anticipates closing investments on three overleveraged properties in early February. The firm is currently evaluating about a dozen similar deals.

Gray notes the lack of significant competition for these transactions. Many of these properties, valued under $50 million, require relatively small amounts of preferred equity, not typically attracting large institutional investors.

The process has given Gray Capital insights into the diverse challenges these properties face. The situations vary widely, from a newly developed and fully occupied Florida property struggling with a high interest rate on its construction loan, to a 1970s complex in Dallas and a group of 1980s and 1990s buildings in Florida.

However, Gray points out that some properties are too troubled to be salvaged by additional investment. Poor management has led to situations where even an injection of capital wouldn’t be enough to turn things around, with some cases being particularly severe.

2024 Sees Few New Apartment Developments

This year, while many developers will complete existing apartment projects started before the interest rate hike, it’s unlikely that many will begin new constructions in 2024.

CP Capital, which initiated seven new apartment projects in 2022, found it challenging to start new developments as interest rates increased in 2022 and 2023. The firm didn’t begin any new projects in 2023, choosing instead to focus on its current portfolio.

Several planned projects for 2023 were either delayed due to typical issues like permits or canceled due to the economic climate. “The projects weren’t viable anymore under the current market conditions,” notes Logan King, investment director at CP Capital.

CP Capital intends to start two new apartment projects in early 2024, but has no other construction plans for the rest of the year, although they are open to opportunities. King notes, “There will be very few new developments in 2024, but we’re optimistic about the sector’s long-term prospects.”

Across the U.S., developers are finding it hard to secure financing for new apartment projects, with a 40% decrease in new constructions in the first three quarters of 2023 compared to the previous year, as per MSCI. Investors like Excelsa Properties are now focusing on purchasing existing apartments rather than developing new ones, as the costs for development remain high.

“Buying a new property and managing its lease-up is a better risk-adjusted value than starting new construction,” says Excelsa’s Fletcher.