ISSUES AND OPPORTUNITIES IN MULTIFAMILY PROPERTY MANAGEMENT

THE FOLLOWING IS THE WINNING ACADEMIC ESSAY FROM THE 2012-2013 REAL ESTATE MANAGEMENT ARTICLE COMPETITION FOR FACULTY.

This contest, sponsored by IREM and the IREM Foundation, is a writing competition among college and university real estate faculty to encourage scholarship in the area of real estate property and asset management. The winning essay had to include one of the 12 critical issues that now, and in the foreseeable future, is having a significant impact on the real estate management industry and its practitioners. Entries were judged anonymously by a panel of practicing real estate managers.

Executive summary

I discuss the implications of two key critical industry issues as identified by the IREM 2012-2013 Strategic Plan. While the strength and growth of the multifamily sector presents a challenge to the property management profession, it also offers an opportunity to acquire talent for long-run development. Firms that can successfully integrate these issues and opportunities are likely to thrive in coming years but will have to overcome the longstanding division between residential and commercial property management specialization. I argue that this functional separation is artificial and maybe grounded on outdated research.

Background

Since the housing market downturn, the multifamily segment has received increased investor interest. How large is this segment and how does it compare to other segments of the commercial real estate market? Where do multifamily properties tend to be located and why? Recent research published in the Journal of Real Estate Portfolio Management (Florance, Miller, Peng, and Spivey [2010]) addresses these questions.

Nationwide, the multifamily segment contains approximately 22.6 billion square feet of space, representing 27 percent of all income-producing real estate in the market, defined to include not only the major categories office, retail and industrial but also specialty property types, such as lodging and healthcare. The market value of all multifamily space as of 2009 was about $1.4 trillion, representing 13 percent of the total value of all commercial properties. Comparing the major segments of retail, office and multifamily, retail properties led with an aggregate value at almost $3.0 trillion, followed by office at $1.6 trillion, with multifamily in third place. The difference reflects the higher per-square-foot rents commercial uses command. In the aggregate, commercial real estate had a market capitalization of $10.9 trillion, almost as large as the value of all shares listed on the New York Stock Exchange ($12.5 trillion). As the IREM 2012-2013 Strategic Plan states, "The U.S. apartment sector appears to be the consistent bright spot, being energized by pent-up demand from the recession and a transition from home ownership to rental housing..." (IREM, 2011).

Moreover, multifamily properties tend to be concentrated in urbanized sections of the U.S. and especially in higher-density metro areas, exactly the same market areas as major retail and office property. Much of this pattern is due to land costs: where land is widely available and inexpensive, homeownership rates are high and the proportion of the population who rent is low. Economic growth leads to higher land values and increased density; increased demand for multifamily housing naturally results. Given that about one third of U.S. households are renters, that multifamily properties are a major category of asset should is hardly a surprise. What has changed recently is the renter profile.

RECENT CHANGES IN THE MULTI FAMILY MarketWhile traditionally apartment renters have been young adults in earlier phases of household formation, the economic downturn of 2008-2009, the capital losses experienced by many homeowners during the housing bust and the lingering high rate of mortgage default and foreclosure have expanded the renter population to include many older and middle-to-upper income households who would have, in rosier times, become homeowners.

For example, the categories of married couples, seniors (defined as those aged 65 and over) and households with incomes in excess of $75,000 per year, each now represent about 15 percent of the rental market (Harvard, 2012). This situation is unlikely to change anytime soon. Federal budgetary pressures-coupled with potential tax reform initiatives, as well as the eventual unwinding of the taxpayer subsidies inherent in Fannie Mae and Freddie Mac and ultimately higher long-term interest rates- are expected to drive up the cost of homeownership over the next decade, making rentals relatively more economically attractive.

Another trend favoring rentals is their flexibility, particularly for what economists would call labor mobility. While home ownership certainly offers benefits to individuals and neighborhoods, renters can much more easily respond to changing job market conditions when new opportunities beckon. If the employment market remains relatively weak, many households will prefer to rent to capture that flexibility and the ability to readily relocate for attractive job opportunities.

In addition to a new population of renters, there is clear evidence of pentup demand for housing based on the rate of new household formation. A total of 1,150,000 new households were formed during the twelve months that ended in September 2012, according to census data, a significant increase over the 650,000 per year average over the last four years {Wall Street Journal, 2012). Multifamily housing is thus experiencing both a growth in traditional customers as well as an expansion of its customer base.

The combination of growing demand with a limited increase in supply is the classic recipe for rising prices. Accordingly, apartment markets across the country have continued to improve over the past three years (Multi Housing Council, 2012).

DEMAND FOR MULTIFAMILY PROPERTY Management Talent

Clearly, the expanding multifamily sector will require more property managers-where will they come from? This question is related to a second issue identified by the IREM 2012-2013 Strategic Plan : talent, and the issue of "attracting, developing, and retaining a qualified workforce" (IREM, 2011). Integrating the need for new talent with the demand for multifamily property managers represents a significant opportunity for the property management industry. Multifamily property managers can learn many of the core skills essential for success in real estate management: tenant relations; maintenance and repair decision-making; negotiating with vendors; budgeting and recordkeeping; as well as marketing and prospect screening.

New hires in this market segment can learn the ropes in multifamily property management. Then, as they prove themselves and increase their training (through IREM coursework, state licensing and otherwise), some fraction will be ready, willing and able to make the transition to commercial property management. Recent college graduates are a natural choice for these entry level positions. While not necessarily a good fit for every rental community type (probably not for senior housing), recent grads are of the same generation as many of their rental market customers, familiar with internet, social media and other new marketing techniques, and eager for job opportunities that lead to a satisfying long-term careers, such as those offered in property management.

Barriers to Implementation

What are the barriers to implementing such a strategy? Traditionally, a great divide exists between residential and commercial properties, both in brokerage arena and in property management. Many, perhaps most, property management firms specialize in only one of the two segments, viewing the two as distinct businesses. This gap must be bridged. The property, the customer and the contract may differ but the fundamental product is the same: space at a particular location that meets customer needs.

Why does the division exist? The short answer is that specialization has proven important to the success of investors in real estate as an asset class. Traditionally, the majority of institutional real estate investors, including life insurance companies and pension funds, held portfolios diversified by property type. Research documented the benefits of such an approach; for example, Webb and Rubens (1987) found that over 60 percent of institutional investors diversified across property type. With the ascension of firms organized as real estate investment trusts (REITs), however, this pattern has changed. The majority of REITs specialize in a particular property type.

The Growth of real Estate INVESTMENT TRUSTS

REITs have grown exponentially in the U.S. over the last two decades. In addition to their tax-favored status, publicly traded REITs have brought stock market liquidity to the otherwise highly illiquid commercial property market. With their ready access to public capital markets, REITs enjoy considerable market clout. Moreover, success in the U.S. has fostered REIT-like legislation enabling similar structures in some 20 countries thus far, including developing economies such as Ghana, the Philippines and Bulgaria in addition to developed countries including the United Kingdom, Germany, France, Canada and Brazil.

Research suggests that ownership form matters for property performance. For example, Hardin and Hill (2009) use data from Atlanta to show that multifamily properties owned by real estate investment trusts generate higher effective rents at the property level than non-REIT-owned properties. Such studies are part of a broader strand of research that has also documented that property operating performance can be affected by owners, managers and investment strategies. REITS, in particular, represent diversified scale operators with property management skills.

WHY DO REITS Specialize?

The simple answer is that specialization appears to improve performance and shareholder value (Capozza and Seguin, 1999). This finding is consistent with broader research in the finance area that finds a penalty associated with firm diversification (Lang and Stulz, 1994; Berger and Ofek, 1995, Graham, Lemmon, and Wolf, 2002). Some readers may remember when Mobil Oil purchased the department store chain, Montgomery Ward. Did that acquisition really make any sense? In general, research in finance suggests that firm diversification into unrelated lines of business destroys value, rather than creating it.

Moreover, in property markets, there are a variety of arguments as to why specialization might produce benefits. First, economies of scale may come into play in property management activities. Fixed costs can be spread over a larger number of units, for example, and bargaining power with vendors will tend to increase for larger firms. In some market segments, particularly retail, there can be relationship effects, where a mall owner with multiple locations might negotiate with chain stores for several sites at the same time. More controversial is the theory sometimes advanced that managers have special expertise in particular property segments leading them to extract greater returns than would otherwise be the case.

Newer research, however, suggests that the benefits of specialization for REITs may be over-stated. Ro and Ziobrowski (2011) compared the returns from investments in specialized versus diversified REIT portfolios over the period 1997-2006. They find no evidence of superior performance by REITs specializing in a particular property type. Moreover, they find that specialized REITs have higher market risk, meaning their share prices decline more in down markets, as compared to diversified REITs. Given these findings, perhaps the benefits of specialization in property management are overblown, too.

Conclusions

In this article, I have brought together two key elements of the IREM Strategic Plan, the strength of the multifamily market segment and the need for the industry to acquire and develop talent. It is sometimes said that challenges are merely opportunities dressed in work clothes and a similar argument may be made about the growing demand for multifamily property managers. If the industry can overcome the longstanding and arguably misguided separation between residential and commercial property management functions, hiring programs for residential expertise may well translate into a flow of qualified employees for the commercial property management segment well into the future.

Traditionally, a GREAT DIVIDE EXISTS BETWEEN RESIDENTIAL AND COMMERCIAL PROPERTIES, BOTH IN BROKERAGE ARENA AND IN PROPERTY MANAGEMENT.

INTEGRATING THE NEED FOR NEW TALENT WITH THE DEMAND FOR MULTIFAMILY PROPERTY MANAGERS REPRESENTS A SIGNIFICANT OPPORTUNITY FOR THE PROPERTY MANAGEMEN INDUSTRY.

References:

Berger, P. and E. Ofek (1995). Diversifications Effect on Firm Value. Journal of Financial Economics 37: 39-65.

Capozza, D, and P. Seguin (1999). Focus, Transparency and Value: The REIT Evidence..

Real Estate Economics 27(4): 587-619.

Florance, A., N. Miller, L. Peng, and J. Spivey (2010). Slicing, Dicing, and Scoping the Size of the U.S. Commercial Real Estate Market. Journal of Real Estate Portfolio Management 16(2): 101-118.

Graham, J., M. Lemmon, and J. Wolf (2002). Does Corporate Diversification Destroy Value? The Journal of Finance 57: 695-720.

Hardin, W. G. and M. D. Hill. (2009) Ownership Structure, Property Performance, Multifamily Properties and Reits. Journal of Real Estate Research 31(3): 285-306.

Harvard University (2012). The State of the Nations Housing 2012. Cambridge, MA: The Joint Center for Housing Studies at Harvard University.

Institute of Real Estate Management (2012). Strategic Plan 2012-2013.

Lang, L. and R. Stulz (1994). Tobins Q, Corporate Diversification and Firm Performance. Journal of Political Economy 102:1248-1280.

National Multi Housing Council (2012). Quarterly Survey of Apartment Market Conditions. Washington, D.C.

Ro, S. and A. Ziobrowski (2011). Does Focus Really Matter? Specialized vs. Diversified REITs. Journal of Real Estate Finance and Economics 42: 68-83.

Wall Street Journal (Robbie Whelan, author) (Nov 7, 2012). More New Households Sprouting Up.

Webb, J. R. and J.H. Rubens (1987). How Much in Real Estate? A Surprise Answer. Journal of Porfolio Management 13: 35-43.

U.S. Census Bureau (2010) Survey of Market Absorption of Apartments 2009.

By Michael LaCour-Little, Ph.D.

BY MICHAEL LACOUR-LITTLE, PH.D., (MLACOUR-LITTLE0 FULLERTON.EDU) IS PROFESSOR OF FINANCE & DIRECTOR AT THE REAL ESTATE AND LAND USE INSTITUTE AT CALIFORNIA STATE UNIVERSITY-FULLERTON IN FULLERTON. CALIF.