Phoenix Multifamily Braces For May, As Investors Hunt For Deals

The Phoenix metropolitan area's multifamily real estate market had been on a decade-long hot streak until the coronavirus arrived.

“The second-quarter numbers are going to be bad and nothing can change that fact, so now all we can focus on is what to do with the new normal,” Colliers International Arizona Research Director Thomas Brophy said.

Colliers data shows that Phoenix’s Maricopa County was the fastest-growing county in the nation for four years in a row, leading to a multifamily supply shortage of nearly 33,000 units.

“The multifamily market in Phoenix has been on fire and the super low cap rates continued to draw investors into the market,” Phoenix Real Estate Investors Association President Chris Eymann said. “With the onset of the virus, who knows where the market goes from here.”

Prior to the onset of the coronavirus, occupancy rates were at 95%, making the first quarter of 2020 the 32nd consecutive quarter that occupancy has been above the 20-year average. Brophy said 91% to 93% is the ideal occupancy rate for the market.

“Before the virus hit, increased per unit costs led to higher retention rates, that held within the 55% range, 5% above previous market highs," Brophy said. "With people being on lockdown, we have seen retention rates between 60 and 70% for March and April, so turnover has been limited during these uncertain times.”

One benefit that made the market stronger after the 2008 recession? Multifamily builders offered more on-site features to duplicate the first-time homebuying experience, including washer and dryer units and stainless-steel appliances, in order to attract renters.

“It was the best thing developers ever did to keep tenants happy and extend their time period as a potential resident for up to an additional 10 years,” Brophy said.

“Now that the industry has had to stop on a dime once again for a monumental shift, we may see changes in floor plans with a society that may have long-term telecommuting in its future,” he said. “How do we respond to that, especially if we continue to see an influx of new residents coming to the valley?”

Phoenix real estate professionals also have a cautious optimism that new residents from high-influx markets like Chicago, New York City and Southern California will continue to arrive.

“We still like areas poised for long-term growth, including Arrowhead, downtown Chandler and downtown Gilbert,” ABI Multifamily Vice President Patrick Burch said.

“We also like Arcadia, where we just closed a deal for a 13-unit, 1.6K SF individually owned condo development for $3.7M," he said. "The buyer was a long-term holder from out of state that had a lot of questions in this changing market, while having to put up more cash than they initially thought, but we completed the deal.”

The Phoenix multifamily market is often split between the 20-unit and smaller product, which depends more on financing deals with local and regional banks, a new dynamic that has yet to sort itself out in the new post-coronavirus financial environment.

“Every multifamily deal I see is asking for more time, while we have also had multiple deals fall out of escrow,” Burch said. “Borrowers want to get deals done at the same rates as before, and we are seeing eight- and 12-unit deals being stuck with traditional fixed rates. No jumbo residential financing is even available.”

With the average asking per unit rate rising from $700 to $1.1K from 2009 to 2019, according to Kidder Mathews’ First Quarter 2020 report, large-unit transactions have dominated the Phoenix market, especially Class-A deals in affluent suburban areas.

"The short-term pain in the market will not be as location-based as it will be with owners and operators who have cut corners on-site and in communicating with their tenants," Kidder Mathews Senior Vice President Karl Abert said.

"Single-family homes could also take a hit, opening up the multifamily market even more. We could also see a demographic shift to more studios and one-bedroom units as people plan to work from home even more," Abert said. 

Multifamily units in affluent neighborhoods in the east valley are still in demand. On April 10, the sale of Park Place was announced, along with a $63.5M price tag for the 230-unit Class-A multifamily community located in the affluent suburb of Fountain Hills, located just east of the highly desirable Scottsdale market.

Kidder Mathews’ First Quarter 2020 report shows a sizable 10-year increase on average sales price per unit, from $60K per unit in 2009 to $150K in 2018, and a small decrease just below $150K for 2019.

That long-term increase in per unit pricing has made multifamily a popular investment position in Phoenix, one that may be able to withstand a large downturn from the coronavirus, with one possible exception: high-rise buildings.

“Now that people are over the shock factor and activity has picked up over the last three weeks, we are seeing that renovations may be a better long-term play than high-rise buildings, because of all the additional living factors like the close proximity of elevators and close living quarters,” ABI Multifamily Vice President John Klocek said.

“Renovations provide more tangible profit margins while new projects are on hold. The fix and flip units or renovate and hold units are where people want to be during uncertain times like this.”

Klocek is not the only industry expert that sees issues for the high-rise development market in Phoenix.

“The Phoenix market is just now opening up to high-rise developments and we do not know how this will affect those buildings,” Eyemann said. “The saving factor may be the continued influx of new residents with our shortage of supply.”

But the market slowdown provides opportunity for multifamily projects to come online with the proper financing and terms. Unit sellers, however, may have less opportunity in the post-coronavirus market.

“Buyers are looking for discounts, so if you have to sell right now, be prepared to take a haircut and identify if you are selling based on panic,” Brophy said. “Even if the number of renters from new residents only increases 3% over the next year or two, that is still an additional 75,000 to 100,000 units needed for inventory."

Overall, most of the people interviewed for this story were optimistic that Phoenix is better prepared to face this recession than the last one.

“I do not know what May is going to bring, but at least the Phoenix market has not been as horrific as other parts of the country,” Brophy said. “We have missed out on our peak leasing season, which is February through May, but we have not missed out learning lessons from this scenario that could make our market stronger in the long term.”