Sucker's Rally or Starting Point?

The market as a whole is beginning to see small, positive signs. The private sector is starting to add jobs, even if they are all McDonald's burger-turners. In some areas, where job creation has been brisk and multifamily (MF) is starting to thrive, REIT's involved with MF are starting to push rents aggressively beyond the normal 3% CPI increase. For some, this is signaling that now may be the time to start developing more properties. Sure, this may be a prudent starting point to help capture local markets, or it may be the continuation of an infamous sucker's rally.

At the company where I work, "Davidson," a lead developer recently came to speak with me about the "opportunity" to develop a 300+ unit project. After surveying the market, it all sounds very promising: only one new class-A property built in the last 8-10 years, and a relatively well-off area with high household AGI's, with metro access all over. The only catch is that a competitor's class A property built in the last 3 years is barely meeting industry benchmarks in a time when REIT's are pushing rents to pump up the bottom line.

When confronted with this factoid, the developer told me, "We are trying to capture the market; it's going to be urban and the newest thing out here." I guess nobody informed these developers here and all over the country that the attack of the "zombie" foreclosures is about to happen any minute. Thousands upon thousands of shadow foreclosures are going to continue to depress rents for those MF REIT's trying to capture the class A and hi B dollar. Step into the shoes of the typical double income no kids (DINK) spending $1800-$2400 on a 1,300 square foot apartment, or spend $1,500-$1,900 on a 30 year note (with record low interest rates) on a REO from the bank. Asking for class A rent in a market where class A sites compete with cheap investment property rental rates and very cheap foreclosures doesn't sound like a winning combo.

With the larger economy in focus, is developing property or even buying property a really good idea right now? The federal government's actions in the housing market via the $8,000 tax credit in 2009 might have impelled first time buyers into the market. Coupled with the feds pumping more than 1.5 trillion dollars into the marketplace, they may have created one of the most devastating sucker rallies ever concocted. Do first time home buyers really want to hear that the market has another 20 % loss til they reach bottom? For the REIT developer, having the false confidence of record amounts of liquidity in the market doesn't mean it will be there fifteen months in the future. The people suckered into "Trump University" think developing now is a bad idea. Now that the banks have recorded profits and been exceedingly tight with capital, it doesn't really sound like a time to take a gamble.

Let's remember the cardinal rule of development: "Developers don't get paid unless they develop something." When the smart money is sitting on the sidelines, maybe we should listen.

-The Inside Associate