There is one U.S. county that has largely outpaced all the rest before, during and after COVID-19. It’s Maricopa County, which includes the Phoenix metropolitan statistical area (MSA). The county was home to about 4.2 million residents in 2012. Today, that number stands at more than 5 million, per the U.S. Census Bureau.
Prior to COVID-19, much of that migration was tied to job growth, notes Christian Garner, president and CEO of Avanti Residential. “Phoenix over the past 10 years has greatly diversified through industries like education, medical and technology,” he says.
In fact, the county’s annual job growth of 2.8 percent over that 10-year period generally outpaced the state and the nation, according to the Arizona Office of Economic Opportunity (OEO). This number includes the pandemic years of 2021 and 2022 when job growth in Maricopa County increased 4.2 percent annually, boosting nonfarm payroll employment by 326,000 during the period.
The pandemic also brought nearly 140,000 new residents to metro Phoenix. And that in turn led to the development of more housing, including apartments.
“After years of middling confidence in housing market reliability following the Great Recession, there has been a massive increase in the number of units [delivered] and multifamily housing permits [issued] in the last handful of years,” says Chris Camacho, president and CEO of the Greater Phoenix Economic Council.
“The annual number of multifamily housing permits ranged from 7,000 to 10,000 for most of the century, with the exception of the Great Recession. But starting in 2019, the number of permits broke above the 10,000 mark. In 2022, it rose above 20,000 permits issued.”
Signs of Overbuilding
Camacho notes more than 10,000 multifamily permits have been issued year to date through July. It seems everywhere you look around the Phoenix MSA, there is another apartment start or project that has been greenlighted. This includes 1,890 units approved by the Phoenix City Council in September for three separate projects: 155 units by RAS Developments; 250 by Trinsic Residential; and 1,500 by Petree Properties.
The nearby Tempe City Council also ap- proved 500 additional units during a September meeting that served as a first hearing for an- other 1,000 units that have yet to be approved. The new approvals were for the Marshall at Tempe, a 189-unit community by Aptitude Development, and the 281-unit Skye Tempe, which will allow Hubbard Street Group to redevelop the Sleep Inn & Suites near Arizona State University.
Developers in metro Phoenix delivered 3,315 units across 15 projects in the second quarter of this year, notes ABI Multifamily’s second-quarter report. Another 44,000 units are under construction across 181 properties.
Now that the pandemic and its number-busting trends are over, some worry that Phoenix may be in danger of too much development too soon.
“Fundamentals have cooled substantially since demand far outstripped availability during the early post-COVID days when Phoenix was the beneficiary of migratory trends excited by softer regulatory pressure, greater afford- ability and job growth when compared to both coasts,” says Garner. “New supply and lower absorption have cooled rent growth, and occupancies have ticked down by a percentage point or two.”
NorthMarq’s second-quarter 2023 report on Phoenix notes the Valley’s vacancy rate rose 30 basis over the prior quarter. The vacancy rate now sits at 6.7 percent, up 130 basis points year over year. More supply and higher vacancies have also caused rents to fall. Zumper notes the average rent for a one-bedroom unit in Phoenix is now $1,328, a 5 percent decrease compared with a year earlier.
These trends raise concerns about what im- pact additional supply will have on the market. “The market may not be overbuilt now, but it soon will be,” says Garner. “There are approximately 45,000 units in the process of development, and they will be delivered over the next 18 to 24 months. This equates to approximately 15 percent of the existing inventory and will result in greater vacancy, lower rents and higher concessions.”
Garner adds that much of the to-be-delivered product is Class A projects. This includes the 313-unit Henri, a luxury development by Toll Brothers Apartment Living and EJF Capital. The seven-story asset will feature studio to two-bedroom units when it opens in downtown Phoenix in 2025.
Upscale amenities will include a resident lounge, chef demonstration kitchen and dining spaces, state-of-the-art fitness center, collaborative coworking spaces, a club and game room with fireplace, listening lounge, studio-inspired creator booths, a library and study room, a resident bar, a resort-style pool and courtyard, a sun lounge, a rooftop deck and additional pet- friendly amenities.
Brad Cooke, executive vice president of multifamily investments for the Cooke Team at Colliers, explains how this trend got started.
“In the early part of our current cycle, developers — still wary of overbuilding — only de- livered 25,500 units for the six years ending in 2016,” he says. “Consequently, occupancy rates exploded above 96 percent and average per- year rent increases went from 2 percent to 12 percent by 2015.
“From now through the end of 2024, an additional 9,500 mid- to high-rise units are expected to deliver,” continues Cooke. “Why does this matter? From a construction delivery standpoint, mid- to high-rise developments release more units at one time than their garden-style counterparts. Whereas early-cycle unit releases trended in the range of 40 to 60 units per property per quarter, the upper bound is now trending near 150 as mid- to high-rise units assume a greater portion of the development delivery pipeline.”
Although the focus of many developers may be on Class A assets, the focus of renters may turn to Class B as costs continue to rise, notes Noah E. Hochman, co-chief investment officer and head of capital markets at TruAmerica Multifamily.
“The Class B/workforce housing space fills the demand for the renter-by-necessity demographic that is priced out of new construction and unable to buy a home but wants to live in close proximity to jobs in major MSAs like Pheonix,” he says.
Speaking of jobs, Garner believes the current fundamentals may aid with further job creation.
“Phoenix was for a long time the low-cost provider of housing to companies seeking growth locations,” he ex- plains. “That has some- what disappeared over the last several years, and the new supply will cause occupancy costs to decline. This will be a temporary boost for job creation in Phoenix, which will likely boost demand.”
Two areas experiencing significant job creation are the Loop 303/Deer Valley and Chandler submarkets. In Chandler, Intel is in the process of a $20 billion expansion to its existing facility. Meanwhile, the Taiwan Semiconductor Manufacturing Co. (TSMC) is building a $40 billion, 1,000-plus-acre plant in Deer Valley.
The project has brought approximately 21,000 construction jobs to the site and will allow TSMC to more than double its workforce from 2,000 to about 4,500 employees in its first few years. It is estimated that 160 new companies have moved to Phoenix to support these two new projects alone, notes Colliers.
“Transaction volume in North Phoenix has been more resilient than we would have expected,” says Hochman. “Several large bets have been placed in North Phoenix/Deer Valley because of the well-publicized development of TSMC’s massive chip plant. However, bets like that were much easier in May when the U.S. 10- year Treasury yields were in the low 3s and you could finance with neutral or slightly positive leverage. Financing costs have made the math very challenging today with both negative and lower leverage, combined with stubbornly lower cap rates.”
A Demand Not Yet Met?
All this job and population growth has led some to posit that Phoenix is actually underbuilt and will continue to be as more people enter the region and high development costs persist.
Camacho of the Greater Phoenix Economic Council agrees with that observation. “Despite increased production in recent years, the greater Phoenix apartment market remains underbuilt,” he says. “With the booming population, increased job opportunities and expanding cities, construction has yet to reach an equilibrium with the demand of residents and migrants.”
This demand is likely to continue — just not at the pace it did during the COVID-19 pandemic. The CEO projects Maricopa County to experience a 2.4 percent annualized job growth rate through 2030. This would add nearly 60,000 jobs to the region every year.
“The narrative of an overbuilt market is false — we need to build more. There have been tens of thousands of housing units constructed over the last several years, but we were heavily undersupplied entering 2020 and remain nowhere near full build-out today, particularly with urban growth in cities like Goodyear, Buckeye and Queen Creek,” says Camacho.
“With a projected 1 million new residents between 2020 and 2030, we need to amplify these efforts to build a wide range of housing options, including a mix of single-family and multifamily at a variety of price points.”
Any mention of single-family homes is undoubtedly a thorn in the side of many Phoenix residents.
“A trend that began in earnest post-Great Financial Crisis that is still impacting housing is the tectonic demographic shift that has pushed us further toward a more renter-centric society,” says Cooke. (The global financial crisis occurred in 2007-2008.)
“Against the backdrop of the Federal Reserve’s fastest sustained interest rate increases in 60 years, we are witnessing the largest gap in Phoenix history for owning versus renting. It’s now $2,000-plus higher per month to own than rent.”
He notes that renter household levels increased nationally by about 3.6 percent over the past decade. In Maricopa County, that number was 6.2 percent over the same period.
“The absolute explosion of renter households…is continuing and will continue to impact both multifamily and single-family development,” Cooke adds.
John Kobierowski, president and CEO of real estate brokerage firm ABI Multifamily, shares similar concerns about Phoenix’s impending supply and demand fundamentals.
“With all of these folks coming here, we can’t keep up with the demand for housing,” he says, noting that the region needs about 277,000 additional housing units by 2030. “We have never been able to deliver more than 12,000 multifamily units in any calendar year. We cannot build enough to keep up with the forecasted demand.”
Kobierowski says the region can anticipate about 12,000 units being delivered this year, and another 12,000 next year before a “big drop off” occurs in 2025. This will be caused by the failure-to-launch planned developments, the lack of construction financing, the ballooning costs of construction, and the increasingly complicated and lengthening entitlement process, in his estimation.
“The fact that we need 277,000 more housing units by 2030 and the fact that we can’t deliver them is just the opposite of an overbuilt market. We are underbuilt,” Kobierowski argues. “Plus, the gap between the cost of owning a home and the cost to rent has never been greater. Nationally, we are experiencing the first prolonged period of falling homeownership rates.”
Of course, higher costs are being experienced across the board.
“The costs to build continue to increase and have rarely ever declined,” Garner adds. “Today, regulatory requirements contribute to more than 20 percent of the cost. Interest rates are far higher than in recent memory, and labor costs show few signs of declining. These factors all but guarantee a higher cost to build in the future, which should stall new development until rents catch up.”
Where Does This Leave Investors?
The argument over whether Phoenix needs more units or a break from activity, combined with today’s high costs and high interest rates, leaves investors in an interesting spot.
“The transaction market has stalled because of the bid-ask spread between buyers and sellers who are trying to get pricing from last year,” explains Hochman.
“There is also a wall of looming debt maturities in Phoenix slated for 2024, so many of these owners will begin to feel pressure on assets while the property operations have slowed considerably. Unless there is clarity on actual absorption of the new product being delivered — and/or how these loan maturities are handled — it is difficult to imagine Phoenix transaction volume increasing before the fourth quarter of 2024,” adds Hochman.
With that in mind, Hochman notes TruAmerica’s acquisition efforts are largely focused on off-market opportunities and supply-constrained submarkets.
“We are still bullish on Phoenix over the next five to 10 years,” he adds. “But in the near term, the picture is a bit more complicated.”
Garner notes Avanti still sees some acquisition opportunities in this market.
“Today, we can buy new properties at below replacement cost pricing,” he says. “In conditions such as these — and those I expect to exist for the next several years — the risk-adjusted returns for development don’t make sense to me.
Investment, however, remains a strong interest.” Cooke notes his clients are still showing an interest in some products, while avoiding others that used to be a popular choice.
“From a sales perspective, there is significant investor interest for attainable housing, such as Greenlight Communities’ Streamliner and Cabana brands, as well as new builds, particularly build-to-rent communities,” he says.
Greenlight specializes in thoughtfully designed communities at an affordable price point. It does this by focusing on underutilized land, implementing efficient construction projects and designing communities that are easy to replicate.
“Additionally, we are seeing a slowing trend of investors looking to undergo extensive renovations of older apartment buildings. Over the last several years, operators would often spend $15,000 to $30,000 per unit, in some cases more, to renovate the interior of an outdated apartment unit. This would increase rents and ultimately property valuations.”
But that was when the cost of building materials and interest rates were lower.
“The transaction market is off by approximately 80 percent due to interest rates rising far more quickly than cap rates,” Garner adds.
The U.S. 10-year Treasury yield, a benchmark for fixed-rate permanent financing in commercial real estate, has risen from approximately 1.6 percent two years ago to nearly 4.9 percent at the close of business on Oct. 30.
So, which is it? Is Phoenix experiencing too much multifamily development or not enough? The answer, as it usually does, may ultimately lie somewhere in between.
“In summary, the market has swung back toward an equilibrium,” says Garner.
Cooke agrees, noting the market is in a “reversion to the mean” period. This, he explains, happens when asset prices and volatility of returns eventually revert to their long-term average levels.
“When applied to Valley-area real estate, one of the more salient illustrations of this reversion can be found in occupancy numbers,” he says.
“Phoenix’s long-term occupancy average (from 2000 forward) is 91 percent. During the frenetic 2021 to 2022 period, occupancy hit all-time highs above 96 percent, with current occupancy rates now trending to a more normal 93 percent, but still 200 basis points above the long-term average. Basically, forget about what happened during the COVID years because we are now back to normal metrics.”
This leaves investors with a compelling decision to make. Is it time to buy, sell or build? Is the answer all of the above, or none of the above? Only time will tell.
“If you want to exit, you might have missed the peak in values prior to the interest rate runup,” says Kobierowski. “But that doesn’t mean values are down. It’s just harder to make sense of an investment with higher interest rates until rent increases compound enough to increase the income of a property to make up for those higher interest rates. My advice is to run your property, increase rents and wait for the market to come to you — it will.”
— By Nellie Day. This article originally appeared in the Sept/Oct issue of Western Multifamily & Affordable Housing Business.