Why Is Everyone So Afraid of New Construction in Multifamily?

[Ben Leybovich]

There is a lot of fear of new construction in the multifamily sector. I am not sure I understand why. I think we can use it to our advantage.

@Sam Grooms and I buy apartments in Phoenix. Statistically, considering the demographics, it is thought that Phoenix will need 150,000 new apartment homes by 2030. Currently, there are about 15,000 in the pipeline. The construction costs are up tremendously. Construction volume is also capped by a shortage of skilled labor, as much as anything else. Even if we wanted to build 50,000 units in the next 2 years, we can’t.

So, how do we use this to our advantage?

We just closed on another community. This is a 94-unit community a block away from downtown Mesa. This location is designated a QOZ, and as such a ton of new construction has already broken ground, and a lot more is planned. The community sits right on top of the light rail, with the station right at the corner. Sun Crest backs up to the amazing Pioneer park that the city just spent $8M renovating.

The downtown Mesa is in midst of a fantastic revitalization, and we believe within a few years it will become a hub! Especially considering the ASU expansion that is coming in.

Talk about the Path of progress!

This was a smaller acquisition for us, but we couldn't pass up the growth prospects. We paid $10.6M and we will complete a $3M renovation scope, which will include the construction of a new office and gym, expansions of the pool and a bark park, as well as the typical for us interior scope which includes cabinets, granite, appliances, and W/D install.

Here’s the kicker:

New construction in Phoenix rents for an average $1,500 per month. In this location, looking at the filed permits, I think many of the rents will be North of $2 sq.ft with an average per unit of at least $1,700 - $1,800.

Our re-positioned average pricing is $1,200. These units are large, so this pricing equates to $1.30 per sq.ft.

So - what we have is a community that will offer 85% of what new construction offers in terms of location, finishing surfaces, and amenities, but at 65% of the cost, or less. It will become the budget-friendly option for anyone wanting to be in what will become a trendy location in the East Valley in one of the hottest growth markets in the country. It will offer tenants much of what Class A will, but at a large discount.

[Serge S.]

The concern is rather obvious. When people pay over the cost of new construction for C class assets under the premise that post renovation rents will be more affordable than competing new construction; there is some serious inherent risk. If you talk to large experienced long term players in Arizona multifamily like Ken McElroy, he will tell you that it makes no sense to buy C class when you can build for the same or less all in. Hence all of the new construction.

Rents will not grow indefinitely and when it gets competitive the new construction assets with the same basis as the C class rehab junk will have room to maneuver while the over rehabbed, maxed out rent C class goes back to the bank. It doesn't seem possible that can happen again but it will. There is a real affordability crisis and a renter that qualifies for $1300 rent must gross $45k/year. If your business plan is banking on average rents of $1300 in a demographic where median income is half that do you see how that can be a problem?

The people who say its a great idea to buy a rehab at 3% cap in a gentrifying opportunity zone area are the 2019 version of the SFR investor of 2006. Take a hard look at SFR rents in said gentrifying opportunity zone and ask yourself if people will pay the same rent for rehabbed one bedroom apt as a 3-4 bedroom house around the corner. Ask yourself if your end buyer will pay the average regional SFR median price for 1-2 bd apartments in one of the lowest county median income regions. Be careful who you listen to on BiggerPockets. You will not hear @Brian Burke boasting about his latest 3 cap deal.