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High-Rise v. Garden-Style: Examining the Path to Prosperity

High-Rise v. Garden-Style: Examining the Path to Prosperity

Historical appreciation advantage belongs to high-rise apartments

Circling back to the correlation between NOI growth and valuation, high-rise apartments experience faster appreciation. Again, this is not surprising given the track record of stronger NOI growth. Historically, high-rise apartments have appreciated on average 103 bps faster on an annualized basis when compared to garden-style (see Figure 4). However, more recently, that trend has shifted in the favor of garden-style apartments. From 2nd quarter 2014 to 4th quarter 2014, results have swung in the opposite direction towards garden-style as some level of price fatigue sets in for investors of high-rise apartments. While it’s not clear if this is a blip or a trend, we’d be remiss by not mentioning it here.

High Rise - Chart 3

Just give me the answer already!

Back to what you really want to know: If I invest in apartments, what product type should I pursue? Despite the pride of owning a high-rise apartment complex in a major metropolitan area, total returns between garden-style and high-rise apartments are almost identical on a national basis (see Figure 5). Furthermore, Figure 6 illustrates that risk-adjusted returns by the slightest of margins, tend to favor garden-style apartments, a fact that runs contrary to traditional thought.

High Rise - Chart 4

Since garden-style apartments are typically associated with suburban areas, these results resemble a perception-realty gap. Said another way – the perception may be based on vanity (it’s more prestigious to own a high-rise) versus the value gap that has existed on a historical basis. Moving forward, the fact that the largest population of renters – Millennials – tend to prefer the live-work-play lifestyle that high-rises often afford, future results may very well look different. At least this appears to the thinking based on capital flows.

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The changing landscape of institutional ownership

If all signals point to a slight advantage toward garden-style apartments, does private equity and institutional investments support these facts? The results are actually counter-intuitive. In reality, institutional ownership of high-rise apartments has been on a steady uptick. There are several possible explanations. First, institutional investors are risk-averse, and as such, they may be attracted to the liquidity aspect of high-rise apartments due to the sheer amount of capital chasing deals. Second, apartments were not embraced by institutional ownership until recently. For comparison, apartments comprised 16% of the NPI index by market value in 4th quarter 1999 compared to 25% today. As institutional capital flowed into apartments, it headed into the higher barrier-to-entry markets, which typically comprise of more high-rise apartments. Third, as institutional investors look to apartments as an effective way to allocate capital, they also tend to favor investing in newer product as a way to enhance their income return. And since apartment construction has shifted toward urban, infill, high-rise product, the institutional money followed suit. Finally, institutional investors who want to deploy a large amount of capital will naturally gravitate towards the most expensive product – in this case high-rise apartments. As a result, the composition of ownership has shifted from a heavy concentration of garden-style apartment units to nearly a 50/50 split, as seen in Figure 7.
If all signals point to a slight advantage toward garden-style apartments, does private equity and institutional investments support these facts? The results are actually counter-intuitive. In reality, institutional ownership of high-rise apartments has been on a steady uptick. There are several possible explanations. First, institutional investors are risk-averse, and as such, they may be attracted to the liquidity aspect of high-rise apartments due to the sheer amount of capital chasing deals. Second, apartments were not embraced by institutional ownership until recently. For comparison, apartments comprised 16% of the NPI index by market value in 4th quarter 1999 compared to 25% today. As institutional capital flowed into apartments, it headed into the higher barrier-to-entry markets, which typically comprise of more high-rise apartments. Third, as institutional investors look to apartments as an effective way to allocate capital, they also tend to favor investing in newer product as a way to enhance their income return. And since apartment construction has shifted toward urban, infill, high-rise product, the institutional money followed suit. Finally, institutional investors who want to deploy a large amount of capital will naturally gravitate towards the most expensive product – in this case high-rise apartments. As a result, the composition of ownership has shifted from a heavy concentration of garden-style apartment units to nearly a 50/50 split.
High Rise - Chart 5

In conclusion, high-rise versus garden-style could be argued from many different viewpoints. The facts are garden-style apartments have historically provided a slightly more favorable risk-adjusted return over the past five, 10 and 15 years. However, institutional investors, developers and some tenants favor high-rise apartments, a fact which cannot be discounted. In the end, from a strategic investment perspective, the decision is based on your investment goals, objectives and risk tolerance.


(Image Source: Shutterstock)

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