Landmark Links April 4th – Nothing in Between


Lead Story…. Visit any older city in the US and you will probably find lots of smaller apartment buildings dotting the landscape in core residential neighborhoods.  Almost without exception, these buildings are older.  Smaller apartment buildings were once a key feature of development in cities but are rarely built anymore for a variety of reasons. This lack of small building development is something that urbanists often lament because the buildings typically add character while providing relatively high density – something that neither sprawling apartment developments, towers or single family homes tend to do.  They also tend to have cheaper rents than larger projects.  Bloomberg’s  Patrick Clark took a look at why this so called “missing middle” isn’t being built anymore (emphasis mine):

According to new research from Enterprise Community Partners, an affordable housing nonprofit, and the University of Southern California, apartment buildings with between two and nine units offer the lowest prices available to U.S. renters.

The chart above uses data from the U.S. Census Bureau’s 2013 American Housing Survey to show average monthly rents based on the number of apartments in a building. The paper categorizes buildings with between two and 49 apartments as “small and medium multifamily housing”—a grouping that makes up 54 percent of the U.S. rental stock.

As noted, America isn’t building as much of this kind of housing as it used to. Small- and medium-size apartment complexes account for a quarter of existing units built in the 1970s and 1980s, according to the report. Since 1990, though, the category has accounted for just 15 percent of new housing stock.

There are a few reasons for that shift, according to Andrew Jakabovics, vice president for policy development at Enterprise Community Partners and one of the authors of the paper. Another author is Raphael Bostic, who was just named president of the Federal Reserve Bank of Atlanta.

Zoning rules have developed to favor single-family construction, making it harder to win approval for larger projects. There are regulatory costs to building multifamily housing, and developers that go through all the trouble to win approvals want to build more than just a few apartments.

In general, there are economies of scale in operating larger complexes. If two units are vacant in an 8-unit building, the landlord is missing out on a quarter of her potential income. In a 100-apartment high-rise, a couple of vacancies are less of a big thing. Those operating efficiencies also make lenders look more favorably on larger apartments, Jakabovics said. It’s a virtuous circle for ever-bigger residential developments, though not so much for smaller ones.

Seeing why builders have abandoned the small apartment complex is easier than figuring out how to rekindle interest in the concept. Rewriting zoning codes to favor the missing middle would be a good start, Jakabovics said.

The flip side is that if builders don’t develop more small- and medium-sized buildings, an important source of unsubsidized, affordable housing may dry up. Rental units tend to get cheaper as they age. The trend in recent decades toward single-family homes and high-rise apartment buildings means that there are fewer smaller apartment buildings to age into affordability.

“We need to build stuff today that’s affordable today,” Jakabovics. “We also need to future-proof ourselves by building stuff today that will be affordable 10 or 20 years from now.”

I would suggest another reason that smaller apartments aren’t being built today: they are extremely difficult to finance.

There are few investments in the world of real estate that represent a more efficient way to commit capital than large multi-family developments.  Financing is relatively cheap and readily available thanks largely to GSE’s, occupancy is high across most of the US and rents are easy to comp out.  Also, leases tend to be short-term in nature, eliminating the possibility of a long-term lease with below-market rents in an inflationary environment – a common issue in office and industrial projects.  Combine the above with the fact that there is a massive pool of potential buyers made up largely of REITs and Pension funds that like to invest in stabilized apartment buildings and it’s no wonder that large, class-A apartments have become a darling of developers and merchant builders.

For-sale residential may not enjoy as deep a financing market as large-scale class-A apartments, but it does have dedicated investors that both understand and invest in the space.  In addition, public builders are playing an ever-larger role in the for-sale home builder market, decreasing the need for outside capital.  The exit for builders in the for-sale residential space is home buyers who are typically using mortgages from a GSE – one of the largest and, despite some relatively recent challenges, most efficient debt capital markets in the world.

Small-scale apartments don’t fit neatly into an investment box the way that large-scale apartments and for-sale residential developments do.  There is debt capital available but it often requires a personal guarantee. Equity capital can be difficult to come by, in part because there aren’t a ton of deep-pocket REITS and pension funds waiting to purchase them once stabilized and opportunistic development equity doesn’t tend to like to hold long term due to mismatches in return profile.   Public builders also tend to shun the space.  This means that the typical buyer of a stabilized property is someone looking for a 1031 exchange or a high net worth individual buying for cash flow.  Where there are plenty of those, they have nowhere near the depth and programmatic capital of REITs and large pension funds.  Of course there are family offices and small funds that will finance small apartment construction but they are often looking for a yield premium over larger apartment projects to compensate for the reduced scale and less liquid exit.  Ironically, this yield premium is difficult to achieve due to economies of scale – there is only so low that you can push land values and still have a willing seller.  Why would a developer build a smaller project with a less liquid exit, more financing difficulty and inferior returns?  They wouldn’t, which is why they mostly don’t.

Although the landscape currently looks bleak for new construction of small apartment buildings, there is reason for some optimism.  Before the housing crash and Great Recession, single family housing rentals were a highly fragmented space dominated by local mom and pop investors.  Large institutions stayed away because it was difficult to achieve any economy of scale and management was a headache.  Then the market tanked.  Almost overnight large investors began buying up thousands of homes as the market continued to languish under the weight of foreclosures.  Investors saw an opportunity to buy assets at below replacement value and make a solid yield in a low-rate environment which drew them to an asset that they had no interest in just a few short years earlier.  Will small apartment development eventually attract that same type of attention that single family rentals did? I don’t know but I certainly hope that they do.  Markets change incredibly quickly and besides, how many people out there can say that they foresaw large investors becoming single family home landlords 10 years ago?  At some point, the need for small buildings is going to make it lucrative enough to work as an investment on a consistent basis.  However, a large investor or builder is going to need to solve the financing puzzle in order for that to happen.


Mind the Gap: The gap between sentiment – what people say about the economy – and actual economic data is at an all time record.

So Much for a Sure Thing: After the election, many investors thought that a soaring dollar and falling Yuan were a sure bet.  They weren’t.

Warning Signs: The subprime auto lending market is a mess and loose underwriting standards have resulted in climbing losses.


This Was Inevitable: Start ups are going live with an eBay-style bidding system for renters to bid on new apartments.

Up In Smoke: Legalized Marijuana is reshaping the commercial real estate market in profound ways.


Missing the Mark: Ivy Zelman calls out the Census bureau for inaccurate housing construction data that understates the strength of the market.  She also makes a compelling case of how this could result in a labor and lot shortage that will have at negative impact on the market. (h/t Tom Reimers)

Positive Impact: Yet another study finds that increasing housing density is undoubtedly good for the environment since it means less automobile usage.  Now if only faux environmentalist NIMBYs would stop opposing new development….

Graying: Americans are moving to cities with warmer climates mostly for demographic reasons.


Too Much of a Good Thing: California’s snow-pack is one of the biggest on record and ended the severe drought in most areas of the state.  However, it now poses a serious flooding risk.  See Also: Winter precipitation has led to an epic bloom of long-dormant wildflowers across California. And: Mammoth Mountain has enough snow to stay open until July 4th due to it’s record winter.

Below the Radar: Encrypted messaging apps have been widely adopted in the world of finance, creating all kinds of headaches for compliance departments on Wall Street.

Confessing My Unpopular View: Golf is a boring garbage sport.

Chart of the Day

Someone is wrong here:

zelman chart starts


Gotta Hear Both Sides: A man who is a dead ringer for Santa Claus was arrested for selling cocaine to a detective 6 different times, because Florida.

I Know That This Makes Me Immature: But I could watch this video of an angry chimp throwing poop and hitting an old woman in the face at a Michigan zoo all day.

Reality Bites: OJ Simpson will likely get out of jail this year and ratings-crazy TV executives just might give him his own reality show.

What a Way to Go: A college student recently died as a result of choking while competing in a pancake eating competition.  I’m somewhat surprised that this doesn’t happen more often.

There’s Someone out There for Everyone: A Chinese engineer married a “female” robot that he built after he couldn’t find a girlfriend.

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