A Second Wind

Reports of the death of the Chicago apartment market were greatly exaggerated.
-with credit to Mark Twain

Friends and Investors:
More and more positive news has come out recently about the state of the Chicago apartment market and I wanted to share a recent report. Here are some key takeaways from the Chicago Winter 2019 Outlook by Yardi Matrix titled "Chicago's Climb" (available here):

• Sale prices for apartments are at an all time high (up 13% YOY)
• Rent growth is accelerating (January's 3.2% YOY is the highest in the past 2 1/2 years)
• New construction declined (2018 delivered 1,100 fewer apartments than 2017, however this trend is expected to reverse in 2019)
• Apartment occupancy remains high and stable (94.3% occupancy in December 2018 down 0.2% YOY)

There is also some tempering news mixed into the report about the effects from a potential 10,500 new apartments being completed in 2019. However, these estimates often turn out to be overstated due to construction and financing delays. In fact, the February 2018 Yardi Matrix projected 9,700 units in 2018, but just 6,708 actually came online. Applying the same ratio of 70% to the Yardi Matrix 2019 projections results 7,350 new apartments completed, just below the 7,400 average since 2015.

Another good piece of news came from the Federal Reserve yesterday when interest rates were left unchanged and they indicated there were no future rate increases planned. This pushed US treasury yields down to their lowest levels in over a year. The lower rates benefit the sale of apartments since most commercial mortgages are priced based on the treasury yield. When rates go down, apartment buildings are cheaper to buy, stimulating more demand and higher prices.

The downside of the Fed announcement is that, since they have more data than the private sector, their current concerns about the country's economy could indicate that there is a recession looming. With the news, the yield curve moved much closer to an inversion, an event which has preceded all seven recessions over the past 50 years. Hopefully, some certainty from China trade negotiations and higher wages will stave off a US recession. Nonetheless, the current economic expansion is close to the longest on record and is on track to surpass the 1991-2001 expansion in June 2019. Thus, a recession in the next two years would not be unexpected and is in fact predicted by 75% of economists.

Apartments purchased with moderate leverage can be good investments in a recession since demand is fairly inelastic (in the non-luxury market) for apartments that are in high demand locations (like the Chicago neighborhoods of Wicker Park, Bucktown, Logan Square and Ukrainian Village) and they hold their value better than many asset types.

Apartment buildings are attractive places for investors looking capitalize on the superior market metrics or to weather a future storm.

Regards,

Brian E. Moore
Managing Member & Founder
Division Street Capital, LLC