Market Forecast: Northwest

By Erika Schnitzer, Associate EditorAccording to the Urban Land Institute (ULI)’s “Emerging Trends in Real Estate,” the top two most promising markets for 2009 were Seattle and San Francisco. Now, midway through the year, these markets are facing their own set of problems—though industry experts do maintain that they have the potential for a strong recovery.The Northwest’s increasing unemployment rate, compounded by big run-ups in rent over the past several years, as well as the huge supply expansion, has hurt the region considerably during this economic downturn.The major cities in the region—San Francisco, Seattle and Portland—are “contracting at an annual pace of 3 percent or more,” reports Greg Willett, vice president of research and analysis at M|PF Yieldstar. Seattle is expected to lose 45,000 jobs this year, while San Francisco and Portland will each lose between 30,000 and 35,000 positions. The good news, however, is that despite the Northwest’s run-ups in rents and what will inevitably result in the region’s big corrections, all three cities started out above the national norm in terms of occupancy rates. San Francisco remains the second-highest occupied market in the nation—following Pittsburgh—at 95.1 percent, as of the end of March, reports Willett. And Seattle is experiencing 93 percent occupancy, while Portland is sitting at 94.2 percent.So, while the region’s largest cities are seeing increasing apartment vacancies, they continue to remain lower than the national average of 7.2 percent.Running up San FranciscoDespite its high occupancy levels, the Northwest region is facing its own set of problems. Because of its enormous rent run-ups in recent years, San Francisco is experiencing a big rent downturn—5.7 percent year-over-year—notes Willett.In the midst of the recession, the Bay Area has seen a decline of 10 to 20 percent in operations, mostly stemming from concessions and the lack of rent growth during the last two quarters, says John McCulloch, principal in ARA (Apartment Realty Advisor)’s San Francisco office. “With concessions back in, one month free is about 8 percent, so it doesn’t take long” to add up, he notes.In fact, Urban Housing Group’s newest edition to the San Francisco market, Strata at Mission Bay—though currently maintaining an absorption rate of 30 units per month—is achieving monthly rents of $2,100 to $4,000, which is approximately 10 percent lower than they would have been just one year ago—a result of a shadow market comprising 2 to 3 percent of the San Francisco apartment market—reports Dan Deibel, vice president of development for the Palo Alto-based company. Noting this trend, the firm is offering residents the choice of one month free or free parking for the term of the lease. This approach has proved quite successful, however; the community has leased 57 of its 192 units since its mid-March opening. The Strata is the second Urban Housing Group project in Mission Bay, whose key component is its 43-acre life science research campus for the University of California, San Francisco. The first project, Edgewater, a 193-unit apartment community, was sold in May 2008 to United Dominion Realty Trust for $595,855 per unit.Today, however, “the Bay Area has been stuck in neutral” from a transaction standpoint, according to McCulloch. But he does note that the Bay Area is “high on the target list” for investors and owners across the Northwest, as the barrier to entry for home ownership is still relatively high. With research and technology “the lifelines of San Francisco in this economy,” Diebel predicts there will be greater interest in the Mission Bay neighborhood, which is located on the central bay shore of San Francisco.And while McCulloch predicts that rents will stay flat and potentially decline 2 to 3 percent in the near term, he remains optimistic in the long run. “We would expect occupancy to stabilize because there are no new starts,” he asserts. “Even with moderate job loss, the Bay Area has seen there is still a positive household formation. The Bay Area remains a place where people want to live.” Overbuilding the Emerald City While Willett reports that Seattle and Portland face only a 4 and 2.3 percent rent decline year-over-year, respectively, this does not mean that the markets are in the clear—both markets have a considerable amount of product under construction. During the best of times, Seattle and Portland enjoy a 5 percent vacancy rate, notes Jim Claeys, senior vice president-Pacific Northwest Region, ARA. And at its best, Seattle had only a 2 percent vacancy. But today, Seattle is sitting at 6.5 percent, while Portland is at 7.5 to 8 percent, he says.Certainly Seattle’s biggest concern right now is the 8,000 units slated for delivery by mid-2010—with approximately 6,600 of these units predicted to be delivered by the end of 2009. And with a shadow market effect in both Seattle’s urban core and Bellevue, M|PF Yieldstar’s Willett notes that the city “will rank alongside Phoenix and Austin in terms of revenue drops.” While most of the country is facing a 4 to 5 percent revenue decrease, Seattle could be in danger of a 10 percent revenue loss this year alone, he reports.Despite this, Claeys predicts that the Emerald City will actually see an undersupply in 2010 and 2011. According to ARA’s Pacific Northwest Multifamily Report, multifamily permits dropped from 14,600 in 2007 to 8,900 in 2008, and they are forecast to drop further, to 4,800 in 2009. Willett, too, remains optimistic. Seattle “is a metro that has a very attractive long-term employment outlook, and it normally outperforms the U.S. as a whole,” he says. With rent increases experiencing a slowdown from 2.5 percent in the second quarter of 2008 to 1.5 percent in the third quarter, Seattle saw rent growth grind to a halt in the final quarter of 2008. The average effective monthly rent in Seattle is currently at a standstill at approximately $1,000, while Portland’s average is approximately $750 to $800. And concessions, which are most prevalent in the Bellevue, Southeast King and Kirkland submarkets, are averaging $36 per month. Despite these conditions, Opus Northwest LLC’s Fifteen Twenty-One Second Avenue, a 38-story, 143-unit luxury condominium development in downtown Seattle, has averaged one new sale per week since the beginning of the year and has closed more than half of its scheduled closings. While Opus has certainly seen great success in this down market, Tom Parsons, senior vice president and general manager of Opus Northwest, does acknowledge that the community doesn’t have much competition in its market. In fact, in the condo market sector of residences $750,000 and over, Parsons says that Opus has closed 90 percent of the first quarter’s closings.Like San Francisco, neither Seattle nor Portland is seeing any noteworthy transaction volume. “Everyone is sitting on the fence, not knowing where they should trade at, and that has caused no sales because no one knows where to pull the trigger,” says Claeys. “Once these deals transact and establish a cap rate, we’ll see more transactions. We’ll see a lot more money placed here in the third and fourth quarters,” he predicts.To comment, email erika.schnitzer@nielsen.com