Desert Revival

How Southwest markets are making a turn-around.

Looking at the aftermath of what has been aptly penned the “Great Recession,” it is clear that one of the hardest hit regions of the recent economic calamity was the Southwestern U.S.—an area that posted vacancies above 13 percent and unemployment rates as high as 14 percent at the onset of the crisis. Yet over the last two years, key factors have shifted in favor of considerable multifamily expansion, and economists and investors are taking note.

“Over the last few quarters vacancy has continued to decline while both asking and effective rents continue to increase,” says Ryan Severino, senior economist at Reis Inc. “The apartment market in the Southwest is benefiting from constrained supply due to scant new completions, while demand for apartments remain strong. With the for-sale housing market still struggling amid deflationary pricing and tight credit conditions, the apartment sector is making strong gains.”

According to Hendricks & Partners’ 2011 market overview of Phoenix, sales velocity is indeed picking up, along with the average unit price. Overall sales volume came in at around $2 billion in the last year, while the average rent for the central part of the city rose from $793 to $840 per month.

Mark Forrester, senior partner at Hendricks & Partners, says that investment opportunities in certain parts of the region are positive signs that the overall economy and multifamily market will strengthen.

“Generally, I would just say there is strong investor activity in the Southwest, especially in Phoenix,” Forrester says. “People see this market in the early stages of recovery. Developers are trying to get back to work, and they will—it’s not easy though, attracting equity, as it probably is in many parts of the country.”

Melanie Morrison, principal at MEB Management in Phoenix, says that her company is seeing strong indicators of renewed growth in most of its markets throughout Arizona, New Mexico and Texas, and that 2011 was a particularly strong year.

“We’ve seen significant improvement in all our markets except for one,” says Morrison. “Of the markets MEB is active in, the strongest market is Flagstaff, Arizona. Phoenix is also coming back strong.  Of the 13,000-plus units we manage there, occupancy has increased from 89 percent at [the end of] 2011 to 93 percent currently.  Net Effective Rents are up 5 percent since year-end.”

Morrison goes on to note the major underlying factor in the positive trends in Southwest multifamily and what MEB is doing to capitalize on current market dynamics.

“Of course, the major factor in the overall improvement is the jobs picture, especially in Phoenix,” says Morrison. “For MEB, we are increasing the number of assets on our revenue management program, which helps us maximize the increase in rental income.”

Forrester agrees that the employment picture is improving but he points out that growth is muddied and the types of jobs being added to the economy are not the same as the ones that left.

“Employment growth is running at the rate of 30,000 to 40,000 a year, which is modest by our historical standards—we normally add double that—but still it’s very positive,” says Forrester. “The jobs we’re adding are typically not the jobs we lost. We’re adding higher-quality jobs: high-tech, medical, government, education—as opposed to some of the jobs we lost, which were in the service and construction areas.”

According to Severino, “After suffering during the downturn, the labor market is projected to create thousands of new jobs over the next few years. Many of these new jobs are being taken by young adults, 20-34 years old, that represent the prime rental cohort. As long as this trend continues, the sector should continue to perform well.”

As multifamily continues to present advantages to mortgage-based housing, there seems to be an opportunity for developers to steal a slice of the market typically exclusive to single-family. As renting has become more popular in the Southwest and across the nation, Class A and luxury apartments are becoming a more attractive option for those wanting to avoid a mortgage.

“We are seeing a fast ramp-up from development companies focusing on A product,” says Morrison.  “National trends favor rental housing now in a way we’ve never seen before. Two of our clients are currently building unique product that combines the best of single family housing and living in an upscale rental community.”

Severino echoes the observation that Class A is doing the best among the region’s multifamily asset classes in terms of both investment and occupancy, but iterates that all classes are doing well compared to what was seen in previous years.

“Class A continues to outperform Class B [and] C apartments,” says Severino. “Vacancy rates are lower, and rent growth is stronger. Nonetheless, all sectors are benefiting now as the high tide of the apartment market is raising all of the ships. Transaction activity by volume has been very stable over the last few years, but the focus in the market has been on higher-quality assets.”

With an overall sense of health in the Southwest markets, it is natural that developers are looking forward to increased construction and new projects. In fact, 2012 is forecast to be a year of renewed growth in the amount of capital available to investors, yet this expansion will not be at pre-recession levels.

“Construction activity is escalating in response to the strong improvement in fundamentals,” says Severino. “New completions in 2012 will rise to roughly triple what they were in 2011, but it is important to keep this in perspective. New construction had dwindled down to very low levels so this is an increase, but new construction activity will remain below historical average annual levels of completions,” adds Severino.

Mark Forrester of Hendricks & Partners points out the divide between developments that have been proposed and those that will likely be completed, and how developers are pushing hard to narrow this gap—which has been particularly wide since FY 2010.

“In Phoenix, there’s probably 15,000 units being proposed,” says Forrester. ”The question’s going to be how many of those are actually built. There’s a lot of infill activity on the development front in Phoenix and in Scottsdale, and in particular there’s probably 7,000 units being proposed, but again the developers tell me they’re working hard to find their equity partners and construction lenders, so the pipeline is getting to be fairly extensive.”

Forrester goes on to describe how this kind of market has attracted certain types of investors to the region, bringing players that are either fresh or that have not been active for some time.

“It’s mostly private capital, basically whether local or not—people without any legacy issues,” says Forrester. “I would say a lot of people are new to the market—if not completely new to the market—in not having done anything here in quite a few years.”

In terms of sub-dynamics in different cities throughout the region, Forrester again emphasizes the strength of the Phoenix market while casting a positive portrait for the other markets as well.

“In Phoenix, stronger properties are up. Most properties are around 90 percent or better now,” he says. “Albuquerque is running pretty strong. Tucson is lagging a bit, but it’s beginning to come back. Vegas is probably the slowest recovery city here, and we’re just now beginning to maybe see some progress in Vegas.”

MEB Management’s Morrison sums up the climate of Southwest multifamily as one of considerable potential, with various factors playing into a likely, healthy expansion.

“The Southwest continues to be viewed as a desirable living environment,” says Morrison.  “Jobs are already starting to return, and this will fuel improvement for our multifamily occupancy and revenue.  Businesses will be attracted by our low cost of living.  Except for regions that may be affected by reduction in military activity, we should see economies in the Southwest continue to improve.”