Manifest Destiny

Pacific Northwest sees fresh opportunities in multifamily.

Even compared to a healthy and expanding nationwide market, multifamily in the Pacific Northwest is seeing exceptionally strong gains. A growing renter population and accelerating job growth have helped solidify cities like Portland and Seattle as cornerstones of the apartment industry, and the positive trends show no sign of letting up.

“Right now we have the lowest vacancy since 2008, and it’s gotten pretty tight, especially in the core Seattle neighborhoods,” says Dave Smith, senior broker at Seattle-based Paragon Real Estate Advisors. “We are outperforming most metro cities. In terms of desirability, we are in the top five most desirable apartment markets in which to be an investor.”

Tom Brenneke, president of Guardian Real Estate Services LLC in Portland, agrees that current market conditions are exceptionally strong and points out a key sociological dynamic underlying this reality.

“Gradual tightening in the market has caused vacancy to fall,” says Brenneke. “The estimate for Portland and Seattle markets is four percent. The homeownership percentage [is] falling in favor of rentals. People want mobility, and we have come to appreciate that success in life is not defined by owning a home.”

In terms of which areas are performing best, David Mortensen, senior associate at Seattle-based Colliers International, highlights a familiar and near-ubiquitous trend in the apartment industry over the past few years—indicating that submarkets in and around downtown areas remain the driving force of multifamily growth.

“In this marketplace, the biggest factor affecting speed of rental market recovery is proximity to the urban core,” says Mortensen. “Vacancy and rents are improving fastest in those areas closest to the [central business districts] of Seattle and Bellevue. Vacancy is around 3 percent in most neighborhoods in and around Seattle —down from 3.5 percent a year ago—and rents are up over 6 percent year-over-year.”

Smith concurs with this observation with respect to the Seattle market and adds how this has translated into asset-class performance, both with respect to the core urban submarkets and outlying suburban submarkets.

“I would tell you, from a performance standpoint—meaning rents and vacancies, that A, B and C quality properties in the core Seattle neighborhoods and Eastside market—meaning Bellevue and Kirkland—all of those assets are performing very well,” says Smith. “As you get into outlying areas and more of your suburban infill, I think some of those C-class properties still can be difficult to operate.”

Room for expansion

With such positive indicators in core urban markets, developers are taking advantage of the favorable climate and ramping up construction of new projects at a substantial rate. This surge comes after a considerable lag in construction the city witnessed in 2009 and 2010 in the aftermath of the financial crisis.

“Seattle is looking at the biggest construction pipeline in its history,” says Mortensen. “With demand for rental housing as high as it is despite continued unemployment around 8 percent, it is no surprise that developers want to build in the urban core locations.”

Smith of Paragon echoes this point and extrapolates on what such a wide pipeline could translate to over the next few years in Seattle, hinting that developers in the metro could be in for an exceptionally busy cycle.

“It’s fuller than it has been for years,” says Smith. “In 2011, we only saw about 1,500 units of new construction come to market. In 2012, we’re going to see about triple that—about 5,000 units. I believe if you look at the next five years, we’re going to see about 12,000 units added to Seattle, and that’s Seattle specifically.”

Yet even with the seemingly pristine industry climate, some are becoming worried that the surge in construction may lead to oversupply, and thus, higher vacancy and reduced rents down the road. Brenneke says that he’s aware of these concerns but thinks they may be exaggerated, especially if positive employment trends continue.

“[There is] lots of new construction going on, [and we are] expecting more,” says Brenneke. “Concerns are growing about oversupply, although I believe it will be short term. Improved employment should absorb what we are building—substantially more.”

Smith of Paragon also believes that the fears of excess construction and apartment inventory is over-hyped and that such low vacancies across King County in particular justify an increase in new multifamily properties.

“There are some fears that our downtown market could get overbuilt with too many high-end units, but my argument is that those rents in those downtown high-rises aren’t any cheaper than urban infill properties for the most part,” says Smith. “Statistically, our vacancy for the county is about 4.7 percent. Landlords are filling the rentals as soon as they become vacant.”

Smith goes on to note economic developments in the region that will likely support a robust expansion of multifamily, especially in certain submarkets.

“I’d say that the biggest thing for Seattle moving forward is the transformation of South Lake Union and the development of Amazon’s growth,” says Smith. “They’re headquartered here, they are hiring like crazy, they’re supposed to build over a million square feet more than what they have right now, and a lot of developers want to capture some of that energy with housing around that corridor.”

Brenneke also sees key developments in the region that could bolster apartments in the near future, noting that the Pearl District in Portland and various “transitioning neighborhoods near the stadiums” are hotspots to watch. Properties in these areas are “very gritty and still affordable, but the potential is huge,” says Brenneke.

Shifting interest, attitudes

Like the rest of the country, the Pacific Northwest has seen an realignment in people’s perspectives of single family
homeownership versus renting, especially within the younger demographic. Yet it remains an open question if a renewed preference toward renting can last, especially in high-rent markets and submarkets.

“The interesting thing to look at going forward,” notes Smith, “is whether, with rents increasing, that will translate into some of these renters being taken away from apartments and made into purchasers for single family homes.”

Smith also points to a dramatic shift in values brought on not only by the most recent recession, but also by unique preferences among those in Generation Y.

“It used to be, you’d get out of college and the goal was to buy a house. Your parents preached it; everybody would say that’s what you should do,” says Smith. “Generation Y, they’re not owners. They tend to like to be renters. They don’t own a lot. They want to be mobile. They want to live in urban neighborhoods.”

Tom Brenneke believes the change that has occurred is the natural result of a previously flawed and naïve cultural mindset, and that the pragmatism of renting will keep it popular well into the foreseeable future.

“We’ve had an entire generation of first time homebuyers witness the stark reality that home prices can go down,” says Brenneke. “Politicians are finally beginning to appreciate that past liberal housing policies that encouraged homeownership ‘for all’ did a disservice to many who really could not afford it.  I believe the pendulum is swinging in favor of rentals and will continue to do so in the years to come.”

In terms of specific regional attributes that could keep the high supply of inventory afloat, Smith notes the unique preferences of residents in cities like Portland and Seattle and why apartments could remain strong there, regardless of what happens in single family.

“Seattle has actually become one of the cities on the West coast where you want to live in the core, and Portland may be going this direction as well,” says Smith. “People want to live in this downtown core. They want the urban amenities. They want to be able to walk; they want to be able to bike, despite our weather. They don’t really want to live in the suburbs as much.”