Midwest Apartment Market on Rebound

Apartment fundamentals in Chicago, Kansas City and St. Louis indicate a bounce back from previous lows.

Source: Reis Inc., Apartment Realty Advisors

Despite subdued job growth and employment statistics, the Chicago multifamily market is rebounding very satisfactorily, posting the best rent growth, occupancy and demand driver statistics since 2008.

The downtown and principal suburban investment-grade multifamily markets consist of about 575 properties with 162,000 units. The downtown market represents about 18 percent of inventory, while suburban properties are located in South and West Cook, DuPage, Lake and other suburban counties that are included in the Chicago Metropolitan Statistical Area. Properties in both sectors report that apartment demand is increasing, resulting in higher occupancies, increasing effective rents and declining concessions.

The downtown multifamily market struggled with unsold condo inventory in 2008 and 2009, which put downward pressure on both pricing and occupancy. Demand strengthened in 2010, resulting in 94 percent occupancy for stabilized properties, up from 93 percent in the second quarter of 2009. Effective rents for stabilized properties are $2.11 per square foot, 3 percent higher than last year. Concession loss is subsiding, even at high-end properties in initial lease-up. Discounts for stabilized properties average about 8 percent, or one month’s rent, while properties in lease-up are offering slightly higher discounts, averaging about 1.5 months’ rent.

Source: Appraisal Research Counselors, Apartment Realty Advisors

Suburban effective rents grew 6 percent over the past year, reaching $1.13 per square foot in mid-2010, their highest level since early 2007. Average occupancy grew to 93 percent, 200 basis points higher than this time last year. Concessions are still in place, but we rarely see discounts totaling more than one month’s rent. An increasing number of properties are using lease rent optimizer systems, which incorporate concessions into asking rents.

Rent and occupancy statistics are encouraging, especially in the face of underwhelming job loss and employment figures for the Chicago metro. Almost 70,000 jobs—most of them in the construction and business services sector—were lost between the second quarter of 2009 and 2010, for a decline of 1.9 percent. July 2010 unemployment stood at 10.5 percent, only 0.1 percent less than one year ago and higher than the overall national average of 9.5 percent. However, most economists project that the bad news will subside by the end of the year and that Chicago will enjoy job growth through 2012. More good news: the MSA’s population, real personal income and total employment growth statistics are all projected to be positive at year-end 2010 for the first time since 2007.

As in all other Midwest markets, Chicago’s new construction, both downtown and in the suburbs, slowed to a trickle in 2008 due to turmoil in the lending markets. New deliveries were scarce in 2009, totaling only 550 units. In comparison, about 2,400 units are expected to be delivered by the end of 2010, mostly in downtown submarkets such as River North, the Loop and the northwest Loop. About 49 percent of new deliveries downtown have already been absorbed, and properties should reach stabilized occupancy (95 percent) by the fall of 2011.

Absorption is further strengthened by the scarcity of upcoming approved projects. Very few new developments have been announced. An estimated 1,200 units are proposed for downtown, with start dates delayed until the end of 2011 or later. In the suburbs, proposed projects face barriers to entry, which include municipalities’ preference for condominium construction and the lack of sites suitable for multifamily development.

Multifamily sales transactions peaked in 2007, when volume totaled almost $2.5 billion. Volume in 2008 declined to $725.7 million, with 2009 sales totaling only $395 million for about 4,000 units.

This year has brought the beginning of recovery, with increased availability of financing from agencies (Fannie, Freddie), HUD and life insurance companies, renewed interest by REITs and other institutions, as well as the return of equity to the market. Year-to-date 2010 transactions total about $277.5 million for 2,800 units, with an additional 1,500 to 2,000 units estimated to close by the end of the year. The beginnings of market recovery is illustrated by the second-quarter 2010 sale of Burnham Pointe, a South Loop tower that was converted to rentals from condos before it was completed in 2008. The $88 million sale price ($295,300 per unit) represents a 4.8 cap rate on trailing income, demonstrating investor confidence that rents and occupancies will continue to strengthen.

Whether located downtown or in the suburbs, limited product is on the market now. Downtown offerings are limited to condo developments that were unable to sell out and were converted to apartments. Many projects are underwater, and the market continues to see condos being sold at bulk prices. Nevertheless, the lack of available properties and encouraging multifamily economic indicators are holding cap rates at low levels. The cap rate for the Burnham Pointe sale was 100 basis points lower than the lowest 2009 downtown transaction, and suburban trades are reported at sub-6 percent caps, 100 to 150 basis points lower than last year.

Rents, occupancies and concession loss recovering to pre-recession levels, near-term job growth, healthy absorption supported by scarce new development, low-interest debt and the return of homebuyers to the rental market all point to continued improvement in both the downtown and suburban Chicago multifamily markets.

Safe in Kansas City

By Mac Crowther, principal,
ARA-Central States

The greater Kansas City apartment marketplace is arguably one of the healthiest in the country, in terms of the condition of its overall economy, as well as its apartment fundamentals. While Kansas City has not been immune to the effects of the national recession, it has weathered the storm quite well in comparison to other cities in the country.

The metro’s overall unemployment rate is 8.5 percent vs. the national average of 9.6 percent, with some submarkets as low as 5.9 percent, i.e., Johnson County, Kan. Population growth for 2010 is projected to be positive at 1 percent, and 2011 is forecasted to be even stronger. While job growth for 2010 is expected to be somewhat flat, 2011 is expected to be positive. The city’s diversified employment base helps generate these positive numbers. Most all of the major employers are doing quite well, i.e., Cerner, Kansas City Southern and DST.

The overall physical occupancy for Kansas City is 93 percent. More specifically: Class A is at 94 percent to 95 percent-plus; Class B is at 92 percent to 93 percent-plus, and Class C is achieving between 90 percent and 92 percent-plus. These occupancy numbers have occurred due to historically positive annual job growth, albeit before the recession hit, and a less-than-robust level of new development, except for one submarket, the Northland.

Rent concessions are limited, especially in comparison to 2008 and 2009. Most well-run properties are not offering concessions. The typical range of concessions that these complexes are offering is between 2 percent and 8 percent of gross market rent. Expectations are that occupancies will continue to be strong and even improve, while overall concessions will be reduced.

A number of complexes have experienced a rent reduction, or flat rents, for the past two years. However, many A and B complexes in submarkets like Johnson County, the Northland and Eastern Jackson County (Lee’s Summit) have and continue to benefit from 4 percent-plus annualized rent growth. Overall rent growth is expected to improve over the next year.

Capitalization rates in Kansas City have been fairly comparable to other cities throughout the United States, except of course, normally more aggressive regions, i.e., California.  At present, cap rates that are being generated are Class A—5.5 percent-6.5 percent; Class B—7.25 percent-7.75 percent; Class C—8 percent-plus. These cap rates assume stabilized complexes and trailing 12 months actual performance. Capitalization rates are expected to continue to fall due to increased competition to acquire assets and the dramatic recent reduction in interest rates.

What most investors are assuming will occur in Kansas City over the near term is quite positive. Population and job growth is expected to get back on track and produce positive numbers. The unemployment rate will decrease and continue to be lower than the national average. Occupancies will continue to be good and even improve. Concessions will be less prevalent. Rent growth, overall, will be at least 3 percent, with 4 percent or better for Class A and B complexes located within investor preferred submarkets. Kansas City will continue to be a safe, predictable and lucrative place to acquire apartment communities.

St. Louis’ Fragile Demand

By G. Reid Teaney, senior vice president, ARA-Central States

St. Louis’ unemployment rate, per the Bureau of Labor Statistics in July 2010, is reported to be 10.1 percent, an increase from the June rate of 9.9 percent and the May 2010 rate of 9.2 percent. The national unemployment rate sits at 9.6 percent at this time. This report is not consistent with the earlier Moody’s Economy.com prediction of flat employment in 2010 followed by a boom in 2011 and 2012. Most of the jobs have been lost in the manufacturing sector, specifically the automotive industry and the suppliers that are supported by auto manufacturing demand.

There are about 120,000 multifamily units in the St. Louis market, and fewer than 200 units are anticipated for delivery in 2010. Overall occupancy in the market hovers around 91 percent, with rental growth estimated to be just under 1 percent, annualized for this year, and 2 percent for 2011 through 2014, according to Reis.

Concessions have been dwindling and are starting to cease in stronger submarkets like West County. We anticipate that effective rents will be stronger in the last quarter of 2010. Demand is fragile in the St. Louis market as the median age is 36 and most apartment dwellers are reported to be in the age range of 20-34 years of age. That target age group is expected to grow at a slow pace over the next five years.

Few quality assets are on the market. Transaction velocity has been slow, with only three major trades taking place in 2009 and two so far in 2010. There have been some distressed dispositions where the assets traded in the range of $13,000
to $23,000 per unit. Cap rates for both Class A and Class B are in the 7 percent and 8 percent range, respectively.

We subscribe to the conventional opinion that more assets will be coming to market before the end of 2010. With performance measurements improving and the debt markets becoming more attractive, more deals will become attractive for both buyers and sellers. At press time, there were five Class A and Class B institutional-grade multifamily assets active in the market.

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