Staying Strong

By Philip Shea, Associate Editor

As markets across the country continue to strengthen, one region that has been relatively constant in its robust performance has been the Mid-Atlantic—Washington, D.C., in particular. While not necessarily unaffected by the financial crisis, the toll of the weak economy on occupancy and rent has been minimal as compared to the rest of the nation, and the prospect for continued expansion is all but assured.

“The D.C. market has been a leading market in terms of its tightness and rent growth over the last cycle,” says Drew White, principal in Apartment Realty Advisors’ D.C. office. “It still looks like we’re roughly going from a 3 percent vacancy to a 3.5 percent vacancy marketwide. So it has somewhat softened a bit, but still, most markets in the country would love to take north of 96 percent occupancy.”

Additionally, while product in all asset classes and across most submarkets have been performing well, the higher-end units continue to perform best as the D.C. metro maintains its popularity with young professionals who are not yet interested in entering the single-family market.

“Class A and B assets in this market in good locations do tend to be in the highest demand, and I think a lot of that goes back to when you look at the demographics of the people who live here, who move here, who come here to work—it’s a highly educated population,” says White. “Class A rents [have] the [fewest concessions] if you take out the effect of the lease-up.”

Toby Bozzuto, president of the Bozzuto Development Co. based in Greenbelt, Md., agrees that Class A is the market’s prime product but notes some specific characteristics that are key in terms of attracting residents in this type of city.

“I think that there will still be some good opportunities specifically with Class A apartments that have attributes like proximity to transit, walkability and mixed-use,” says Bozzuto. “Projects that are anchored by grocery or interesting retail—something that’s got more [appeal] than an apartment in the middle of nowhere.”

Yet while strong performance in this and other multifamily products has been quite reliable over the past few years, Bozzuto cautions that the next few years may bring a new wave of supply—and thus an intermittent increase in vacancy—as a backlog of projects in the city’s construction pipeline are finally developed.

“What we’re starting to see is the delivery of a relatively massive pipeline of product,” says Bozzuto. “What I think will happen is that rents will plateau, and maybe we’ll begin to see some concessions, but that will be a temporary phenomenon—maybe a year or two—until all of these new apartments are absorbed.”

White expects the same and believes that, since prospects for employment across the metro remain favorable, the only threat to occupancy is the exceptional size of the current pipeline and the likelihood of numerous deliveries over the next couple of years.

“[There will] either be massive pullback in job growth or massive increase in supply, and I think that what we’re going to have here is primarily the latter,” says White. “When you look at the pipeline of deals in Washington D.C., it’s up tremendously. It went from roughly zero in 2010 to, in the early part of 2011, having something like 35,000 units in the next three-year horizon.”

In terms of surrounding metros in states like Maryland and Virginia, Bozzuto is noticing roughly the same trends and believes that cities like Baltimore represent tremendous opportunities. And while the current construction pipeline is certainly daunting, he believes that some areas will fare better than others.

“I would say it’s very, very similar. They all have some unique characteristics, but everything across the board has been very healthy,” says Bozzuto. “I think there are certain submarkets where, regardless of the massive pipeline, there are some neighborhoods that don’t have anything going on.”

Indeed, Bozzuto Development is taking advantage of the favorable conditions in certain areas and developing unique, high-end properties it believes will effectively cater to the professional-type renter that has come to characterize the market. And the number one tool in the quiver, according to Bozzuto, is design.

“If there was a particular angle that I’m excited about right now, there’s a project in Baltimore called Union Wharf,” says Bozzuto. “I have been pushing as a part of our company culture that design matters, and I think that providing an exquisitely designed community will help us attract the very limited renters in the market by providing the best value and best design.”

Indeed, the city of Baltimore represents a valuable opportunity for developers of Class A communities, as the average rent in this metro recently topped $1,760 per month.

Additionally, another city that is becoming conducive to high-end product is the urban Philadelphia market, with rents there averaging $2,227 in 2012. While vacancy in the MSA is currently at 3.5 percent, the rate for Class A product in the central part of the city is far lower—at 2.6 percent.

Ron Brock, president and CEO of multifamily research firm Pierce-Eislen, notes that there is a significant departure in market dynamics between the urban and suburban portions of Philadelphia, and that while rent changes in the two areas were stable among renters-by-necessity, there were greater fluctuations among discretionary renters in the suburban areas.

“In the suburban area, rents for discretionary renters increased $59, or 3.9 percent,” says Brock. “The two top asset classes are [those that serve] “lifestyle” renters, who rent because they choose to rent, and they’re willing to pay. For the very top end, which is “discretionary,” which is wealthy empty-nesters, there really wasn’t that much of a change [in the urban areas].”

Brock notes that, overall, Philadelphia is a relatively “slow-growth” and “stable” market, and that any changes in vacancy and supply tend to be predictable. In terms of what’s happening now, there appears to be a steady increase in the supply of market-rate apartments, while delivery of affordable housing seems to be lagging behind.

“There are 20 properties under construction, 3,384 units. Of that total, 13 are market-rate, 2,868 units. So that makes it about 85 percent of what’s under construction,” says Brock. “There are also five fully affordable properties, 282 units, not nearly enough to handle the market’s requirements.”

In terms of the best opportunities for investment in the “City of Brotherly Love,” Brock says that every firm and investor is unique and that the market has numerous opportunities for a wide array of speculation and interest.

“It depends on who you are,” says Brock. “The general thought about an investor’s interest is kind of like a thumbprint—everyone’s is different. If you’re a REIT, you might want to rethink urban and go to suburban, based on what we’re seeing in rents. If you’re an added-value investor, then you want to look at the low-B category and also the blue-collar in good locations.”