About 31,000 apartments units will be built in the Seattle area from 2013-2015, that’s more than were built in the last nine years.

By Seattle Business Magazine August 5, 2013

Kidder Mathews has released a real estate market review that shows vacancy rates in Seattle are falling while construction of new apartments is steadily rising:

The regional market vacancy rate is currently 3.8%, below the long-term average of 5.3% indicated over the past 20 years. The regional vacancy rate last peaked at a rate of 7.2% in Fall 2009 then fell sharply through 2010 to a low of 4.6% in the Spring 2011 survey. Vacancy briefly increased 70 basis points to 5.3% in Fall 2011, due to normal seasonality plus new inventory hitting the market, but has since fallen to the current 3.8%. Rental rates have recovered to well above prerecession levels and both use and quantity of concessions have decreased, resulting in increasing overall effective rents.

The ongoing favorable market performance in the apartment sector has been attributed to several demand factors including:

Changing rent vs. own psychology, where potential home buyers are remaining in rental properties due to longer term lack of confidence in the home market brought on by the foreclosure crisis.

Return toward traditional lending regulations with large down payment requirements has postponed many home puchases and will likely keep a portion of the population as renter households.

Recession has relieved many qualified households of their savings, pushing off home affordability.

Many younger households prefer the mobility of renting, especially in a slow home sales market.

Households age 25 to 34 are expected to dominate growth over the next five years and this group is traditionally mostly renters.

These factors point toward continued demand for apartment units over the next few years, especially better quality apartments, given renters are looking at longer stays, justifying a flight to quality.

The number of new homes and new lots brought to market is at an all time low and the number of new applications is at an all time low. According to analysis provided by New Home Trends, the near term supply is not adequate to meet demand as home buying has gained momentum.

The likely outcome is increased demand for rental housing. In addition, there will likely be some loss of apartment inventory as conversions of newer or planned apartments to condominiums are likely to provide entry level units as the for sale market continues to recover.

New apartment development has accelerated and this trend is expected to continue over the next three years. In 2012, an estimated 6,075 new units were completed. New development has ramped up and is anticipated at about 8,382 new units for 2013. Currently, there are 11,774 units under construction and another 20,698 planned over the next four years for a combined future potential of 35,428 units (2013 through 2016). Although vacancy has remained at very low levels for the past two years, accelerating future apartment deliveries should begin to put upward pressure on the market vacancy.

Based on the latest new unit delivery timelines projected by Dupre+Scott, our forecast predicts the regional vacancy peaking at about 6.4% by mid 2015. As these new units are delivered, it is expected that use of concessions will temporarily increase and rent growth will moderate as these new units make their way through the system.


Vacancy Trends

According to the Spring 2013 Dupre+Scott Vacancy Survey, the regional (five county) vacancy rate is estimated at 3.8%. This is a measure of market vacancy that excludes units in lease-up and those undergoing significant renovation. Including these units, the gross market vacancy is 5.2%.

Vacancy rates generally have an inverse relationship with changes in rent; as vacancy rates increase the rate of rent growth generally decreases. Over the past twelve months the average regional rent on a per square foot basis increased from $1.21 to $1.28/s.f./month (5.8% increase) in tandem with vacancy falling by 90 basis points.

Over the last 20 years, the regional market vacancy was as high as 7.5% in March 2003 and as low as 3.6% in September 1997. Historically, the regional vacancy has averaged about 5.2%. Our baseline forecast predicts the regional vacancy peaking at about 6.4% by mid 2015 based on the latest anticipated new unit delivery timelines projected by Dupre+Scott. As these new units are delivered, it is expected that use of concessions will temporarily increase and rent growth will moderate as these new units make their way through the system.

Rent Rate Trends

The King-Seattle sub-region (All Ages) has the highest rent levels achieved at an overall average of $1.87/s.f./month. Over the past 12 months, the percentage of property managers anticipating increasing rent has remained constant at 69% to 74% of those surveyed, with an average growth of 2.8% anticipated over the coming six months.


Concessions

Properties offering concessions have also remained mostly even at between 20% to 26% of those surveyed. Regionally, the average giveaway is currently $480 (averaging about 1.8 weeks free rent).

Current Inventory/Supply

Currently, there are an estimated 244,600 market rate units in complexes with 20 or more units in the five county region. King County has the largest proportion, with 60.9% of all existing units, followed by Pierce County with 18.1% and Snohomish with 13.5%. The smallest sub-region is Kitsap County with 3.0% of the regional supply.

Historically, new construction peaked from 1985 to 1991 with more than 86,000 units delivered during this period; equivalent to 14,333 units per year on average. Excluding this exuberant period, the rate of new construction delivered has averaged about 3,600 units per year over the past 30 years.

The region is currently experiencing another period of expansion. In 2012, 6,075 units were delivered by year end (reflecting an addition of 2.5% to the existing housing stock), 8,382 units (3.4%) are planned for 2013 delivery, 10,143 units (3.9%) for 2014, and another 12,228 units (4.5%) in 2015. The total growth over the next three years is 11.8%, compared with projected job growth of 7.5%.

Offsetting new construction is the loss of apartment units that have been demolished or converted to another use. Since 1990, these have averaged 985 units per year, excluding the period from 2005 to 2007 when the rate spiked to an average 5,901 units per year, decreasing the overall apartment inventory. This loss of units was mostly driven by condominium conversions, which grew from about 30% of removals to more than 80% during this period.


Projected Future Supply

A total of 6,075 units were completed region wide in 2012. That number is set to increase significantly in the next three years.

As apartment construction became feasible, developers first looked for sites already entitled or with plans that could quickly be finalized, as being first to market was important in this phase of the cycle. That window has now closed and buyers are willing to entitle their own sites as they look past the peak in 2015 with developers working on 12,228 units for delivery that year (4.5% of existing supply). It is expected that most projects due in 2014 will be completed as almost all are already under construction or nearing a start. The additional inventory is expected to apply gradual upward pressure to the vacancy rate as deliveries mount later this year.

Most planned new construction has been focused toward the core urban metropolitan locations where job growth has been focused, new houses and condos are scarce, and existing infrastructure is present. Of the more than 35,428 future potential units planned over the next four years (2013 through 2016), 31,025 units (87.6%) are located in King County. Of these, 19,864 units (64.0%) are in the Seattle sub-region.

Estimate of Future Apartment Demand

The latest employment figures for the greater Puget Sound region by the Puget Sound Economic Forecaster and the Thurston Regional Planning Council report that there are approximately 1.946 million jobs in the region and about 240,100 occupied apartment units (in projects over 20 units) based on the latest survey figures. This translates into a demand factor of one occupied apartment for every 8.1 jobs. Considering that fewer sub-20 unit apartment projects are being built in the recent and future market, it is likely that will change as more demand is sent to the larger complexes.

Its difficult to handicap which proposed projects in future years will be completed. Mike Scott of Dupre+Scott has been quoted that their projections for one year are pretty accurate because most of these units are already under construction. However, projections two to three years out are typically off 20-40% or more. Our forecast applies baseline, optimistic and pessimistic assumptions to the projected apartment completions. Our baseline forecast applies an 80% completion to planned projects; our optimistic forecast applies a 70% completion rate; and our pessimistic forecast applies 90%. Units that are already under construction are assumed to be completed and added to the existing stock. Based on current demand factors along with anticipated employment projections, our forecast predicts baseline vacancy peaking at about 6.4% by mid 2015. As these new units are delivered, it is expected that use of concessions will temporarily increase and rent growth will moderate as these new units make their way through the system.


Demand Drivers

Our forecast is a function of both the timing and magnitude of the economy principally relating to employment growth. With future apartment demand primarily a function of employment and population growth, future economic forecast changes (even modest) would impact future demand projections. The other item impacting future demand is the amount of inventory delivered. At this time, we can reasonably assume that projects already under construction will be completed. Timing and completion of planned projects in 2014 and beyond are less certain and carry a higher degree of risk.

Another driving factor that will influence future apartment demand, especially on the investment side, is interest rates which are currently at an all-time low. This is a function of the federal government artificially keeping rates down through bond purchasing in an effort to stimulate the overall economy. As the economy improves and unemployment drops, support of low interest rates at the national level will diminish and rates should begin to increase. Overall capitalization rates trend with interest rates and available financing, which would then influence pricing and investment activity.

Investment Inventory

Sales velocity peaked in the Puget Sound Region in 2005 with 268 sales ($2.65 billion in volume). The pace moderated in 2007, although the price per unit increased and economic indicators were flat. In 2008, the number of sales swiftly dropped, and by 2009 the region ended the year with 53 sales reflecting a combined sales volume of about $333 million. This compares to the $1.53 billion in sales in 2008 (107 sales), reflecting a decrease in transactional volume of 78% over this period. This was a result of difficulties in attaining financing as well as reaching a middle ground between buyers and sellers.

Institutional investors returned to the market in 2010 with over a dozen major sales and capitalization rates back to the 5.0% range for close-in newer vintage properties. These buyers were responsible for the majority of the dollar volume in 2012. This trend is expected to continue through 2013 as these buyers continue to place Seattle at the top of investment lists for its strong economy and barriers to entry that limit new construction.

Regional Conclusion

The regional apartment market appears to be reaching the pinnacle of its ascendant phase of the real estate cycle. The general long-term outlook for the Puget Sound region continues to be better than most markets nationwide and it is expected that the peak may be more of a plateau. Rental rates have returned to historic highs and use of concessions is minimal in most markets. In response, new development has ramped up with an estimated 8,382 new units expected during 2013. Currently, there are more than 11,774 units under construction and a total of 20,698 targeting delivery in 2014 through 2016. Although vacancy has remained at very low levels for the past two years, accelerating future apartment deliveries should begin to put upward pressure on the market vacancy.

Based on these latest new unit delivery timelines projected by Dupre+Scott, our forecast predicts the regional vacancy increasing to about 6.4% in mid 2015. As these new units are delivered, it is expected that use of concessions will temporarily increase and rent growth will moderate as these new units make their way through the system.

Contact:

Jeffrey S. Lyon, CCIM, SIOR

Chairman and CEO

206.296.9600

[email protected]

The information in this report was composed by

the Kidder Mathews Valuation Advisory Group.

Jeremy Streufert and Gary Klockenteger, MAI

206.296.9600

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