In the realm of apartment market research, Seattle represents a bellwether of sorts these days, where broader trends and themes can be parsed. Seattle’s economy, population and real estate landscape have grown at rates previously considered impossible in a primary market. The city stands at the veritable intersection of technological and generational change — the corner of Large Cap Tech Boulevard and Millennial Street — and it has developed into the avatar of the infill, wood-frame mid-rise design touchpoint that defines so much of today’s urban apartment architecture. What happens here will reveal some of the trends likely to follow in similar markets — from Raleigh to Portland.
Seattle was also the first major U.S. metropolitan market to grapple with the novel coronavirus, so the path that it follows will provide some insight into how the American multifamily market will mutate as we adjust to “life in the time of COVID,” to borrow a note from Garcia Marquez. By the same token, the Jet City faces the prospect of digesting an enormous multifamily supply pipeline that was, for the most part, conceived for the pre-COVID-19 world. The manner in which this supply is absorbed will speak volumes about how the primary and growth markets will fare over the next few years.
Most of the data available at this writing have a hopeful, if not entirely positive, tone: weaker than February but not evocative of a material erosion of market fundamentals. Same-store performance among properties stabilized at least 12 months surveyed by Yardi and tabulated by RED Capital Research show moderate declines in physical occupancy and rents across classes and submarkets, especially in the Class A segment. But so far, at least, there is no sign of a large-scale exodus from the urban core (Belltown, Capitol Hill, Queen Anne and South Lake Union), nor has material rent discounting been observed.
Occupancy among a sample of 869 same-store properties averaged 94.71 percent in June, a decrease of 40 basis points from the pre-pandemic February peak level. Under ordinary circumstances, Seattle occupancy would rise during the spring leasing season — last year sample occupancy increased 42 basis points from February to June — so performance was unquestionably weaker than normal. Still, absorption in this sample plus properties in lease-up and undergoing renovation was solidly positive in March and April and essentially flat in June. Occupancy attrition was not outside the range of typical summer/fall seasonal patterns. In short, with respect to space demand, the first four months of lockdowns were poor from a seasonal perspective but not outside the range of ordinary seasonal fluctuation.
Moreover, June sequential month trends showed significant improvement over May. Sample occupancy dropped only 7 basis points in June after suffering a 21-basis point dip during the previous month, and occupied stock of all properties declined only 7 units after plunging 299 in May. June gains emerged in spite of deteriorating trends in urban core neighborhoods, where tenants vacated a net of nearly 200 units, a phenomenon more likely attributable to downtown Seattle’s recent social and civil unrest than to COVID-19 concerns.
Rent trends followed a similar pattern. Average same-store unit rent in June was 1.54 percent below the February level and 0.33 percent lower than the year-ago comparison (1.12 percent for Class A in February). As with occupancy, sequential month rent trends also exhibited modest improvement, having declined 0.43 percent in June, after respective 45 and 48 basis point decreases in April and May.
Again, the urban core hampered overall performance. Core rents declined 2.66 percent from February to June, including a 71-basis point sequential month drop in June — a retreat but not a disorderly collapse of the phalanx.
Not surprisingly, property markets nearly ground to a halt. Only five multifamily investment sales were closed in the second quarter and two of these involved affordable properties. Still, the public health issue seemed to have little impact on pricing as purchase cap rates applicable to each of the market-rate transactions appeared to fall below 4 percent, impressive levels even by pre-coronavirus standards.
What lessons can we learn from Seattle’s spring performance? First, it is clear that the pandemic will affect American apartment market performance, even in the most dynamic markets. Also, space demand in core urban areas is declining at a faster than average pace: lease-up at new infill product is likely to be sluggish. Still, revenue decay has not been as great as some feared nor is it likely to dramatically deteriorate so long as the economy stays on a V-shaped recovery course.
Indeed, RED Capital Research’s historically specified models project that average Seattle effective rent is likely to stabilize by late-2020, and that rents will return to pre-pandemic levels during the second half of 2021. Most probable prospective unlevered annual returns remain near 8 percent, even for acquisitions made six months ago. In other words, investors have cause for concern, but the most likely outcome is benign, even in the most densely populated urban centers.
— By Daniel J. Hogan, ORIX Real Estate Capital’s Managing Director for Research. RED Mortgage Capital, a division of ORIX Real Estate Capital LLC, is a content partner of REBusinessOnline. The views expressed herein are those of the author and do not necessarily reflect the views for RED Capital Group or of the author’s colleagues at RED. For further analysis from RED Capital Group, click here
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For Hogan’s insight into other markets, click here.