For the remainder of 2018, positive demand drivers will alter new apartment supply’s impact on operations in Louisville. The metro has had a large volume of new apartments to open this business cycle. Since 2013, an annual average of 1,500 units has been completed, totaling approximately 7,400 apartment units. As this new supply entered the market, initially strong leasing helped push vacancy down 100 basis points to 4.6 percent at the end of 2016.
However, absorption of apartments softened last year as new units continued to open, lifting vacancy back up 90 basis points to 5.6 percent. This year, approximately 2,800 apartment units will be completed, further testing demand for luxury rentals in Louisville. A team of factors should fuel positive absorption, preventing an alarming uptick and keeping the vacancy rate in the mid-5 percent range.
Payroll expansions by tech firms, manufacturing companies and hospitals will support consistent year-over-year hiring and income growth this year. Sub-4 percent unemployment suggests employers will recruit from outside the market to fill open positions or hire recent graduates from the University of Louisville and other local colleges.
Colby Haugness, Marcus & Millichap
These job gains should increase the rate of household formations and bolster the market’s millennial base, an age cohort with a well-documented propensity to rent. As the lease-up of these new apartments continues, market demand will push the average effective rent up 3.4 percent to $855 per month, a softer pace this year than previous years in the cycle.
The Southwest Louisville submarket will welcome the largest concentration of new apartments, receiving just over 830 units this year. More than half of these have been completed during the first half of 2018 as slightly over 730 units were leased, pushing this submarket’s vacancy rate down 100 basis points to 3.5 percent as of June. This is the lowest average vacancy rate in the market, revealing strong rental demand. Yet the average effective rental rate remains essentially the same compared with last year — in the low $700s per month.
The minimal increase is due in large part to a decrease in effective rents for assets built prior to 1979. Operators of these units have pushed up concessions to lure tenants back to these properties.
The Northwest and South Central submarkets also had an average sub-4 percent vacancy rate this past quarter, standing at 3.8 percent and 3.7 percent, respectively. The average rental rate in each of these submarkets has increased by almost 3 percent.
The submarket with the highest vacancy rate is Central Louisville, where the second-quarter rate lifted 130 basis points over the past year to 7.8 percent, as approximately 525 units opened. Due to softening rental demand, Central Louisville is the only Louisville submarket to drop rental rates, falling by 4.9 percent since last July. This is largely attributed to the 10 percent year-over-year drop in the average monthly effective rent within properties built before 1970. These vintage assets comprise one-third of the submarket’s inventory, the largest composition of this niche in the market.
As vacancy remains tight and apartments’ revenue stream continues to be strong, out-of-state investors jockey for larger listings as local buyers broaden their investment radar. Investors are targeting core and suburban properties at an average cap rate of 7 percent. Buyers from outside the metro are pursuing newly built Midwest assets with 200-plus units in the East End at low-5 percent yields.
Regional value-add firms are drawn to South Jefferson County, acquiring larger Class C assets at mid- to high-7 percent returns while rental development remains limited. Increased competition in this area is moving some local buyers to also target opportunities in Shawnee and Crescent Hill, where sub-25-unit properties frequently sell for less than $50,000 per unit, significantly below the $90,000 per unit average for the metro.
Downtown neighborhoods, most notably Old Louisville, represent an additional focus for in-town investors seeking a mix of vintages and above-average yields.
— By Colby Haugness, Regional Manager of Louisville and Cincinnati, Marcus & Millichap. This article originally appeared in the September 2018 issue of Southeast Real Estate Business.