By Kevin Assef, Marcus & Millichap
The diverse markets comprising the Western commercial real estate region have been impacted in varying degrees by the credit crunch and subsequent devaluation of the U.S. dollar that manifested itself in the last half of 2007. Despite fallout from the subprime mortgage crisis, prices for well-located Class A product have remained relatively stable and will continue to increase steadily in 2008, particularly in cities such as San Francisco, Los Angeles and Seattle. Investors will monitor smaller, secondary markets and the performance of Class B/C assets closely this year as pricing shifts become more apparent.
APARTMENT INVESTMENT TRENDS
Renter demand for Denver apartment properties will remain strong in 2008, supported by an expanding pool of renters and the metro’s fifth consecutive year of healthy employment growth. While job gains will be more modest in 2008 than in recent years, population growth will generate additional renter demand, with an annual average of 29,000 new residents forecast to enter the metro in the next 5 years. On the supply side, apartment builders will accelerate construction activity this year, particularly in the Aurora-South submarket, where deliveries will result in a 5 percent inventory gain by year’s end. Higher levels of condo construction, some of which could ultimately enter the market as shadow-rental stock or high-end rentals, may provide some competition for apartment owners, especially in the Denver-North area.
Apartment properties in Los Angeles are expected to record strong performance in 2008 due to tight operating conditions and low housing affordability. Layoffs in housing-related industries have slowed employment expansion in recent quarters, but job growth is forecast to accelerate slightly this year, supporting renter demand for apartments. In addition, the income required to purchase the median-priced home is nearly $100,000 higher than the metro’s median household income, and with credit for marginal buyers essentially nonexistent, the transition from renting to owning has become more difficult. With homeownership out of reach for the foreseeable future, some renters will look to upgrade into high-end apartments, particularly in the west side cities, which are expected to record the metro’s strongest absorption and lowest vacancy rate by year-end 2008.
Strong population growth and uncertainty in the local housing market will sustain renter demand in 2008, positioning the Phoenix apartment market to record relatively healthy performance. The metro’s strong long-term demand drivers, including the projected addition of 40,000 new households annually in the next 5 years, supports a positive forecast for apartment fundamentals in the years to come. However, some pockets of the market, such as the rapidly expanding Chandler/Gilbert submarket, have an excess of newly built single- and multifamily homes that may compete with top-tier apartments until the housing market begins to rebound. The shadow-rental market will cause metrowide vacancy to push higher in the near term, and concessions will likely return closer to historical norms. The renter pool is expected to continue to expand, however, as tighter residential mortgage requirements and the resetting of adjustable-rate mortgages create a climate where current renters are hesitant to leap into the for-sale market.
San Francisco’s healthy economy is driving apartment demand, as both employment and population growth are forecast to record increases in 2008 that are considerably higher than the metro’s long-term averages. The market’s very high desirability among renters and active hiring in its largest employment sector — professional and business services — will continue to support apartment demand. Housing affordability remains among the lowest in the country, forcing many of San Francisco’s new residents into the renter pool. Development costs are elevated to the extent that few apartment properties are brought online, as builders instead choose to construct for-sale condo units and office space. Given the metro’s healthy demand drivers and lack of significant new apartment construction, metrowide vacancy will tighten in 2008, with the Haight-Ashbury and Outer Richmond/Sunset submarkets recording the strongest improvements. In turn, occupancy gains this year will provide apartment owners leverage to aggressively raise rents.
Economic growth in the Puget Sound area will be among the strongest in the nation this year, creating renter demand for apartments and driving hearty rent growth. Local employers, particularly technology companies such as Microsoft, Yahoo and Google, are aggressively leasing large blocks of office space in the eastern parts of the metro and expanding payrolls at a healthy pace. In the next 5 years, growth will be concentrated in the 20- to 34-year-old age cohort, which should expand by 86,000 residents, a rate that is nearly twice as fast as the metro’s total population growth. This age group is increasingly drawn to the benefits of downtown living and should provide sufficient demand for apartment properties in the market’s core growth areas, including the Downtown/Capitol Hill and North Seattle submarkets. Several high-end condo developments are under way downtown, although these units are unlikely to compete with apartments due to the wide gap between renting and owning in the submarket.
OFFICE INVESTMENT TRENDS
Developers in 2008 will deliver double the metro's 5-year average, after several years of relatively limited supply growth. Although office-using employment growth is expected to slow to its lowest rate since 2003, years of built-up tenant demand for new space will result in healthy absorption of new supply. In recent years, robust rent growth in the Mile High City’s Class A properties has created spillover demand into the lower tiers. As additional competing space comes online, absorption in Class B/C assets is expected to slow. Overall, vacancy will increase modestly to the mid-15 percent range. New construction will have the greatest impact in the Midtown and CBD submarkets, which are projected to receive nearly half of the metro's completions this year. Due to stiffer competition, the steady decline in vacancy the CBD submarket has recorded in the last 4 years will be reversed in 2008. Absorption is expected to remain strong along the rapidly growing Interstate 25 corridor; most notably the Southeast submarket is forecast to post a 350 basis-point improvement by year’s end, building on last year's 120 basis-point decline.
Modest economic expansion in 2008 will continue to support tenant demand for office space in Los Angeles County. Employers are expected to add jobs at a fairly steady pace, and the metro will record another year of positive absorption, albeit more modest than in 2007. Construction activity will pick up in 2008 after a lull last year; however, deliveries will be concentrated in the San Fernando Valley. The area, which features one of the tightest vacancy rates in Los Angeles County, will receive more than 1 million square feet of new space this year. Elevated deliveries will push metrowide vacancy slightly higher in 2008 after 5 consecutive years of occupancy improvements, although supply-constrained areas such as the west side cities and Long Beach/South Bay will receive minimal new construction, and conditions in these submarkets should remain tight.
Modest economic growth will continue to generate tenant demand for Phoe