Washington’s Tech Boom Changes the Multifamily Investment Calculus
Washington and Northern Virginia are among the nation’s most expensive places to rent an apartment, which in part explains the billions of dollars being spent on apartment construction there. But Capital Area asset returns in the post-recession era haven’t clearly supported these decisions. From 2013 to 2018, rents in Washington and NoVA increased at respective compound annual rates of 3.2 percent and 2.6 percent, tabulating Reis data, materially slower than the 4.7 percent average growth recorded by the 50 largest U.S. apartment markets. Likewise, occupancy trends were no better than average, muted by heavy supply, suggesting that Washington NOI growth in most cases was measurably slower than in alternative markets.
But everything changed last year. Although Washington has been a technology player for decades, the region’s strengths fell primarily in telecom and defense, markets in which proximity to government was a competitive advantage. But the region’s growing prowess in private applications of digital technology reached critical mass in 2019 with Amazon’s decision to site its East Coast headquarters in Northern Virginia, specifically with a view toward tapping its deep reservoir of high-tech talent. The impact on economic growth in the capital is only beginning and seems likely to fundamentally alter the market’s investment calculus.
The first order condition was faster job creation, particularly in high-skill, high-compensation sectors. The pace of payroll job growth accelerated from 1.0 percent year-on-year in the spring and summer, well below the average for U.S. gateway markets, to 1.5 percent in the fall. The catalyst was exceptional growth in the professional, scientific and technical services subsector, wherein headcounts increased on a 16,800-job, 4.1 percent annual pace (accounting for nearly one-half of new jobs in the region), the fastest hiring in this niche since 2006. Rapid expansion among management and scientific consulting shops, professions of particular appeal for recent college graduates, was the principal propellant.
The second order condition was an apparent surge in small business and entrepreneurial activity. Total employment figures — which include the self-employed, gig economy and small business start-up workers not readily identified in Bureau of Labor Statistics (BLS) payroll surveys — increased on a 3.3 percent annual rate October to December, more than twice as fast as payroll employment. At the same time, the labor force (a good proxy for population) increased 3.2 percent year-on-year, nearly four times as fast as the same period 2018.
Thousands of these workers established households in metro apartments. Based on Yardi individual property surveys, tenants absorbed nearly 6,000 metro units last year, including about 4,000 in D.C., an amount equal to 3.8 percent of District inventory, demonstrating powerful space demand.
Rent trends accelerated commensurately. Same-store rents increased in January on 3.9 and 3.4 percent YoY paces in D.C. and NoVA, respectively, easily the fastest rates recorded in Yardi’s five-year data series. Surprising strength was evident in the Class A segment, where both D.C. and Suburban Virginia rents rose on rates around 4 percent in spite of the supply torrent, a testament to improving fundamentals.
RED Capital Research’s econometrically derived forecasts are improving as well, particularly in the District. Our models now expect D.C. effective rents to increase at 4 percent rates in 2020 and 2021, and at a 3.8 percent compound annual rate over our five-year forecast interval. Virginia rents are likely to advance on a more moderate pace, averaging about 3.0 percent through 2024.
Investment returns should improve accordingly. Model projections imply total returns in the 10 to 15 percent range for 2020 and 2021, with five-year expected unlevered returns in the neighborhood of 9.5 percent in D.C., and 7.8 percent in Virginia, each figure representing a significant improvement over estimates made at this time last year.
Investment sales activity increased apace. Buyers acquired multifamily properties valued at $3.7 billion last year, a single-year record for the market by 9 percent. Stabilized suburban gardens and infill District mid-rises were the favored targets, with the former trading at cap rates in the 5.0 to 5.4 percent range, and the latter to yields in the 4.5 to 4.9 percent vicinity, each offering relative value comparable to the most attractive primary markets, Seattle and the San Francisco Bay Area.
Investors deeply committed to the Capital region may have experienced a moment or two of doubt in recent years. But their market confidence promises to be rewarded in good time, and recent developments suggest the wait will not be long.
— 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 about the D.C./Northern Virginia market from RED Capital Group click here.