Published August 2002

Rental properties maintaining their value

“During good markets, it seems I spend my time trying to figure out when it’s going to end. During bad markets, it also seems I spend my time trying to figure out when it’s going to end. There’s only about four months in between where I actually relax.”

These are the words of a longtime real estate investor colleague of mine who summed up his experience in the investment real estate market over the past 25 years. They are words that probably describe any market, of course, as markets are always in a state of flux and there’s potential for gains or losses at any point along the way.

Although the operating performance of many income real estate sectors in the Puget Sound are soft right now, investment real estate still presents a relatively stable picture over the long term.

In fact, buyers of institutional grade apartment product are rather numerous still today even though operating performances have been soft in recent months. In deference to the logic of sales values being proportionate to net operating incomes, values haven’t dropped despite flat or, in some cases, reduced net operating incomes of late. Certainly, this seems to be the story for apartment product today.

The low cost of borrowed funds for most investors adds an element of attraction as well. Under today’s market circumstances, the buy strategy is to accept modest initial returns on your investment because of soft front-end operating forecasts, but benefit from “locking” your cost of funds today with a fixed-interest-rate loan on the theory that the operating side will turn around at some point.

Locking low and gaining leverage on the market when rents increase again feels good to many investors. Time will tell if they are right, but the logic of this approach is certainly sound and is driving buyers’ moves and holding up values despite a rather anemic operating return outlook for the remainder of this year.

Consequently, if you own rentals today and are finding vacancy problems or struggling a bit on the bottom line, at least take comfort in knowing that the value of your property, if you sold, probably hasn’t gone south.

Of course, if the local economy lingers in flat or recessionary patterns for more than another six to nine months, then it’s possible values will start to decline a bit at that point. An increase in interest rates would most certainly cause a reduction in values, too, and much more quickly as buyers’ cost of borrowed funds increases.

The Puget Sound offers one other rather unique feature that motivates buyers as well and explains why sales prices are holding up relatively well. Our state’s Growth Management Act combines with other natural physical limits to growth (think wetlands) to have the effect of adding cost to any proposed development.

It’s good to protect the environment, but it shouldn’t surprise anyone that that comes at a cost. The cost is rather invisible to the outside observer, but it ultimately winds up driving rents up artificially because of limitations to the supply of rental housing. New product is just more expensive than existing product in most markets as a result. A similar case can be made for office product.

This kills many mid-rent developments before they ever get started and leaves only the rather small segment of high-end renters served with new product or the low end served with subsidized product.

If interest rates remain within a half point of their current levels, look for values on rental properties to hold up for the remainder of this year.

Tom Hoban is CEO of Everett-based Coast Real Estate Services, a property management and real estate advisory company specializing in multi-family and commercial investment properties. He can be contacted by phone at 425-339-3638 or send e-mail to tomhoban@coastmgt.com.

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