Published December 2002

Report projects soft apartment market for 2003

In the fall 2002 issue of The Apartment Advisor, author Mike Scott paints a rather gloomy apartment market outlook for investors in 2003. Unfortunately, there aren’t any signs, according to the report, that 2004 will be much better.

In the tri-county region that includes King, Snohomish and Pierce counties, just over 55 percent of apartment properties are offering some type of rental incentive today to entice renters to their properties. According to Scott, “That’s the most we’ve ever seen, and we’ve been monitoring the use of concessions for 17 years.”

On average, it takes 26 days to re-rent an apartment. This, too, is the longest period he has observed in the 17 years he and his team have been collecting this information.

And the pain is being felt in places that historically have been insulated from down markets. Submarkets such as Greenlake, First Hill, Leschi, Issaquah and Shoreline, which traditionally have held up well in soft markets, are now experiencing vacancy rates of 7 percent or higher. An equilibrium market is generally understood to be 5 percent. The average vacancy rate in the tri-county region is 7.1 percent right now.

Of course, there are exceptions. In fact, of the 1,700 properties surveyed by Scott, only 17 percent actually hit the average vacancy loss number of 7.1 percent. So there are markets doing much better and some much worse.

Interestingly, the shoulder markets of Kitsap, Thurston, Skagit and Whatcom counties posted relatively low market vacancy rates of between 2.7 percent and 4.4 percent. Locally, the submarket suffering the most is south Everett, where vacancy rates are close to 15 percent. The remainder of the Snohomish County market is in the 7 percent to 9 percent range. Tough times.

Things changed fast, and investors have had to react more quickly than in prior downturns, according to the report.

In September 2001, vacancy rates were just 3.9 percent. At 7.1 percent today, a more than 3 percent swing in the market occurred in just one year — a major hit for a market that’s used to no more than a 1 percent annual swing in most years.

The reasons for the rather gloomy outlook seem to be fourfold:

• Job losses at levels not seen since the early 1980s.
• Historically low interest rates enticing many renters into homeownership.
• A lingering (but dwindling) pipeline of new supply still coming on line.
• General shrinkage of the market as tenants double up or move in with family or friends during tough times.

So, where’s the good news? According to Scott, there really isn’t much except the hope that things will get better. It seems operating expenses are not increasing at as rapid a rate as they were last year, giving investors some help on that side. But that’s probably because power rates shot up so much in the previous year that a stable 2003 looks good in comparison. That said, investors have experienced a large increase in insurance rates, and property taxes are also seeing significant inflation.

The bottom line is most apartment investors are anticipating flat to declining net operating incomes for 2003 when compared to 2001. Scott’s report suggests that net operating incomes will drop 12 percent between what investors booked in 2001 and what they’ll see in 2003. Other industry experts are a bit more optimistic at a 5 percent anticipated drop. Better news, but not good news.

Lower interest rates have virtually played out as a mechanism to reduce the impact of this flat market on the bottom line. Most investors have taken advantage of refinancing in the past few years, so there’s not much room for savings there.

But investors need to put this into perspective. Just two short years ago, the rental market was posting its second year in a row of 10 percent average rent increases. The blended average for the past 10 years, therefore, would post a 3.7 percent compounded annual increase in net operating income, says Scott. Still a better-than-inflation cash-on-cash return for a relatively low-risk investment.

The good news for current investors is that values have not fallen backward despite the current operating conditions. Sales prices indicate values holding up, such that overall returns are not sliding the same way current operating incomes might be. Bargain hunters aren’t finding any cheap deals to buy out there, though, despite being able to point to sliding operating results as justification for their offers.

So, what’s the best move to make right now? Well, for starters, if you know anybody who wants to buy some airplanes, now would be a good time to give them a call. With the supply side of rental housing dwindling down in response to the soft market of late, it’s all about stimulating demand to turn things around. That starts with jobs.

Or buy on a low interest-rate play. With rates this low, an investor might speculate that locking today on the expectation that the operating results will improve down the road. We are seeing some of this logic among more well-heeled investors with adequate equity to carry through a potentially soft first couple of years.

Or, as one salty investor told me recently, “Just wait it out.”

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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