Published January 2004

Rental market could see mild recovery in 2004

Call it “unsettled optimism” as renowned economist John Mitchell put it when describing the outlook for the rental property market at the Institute of Real Estate Manager’s annual Forecast Breakfast in December.

“We have a tendency to underestimate the resiliency of the U.S. economy,” says Mitchell, suggesting to a large audience of property managers and investors that we can dig out of this recession just as dramatically as we went into it.

But, he warns, “Another terrorist hit on U.S. soil or any number of red flags could change a rather optimistic outlook for 2004.”

Rental property investors need a rebound from what has been the softest rental market since 1983. A recovery of the broader U.S. economy is imminent, it seems, but what that all means to Snohomish County rental property investors is really the question.

The day before the terrorist attacks of Sept. 11, 2001, vacancy rates were a mild 3 to 4 percent in most of the Puget Sound area. A vacancy rate of 5 percent is considered a healthy equilibrium point, where tenants and landlords are enjoying a relative balance of power in the marketplace.

As we all know, the terrorists chose airplanes on regular domestic flights as their weapon of mass destruction, causing the airline industry to drop off quickly as their customer base dropped off. This, along with the “tech wreck,” caused vacancy rates to double in a short six months after 9/11.

Sprinkle in remarkably low home mortgage interest rates, and the environment for landlords was about as nasty as it could get in the past two years. Only the saving grace of developers scratching plans to build new product kept apartment property investors from seeing vacancy rates over 15 percent.

In fact, 1961 and 1971 are the only two times in the last 25 years that the pipeline of new units being developed has hit the same low level we’re anticipating in 2004. The entire Puget Sound is projected to deliver an appropriately anemic 2,500 new apartment units to the market in 2004, according to building permit activity in the pipeline now.

Because ours is a region with what developers fairly describe as a “high barrier to entry” market, we already know fairly certainly that 2005 is projected to deliver about the same low number of new units as 2004. So the supply pipeline is at historically low levels and will at least prevent that part of the supply and demand curve from throwing things deeper into the vacancy abyss.

The bottom line? Mike Scott of Dupre + Scott, a regional market appraiser in the Puget Sound, notes that the net operating incomes on apartment properties may climb minimally in 2004 from 2003 levels. But 2003 “posted net operating incomes 15 percent to 20 percent lower than three years prior,” according to Scott.

Predictable and stable job growth is likely to occur in late 2004 and then more solidly in 2005 after current business capacity is filled and business then must hire to meet growth demands. Job growth, of course, is elixir for rental property investors.

Scott is optimistic about the next three years for rental property owners, but acknowledges that the market may only recover “about half of the drop in net operating incomes during the recession of the past three years.” So the recovery, it seems, is a relative thing when put into this perspective.

We can conclude from these reports that the rental market has hit bottom and recovery is upon us, but will lag a bit locally, as job growth will be a bit slower here. A tick up in mortgage rates may do more to support a recovery for apartment investors than even modest job growth, as more than half of apartment dwellers in many parts of Snohomish County leave the rental pool now to buy their first home.

Ultimately, job growth and mortgage interest rates are the two benchmarks to watch as we forge through 2004. These two benchmarks are the ones that convert the forecasters’ tarot cards to reality and allow investors to better assess the risk-and-return equation going forward.

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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