EVEN AS THE RECESSION subsides in Seattle, the hangover endures.

Vacancy rates in the Puget Sound area will likely hit historic highs in 2010—and fundamentals across the board will continue to falter—due to the lingering effects of job losses and additions to stock in recent years.

Large-scale layoffs in 2009 by several major local employers, including Microsoft and Boeing, will limit renter demand near these campuses this year. Hiring activity, however, is forecast to resume in 2010. Employers are expected to add 26,400 workers this year. This is a big turnaround from 2009, when approximately 55,000 positions were shed.

What's more, builders are expected to finish a number of projects in 2010 that were either permitted or broke ground prior to the downturn. In 2010, developers will deliver 2,600 apartments, down from 4,150 units last year. These deliveries will put upward pressure on vacancy, especially in the Downtown/ Capitol Hill/Queen Anne submarkets, where one-third of the metro's 2010 pipeline will come online by mid-year.

Overall, the city's vacancy rates will increase this year by 50 basis points (bps) to 8.4 percent. The shadow market continues to loom large, as subdued condo sales further aggravate the apartment supply/demand imbalance. Unfortunately, that means rents will not rise this year; asking rents are forecast to fall 2.8 percent to $928 per month, and effective rents will drop 3.9 percent to $852 per month.

But even as these trends drop rent and occupancy levels, there is hope on the horizon. The prospects for above-trend rent growth in the years to come will begin to emerge at the end of this year, as the pullback in construction and permitting, burn-off of excess housing inventory, and favorable demographics drive demand.

Transaction Velocity

The late arrival of the recession to Seattle has resulted in divergent investment strategies among local buyers. Some investors are shifting their focus to markets with a shorter recovery horizon, while others wait on the sidelines for discounted properties.

In 2010, investors are expected to focus on properties downtown, although area fundamentals will remain soft in the near term. Projects such as the University Link plan, which extends the light-rail system north from Capitol Hill to the University of Washington, will attract long-term hold buyers.

Initial yields in core areas of Puget Sound were in the low-6 percent range at the close of 2009, while cap rates in the outskirts averaged in the low- to mid-7 percent range and could rise as much as 75 bps this year.

The good news is the drivers of increased sales activity began to align in 2009, despite tight underwriting and limited debt availability outside of the government-sponsored enterprises (GSEs). That trend should accelerate in 2010.

Capital Favors Apartments

In Seattle and nationally, apartments will continue to maintain a financing advantage over other property types due to the availability of debt from Fannie Mae and Freddie Mac. Generally constrained lending, however, will keep sales and refinancing below “normal” levels despite some improvement in 2010 over 2009.

The GSEs now account for the lion's share of new multifamily mortgage originations, followed by banks. The GSEs are increasingly securitizing a greater percentage of their loans, as Fannie Mae's MBS product continued to gain momentum last year. Meanwhile, Freddie Mac's Capital Markets Execution program also holds promise as a viable source of liquidity, following the securitization of $2 billion of debt in 2009.

Nonetheless, traditional CMBS issuance remains limited despite government programs such as TALF and PPIP and is unlikely to be a major source of financing in 2010. This presents the greatest challenge for deals of more than $15 million, an issue exacerbated by a pullback in lending from life insurance companies. Though a handful of life companies have shown renewed interest in lending, capacity limitations dampen expectations for a 2010 surge.

Aside from the GSEs, local and regional banks will account for the greatest share of apartment financing in Seattle this year, focusing on smaller, low-risk deals with strong sponsors.

Delinquency rates continue to rise, though increases vary by lender type. Fannie Mae and Freddie Mac, which account for 38 percent of apartment debt outstanding, each boast sub-1 percent delinquency rates. The CMBS sector, meanwhile, has recorded rapid increases in its apartment delinquency rate, which closed 2009 at an estimated 9 percent.

Overall, expectations for near-term weakness will be balanced by increased visibility on fundamentals and more reasonable cap rates. And although vacancy rates are expected to reach record highs— and rents will continue to trend down—the long-term prospects for the Emerald City remain strong as the city is positioned to enjoy another great run.

GREG WENDELKEN is the vice president and regional manager of the Seattle office of Marcus & Millichap Real Estate Investment Services.