When one of Nick Ingle’s assistants was in college in 1997, he lived in an apartment on the west side of Phoenix. A decade later, he went back. And guess what? He’s paying less for the apartment.  

“It’s extremely telling,” says Ingle, director of capital markets for Phoenix-based Hendricks & Partners, a national multifamily research and advisory firm.

Phoenix is a tough metro for multifamily owners and investors todays. The public apartment REITs have reported problems in the market the past few years and major private operators such as The Bethany Group have seen properties go back to the bank or into Chapter 11. But there are glimmers of hope. Chicago-based Equity Residential says it pushed occupancy 600 basis points in the past week and that’s it's pushing rents again. And, transaction volume, fed by distressed sales, are upward bound. But before the market can be declared in recovery, the city's annihilated submarkets will need to improve.

Differing Performance

Phoenix got into trouble the same way that many other bubble markets did. Supply of both for-sale and rental housing skyrocketed in the mid-2000s, and then job loses, fed by problems in the construction industry, sapped demand. But it had another problem: More stringent immigration laws cut even further into demand in some Class C assets.

“The C grade was hit pretty hard,” says Tony Duplisse, senior vice president for Chicago-based Equity Residential. “Some of the employer crackdown on hiring illegal forced the bottom of the market to get the worst of the impact.”

That distress remains. But certain geographic submarkets have also been hit hard. “There will be a dramatic difference from one neighborhood to another,” says Greg Willett, vice president of research and analysis for Carrollton, Texas-based M/PF Research. “It’s probably a bigger level [of difference by submarket] in that metro than any other across the country.”

These submarket distinctions have been amplified by the multifamily distress in the market. In submarkets where there is multifamily distress, other healthy apartment owners have suffered.

“Phoenix can be pocketed,” says Cindy Cooke, a senior vice president in the Phoenix office of Colliers International, a multifamily broker. “One area could have gotten hit with three foreclosures in six months, and it’s almost like having a new lease-up going on. It pulls the market down. Once they stabilize, then it comes right back up.”

Right now, there are some definite market leaders. “Chandler, Scottsdale, Tempe, and Gilbert are first to recover, and there’s some stability there,” says Brad Goff, a principal in the Phoenix office of Apartment Realty Advisors.

Willett sees similar trends. “The west side—Scottsdale down through Gilbert and Chandler and Tempe—has seen occupancy stabilize. It is roughly eight points higher on that side of the metro than when you get to the far west side.”

Better Days Ahead?

Despite the problems, brokers, owners, and investors feel there are better days ahead in Phoenix, even if the market hasn't bottomed out yet. The Arizona Department of Commerce says metro Phoenix's unemployment rate is 8.4 percent, but real estate research and brokerage firm Marcus & Millichap expects the area to add 11,000 jobs this year (after losing 112,600 last year).

As in most markets, employment will be the key to the recovery. “There is some migration and in-migration to Phoenix but at far slower pace than the past five years,” says Mary Ann Klingler, senior vice president of operations at Birmingham, Ala.-based Colonial Properties Trust. “Job formation will be the primary driver for the apartment industry [in Phoenix].”

Supply is also an issue. After 4,600 units were completed in 2009, only 1,800 are expected to come online in 2010, according to Marcus & Millichap. But the shadow market of foreclosed homes and condos remains an issue. “The big question is, what happens to all of the housing that will potentially come to the market as rentals,” Ingle says. “People are coming back. Will they rent a home or an apartment? It’s something no knows the answer to.”

While that remains up in the air, it appears that enough questions have been answered (and prices have fallen far enough) that investors are jumping back into the market. Goff said that 24 sales occurred in the second half of 2009. “Around the middle of last year, we started getting 20 or 30 offers,” he says. “The perception was that the sales market had hit bottom.”

Most of these deals have a distress element with buyers relying on seller-financing. “Investors feel like the risk has come out of the market,” Cooke says. “They feel that when you are able to purchase at 30 percent to 40 percent off of what the prices were two years ago, it’s pretty compelling. You’re certainly buying below replacement costs.”