Baltimore – The land under this city’s most expensive apartment building was until recently an abandoned industrial site.

Spinnaker Bay at Harbor East is a fair illustration of the recent changes in the Baltimore market: New development is increasingly concentrated downtown in places that had until now been passed over as distressed or even dangerous.

Spinnaker Bay began leasing its 319 apartments in spring 2005, filling an average of 22 apartments a month. That’s well above the average lease-up rate of 11 a month here in Baltimore, according to Delta Associates, a local apartment research firm.

The location was a big draw. The building is set on the edge of Baltimore’s Inner Harbor, giving it views across the water of the Fort McHenry National Monument, and is within walking distance of Baltimore’s light rail system and the established neighborhood of Fell’s Point. It is also just one part of Harbor East, a 65-acre, mixed-use redevelopment that will eventually include 2,000 units of luxury housing, 2,040 hotel rooms, 1 million square feet of retail and another 2.5 million square feet of office space.

“Harbor East has become its own destination,” said Toby Bozzuto, executive vice president of Bozzuto Development Co. “This is a brand new neighborhood.” Bozzuto partnered with H&S Properties Development Corp., the developer of Harbor East, to build Spinnaker Bay.

The apartments at Spinnaker Bay now earn the highest rents in Baltimore, starting at $1,515 a month for a studio and rising to $3,230 for a 1,674 square foot three-bedroom.

In contrast, the average apartment in Baltimore had an asking rent of $886 in 2005. Reis, Inc., a New York-based market research firm, expects rents to grow about 4.2% in 2006.

Competitive landscape

While it leased up, Spinnaker Bay offered concessions of up to two months of free rent, according to the project’s Web site. Many landlords offered free rent in 2005, so that even a successful property like Spinnaker Bay had to follow suit to stay competitive.

Baltimore developers finished 1,067 apartments in 2005, up from 675 in 2004, according to Reis. That’s not too large an amount for Baltimore, which has averaged about 1,300 units a year in fits and starts for the last 10 years.

But to the developers offering concessions, it felt as if a flood of new apartments had entered the market. That’s because since 1999, new construction has increasingly been concentrated in Baltimore’s slowly reviving downtown, so that many projects are now opening in a very small area, according to Bob Aydukovic, vice president of economic development for the Downtown Partnership of Baltimore.

Despite this concentration, Baltimore’s vacancy rate dropped steadily from 5% in 2003 to 4.5% in 2005.

“Up ’til now there’s been reasonable equilibrium,” said Joe Cronyn, a partner with Lipman Frizzell & Mitchell, LLC, a real estate counseling and appraisal firm.

That’s in part because of Baltimore’s strong economy. The city added 30,000 jobs from 2003 to 2005, for a gain of more than 2.5%, and local economists expect more of the same in the near future. Baltimore is likely to benefit from the realignment of military bases, the expansion of universities and hospitals and the addition of two biotech research parks – one of which is being built as part of another large mixed-use redevelopment of a blighted neighborhood, this time just north of Johns Hopkins University in East Baltimore.

Strategic location

Baltimore is also expected to continue attracting relatively high-earning households with jobs in Washington, D.C., that can no longer afford to live in the nation’s capital. “The prices in D.C. are starting to push people up here,” Aydukovic said.

Assuming that all these positive trends continue and Baltimore becomes a steadily safer place to live, especially downtown, Reis expects vacancies to continue creeping downward to 4.1% in 2010.

The local analysts at Delta Associates are more pessimistic, predicting more new construction. But even they are only looking for a “slight increase” in vacancies.

At the same time, condominium conversions are beginning to help Baltimore’s rental market, though little formal analysis has been done.

Of the 1,067 apartments that developers added to the market in 2005, another 745 were taken off the market and converted into condominiums. After subtracting these converted apartments, the rental inventory only grew by 322 units in 2005, according to Reis.

This trend has also affected Spinnaker Bay, which includes 32 condominiums that sold for $1.6 million to $2 million apiece, or an average of $450 per square foot. Before these sales, “condominiums hadn’t been particularly successful in Baltimore in the last 10 to 15 years,” Bozzuto said.

Experts are unwilling to guess how many apartments will be converted in 2006, but unless the market somehow proves that the success at Spinnaker Bay was a fluke, it seems unlikely that the number of conversions will drop back to zero.

The level of new construction is likely to remain about where it is now: Between 1,000 and 1,500 new apartments will come on line each year through 2010, according to Reis.

As Baltimore’s condominium market heats up, investors here are willing to pay a little more for mid-rise and high-rise apartment projects. Three properties sold in the fourth quarter of 2005 at a capitalization rate of 5.4%, less than both the national and regional average. A cap rate represents the net operating income of a property as a percentage of the sale price – so that the buyers of these Baltimore buildings paid a premium for their properties relative to the income they produced.

During the same period, investors bought and sold 17 garden apartment communities at an average cap rate of 6.3%, which is slightly higher than the regional average.