The phrase “distressed opportunities” dominates both the media headlines and wish lists of investors today. Meanwhile, as multifamily players study deteriorating employment figures and weakening fundamentals to project apartment performance in markets across the country, their analysis leads them back to the nation’s capital. The D.C. region’s stability and growth simply cannot be found elsewhere or ignored against the backdrop of deteriorating national fundamentals.
Long revered for tremendous stability afforded by the dominating presence of the federal government, the Washington, D.C., region—which includes Arlington, Alexandria, Fairfax, Loudon, and Prince William counties in Northern Virginia, as well as Montgomery, Prince George’s, Howard, and Ann Arundel counties in Maryland—continuously builds upon this base with steady growth from its diverse private sector industries of service, technology, and health care. Together, this combination has proven to be far less vulnerable to downward cyclical swings in the economy than any of the nation’s other major cities, while providing substantial growth during expansionary periods.
Job growth, which drives household formation and demand for housing, has been steady, though the D.C. region recently reminded economists that it was not immune to job losses. After losing 30,300 jobs in the 12 months ending April 2009, the regional economy created 19,900 new jobs since January 1, 2009, and boasts the lowest unemployment rate of any metro in the country at 5.6 percent.
Through the second quarter of 2009, the area’s multifamily performance continues to lead the nation on many fronts. Included in the region’s most recent enviable statistics is the highest year-over-year Class A absorption ever recorded in the Washington, D.C., metro area at 8,294 units. When viewed along with net regional absorption of 5,210 units in the Class A and B sectors, it is clear that many renters are taking advantage of recently delivered supply to “move up” into new Class A projects. However, with Class B vacancies well- below 5 percent, any perceived softness in the Class B sector tends to be pocketed and often manifested in outer suburbs.
Long gone are the days when developers could build Class A apartments in marginal locations with the expectations of achieving a 6 percent stabilized return on cost using rents trended at 5 percent annually. Even in a market as fundamentally strong as Washington, D.C., available equity and debt for new development is both costly and scarce.
Once estimated at 30,000-plus planned units, D.C.’s pipeline of new multifamily development has been reduced to a small fraction of that number. The sheer cost to develop high-rise residential buildings, once a large portion of the planned pipeline and supported by the condo boom, is now a barrier to delivery. Only the most cost-efficient projects in the best locations stand a chance of starting in the next 18 months.
To participate in the next wave of multifamily development in the Washington, D.C., region, developers will be challenged to build high-quality, yet economically-sensitive rental housing. Most likely, the first starts will be high-density, wood-frame construction at or near transportation nodes in urban or infill neighborhoods.
As was the case nationally, the latter half of 2008 was marked by few investment transactions in the Washington, D.C., metro as investors struggled to get their arms around rapid cap rate expansion and market fundamentals in the wake of general economic unrest. With the market achieving price discovery in the form of several completed and emerging sales, equity investors have now gained the necessary confidence in their ability to once again underwrite risk.
For the first time in a decade, investors, armed with real-pricing benchmarks, are becoming increasingly enamored with the opportunity of “value investing.” While cap rates in the region deservedly remain among the lowest nationally, examples of value investing can be found in stabilized Class A, infill apartment building prices that still represent 65 percent to 75 percent of prevailing replacement cost.
Indeed, operating cash flow is king. The very prominent “value-add” era of the mid-2000s was marked by investors’ aggressive plans to take underperforming B and C assets up a notch with substantial renovations. Today, most investors see the potential to enhance value through similar tactics, but over a more extended investment period and only if it makes sense at the time. Many view the lack of new supply to be delivered in the region, along with the anticipation of job growth, as reason to bet on the future of well-located Class B properties with strong upgrade potential.
The recent scarcity of high-quality investment offerings has seen a depth of qualified bidders that rivals even the hottest of markets in the mid-2000s. While a deep list of suitors from across the capital spectrum continues to hunt for multifamily investments in the D.C. region, the investor landscape is dominated by privately-raised capital versus the institutional investors who fed the frenzy in recent years either directly or through their entrepreneurial partners.
Fast Facts: Washington, D.C.
POPULATION: 5.3 million
OCCUPANCY: 95.7% (Class A and B)
MEDIAN AGE: 36.2
MEDIAN HOUSEHOLD INCOME: $81,163
AVERAGE RENT: $1,484
(Class A and B) UNEMPLOYMENT: 6.2% (as of July)
NOTABLE: The city is home to Nationals Park, the first green-certified baseball stadium in the country. The city also houses an international population. Roughly 15 percent of its residents speak a language other than English at home. Plus, D.C. has more than 170 embassies and international cultural centers.
Sources: Census Bureau, U.S. Bureau of Labor Statistics, and Delta Associates, a Transwestern Co.
Investors continue to take full advantage of the attractive financing available through Freddie Mac and Fannie Mae that is largely unavailable in other property sectors. Both of the GSEs, as well as investors in the debt that they originate, favor the D.C. region. With coupon interest rates in the mid-5 percent range at the end of the second quarter, positive leverage for both large and small deals is available to investors.
While few transactions closed in the first half of 2009, one recent multifamily sale of note is indicative of the type and depth of capital focused on the D.C. metro area. In July, Atlanta-based Post Properties sold Post Forest Apartments, a 364-unit community in Fairfax, Va., to New York-based Pantzer Properties, for $57.5 million. Recognized as an institutional-quality asset in a solid performing submarket that is anchored by Fairfax County government and a host of federal contractors, the Post Forest offering generated 24 purchase offers. Not surprisingly, while the list of interested parties included a handful of household institutional names in the industry, it was dominated by private equity players.
Distress may still be the most frequently used word to garner attention in many of today’s headlines, but the Washington, D.C., region has clearly found a new role as a leading target for savvy “value” investors.
It remains anyone’s guess as to how long the national economic downturn will last, but investors seeking new opportunities will increasingly differentiate between the markets they choose and will continue to favor the nation’s capital. As one astute Washington investor recently said, “I can buy multifamily in D.C. at a seemingly aggressive cap rate or add 75 to 150 basis points and go elsewhere [in the country]. In many cases, the underlying NOI will be the same for both in 12 months. Where would you rather own then?”