IT'S CALLED “America's Distribution Center." And it's the distribution industry—anchored by the location of FedEx's world headquarters, Memphis International Airport (the world's busiest cargo airport), and proximity to several rail and river ports—that has the Memphis market poised for significant growth over the next decade.

Consider that the metro is further strengthening its position with the development of the Interstate-69 NAFTA corridor. I-69 will run from Mexico to Canada and will add to Memphis' logistical strength. When the interstate is complete, it will add 10 interchanges to DeSoto County, providing an expected $700 million in real estate development.

The bioscience sector, too, is burgeoning—at least 20 major hospitals are located in the metro area, including St. Jude's Research Hospital and LeBonheur Children's Medical Center. In addition, more than $1.6 billion in construction is under way in the Medical District, with the 1.2 million square foot UT-Baptist Research Park serving as the anchor.

Once completed, the park is expected to have a $2 billion annual economic impact.

It's no wonder, then, that Forbes magazine included Memphis on its list of “Best Bang for the Buck Cities,” and Business Facilities magazine recently selected Memphis as one of only seven (out of 250) metro areas to be honored in its 2010 Editor's Location Picks. Indeed, Memphis' burgeoning business sectors will help the market generate nearly 70,000 new jobs by 2015, according to CBRE-EA and M/PF Research.

This job growth, coupled with historically low forecasts for new supply, should lead to continued improvement of apartment vacancy rates, rents, and absorption—and an investment outlook that bodes well for the future.

Stronger Numbers

For the first time in several quarters, apartment fundamentals in Memphis have stabilized and begun to move in a positive direction.

Occupancy levels, rental rates, and absorption all trended upward in 2010, mostly driven by a significant lack of new construction.

During 2010, construction deliveries fell to levels that the market hadn't seen since 1993.

While the market averaged more than 1,400 deliveries annually over the past decade, 2010 saw only two properties (one conventional, one tax credit), totaling 250 units, brought online.

These construction trends are expected to remain at similarly low levels into 2011 and 2012.

Current forecasts project 467 and 473 units, respectively, to be delivered to the market. With the construction pipeline remaining stagnant for the near term, fundamentals are expected to continue their improvement throughout 2011.

The lack of construction in 2010 drove occupancy levels up 240 basis points in the metro to 91.7 percent for the year, while rents increased a modest 1.2 percent over the same time frame. The Memphis market also absorbed nearly 1,500 units during 2010, compared with less than 300 units in 2009.

That strong pace of absorption has helped the market return to real revenue growth.

Recent occupancy increases have come with less help from concessions, especially at Class A and B properties. The suburban submarkets of Germantown/Collierville and Cordova, as well as the Downtown and DeSoto County submarkets, continue to be the most stable locations within the Memphis metro area.

While fundamentals appear to be steadily improving, distress still remains a concern, especially in the Class C sector. All of the Class A and B submarkets in Memphis are more than 90 percent occupied, with the 1980s, 1990s, and new construction categories enjoying a combined 93.6 percent occupancy. In contrast, the old construction properties that make up the Class C segment of the market are a combined 87.9 percent occupied, a figure that's been dragged down by the underperformance of numerous distressed properties.

Distress Dominates

Many of the distressed assets in the area are the result of failed CMBS loans that were originated between 2004 and 2007 and were seemingly undercapitalized from the beginning.

However, this is creating a new wave of opportunity in the Class C sector because many of the properties are coming back to the market as REO sales, with a major difference in the perdoor pricing compared with several years ago.

This product type—REO/distressed—continues to dominate the sales market, and private equity investors from all over the country are flocking to Memphis because of the potential of the marketplace. Several new owners that have acquired distressed properties within the past year have reported a positive turnaround after implementing a new management and recapitalization plan. In fact, many of the distressed Class C properties that were acquired as an REO opportunity have since achieved occupancy levels above 90 percent.

Class A and B sales opportunities have been rare over the past several quarters, with one A property and one B property trading hands in 2010. But there are currently two additional Class A opportunities on the market, and more are expected as cap rates continue to gradually compress. Investors can anticipate cap rates ranging between 6.5 percent and 7.25 percent for Class A product, and from 7.75 percent to 8.5 percent for Class B assets.

Meanwhile, the lending environment has been a mixed bag due to the lack of stabilized deals on the market. Fannie Mae and Freddie Mac are the most competitive funding sources for well-located performing assets. Many of the distressed properties have closed all-cash or with some variation of hard money or bridge financing. Local banks continue to remain very cautious and generally on the sidelines. Despite this, however, banks have shown a willingness to participate if an existing relationship exists.

The Memphis market's improving employment outlook, constrained new supply, and rising occupancy and rental rates bode well for an apartment investment future with legs.

Tommy Bronson III is a vice president with CB Richard Ellis' Multifamily Division in Memphis and specializes in the sale of multifamily properties throughout Tennessee, Arkansas, and Mississippi.