Denver’s apartment market turnaround is growing to new heights in this high-altitude city, boosted by vacancy rates not seen in a decade along with welcome relief in cap rates and improvements in a number of employment sectors. Among all these plusses, the Colorado capital’s vacancy rate decline is especially noteworthy. After dropping a full 250 basis points last year, Denver’s apartment vacancy rate should slip another 130 basis points this year, to 4.2 percent—the lowest level on record since year-end 2000—as household formation and job growth accelerate.
Just consider the metro’s forecast for various employment sectors. Last year, area employers added 5,200 jobs, a welcome turnaround from the loss of 66,800 positions over the previous two years. This year, payrolls will rise by 24,000 positions, or 2 percent, an admittedly modest but positive step forward. The professional and business services and education and health services sectors have accounted for the lion’s share of jobs created in the past 12 months, though growth has also resumed in previously hard-hit sectors, including trade, transportation, utilities, and manufacturing.
Despite the job growth, for-sale housing remains out of reach for a large share of renters. While Denver home prices held up relatively well through the downturn compared with other major metros around the nation—and the current median price rests within 10 percent of the peak achieved in early 2006—extremely tight mortgage underwriting standards and higher down-payment requirements have limited the flow of apartment renters to homeownership.
As a result, the apartment market recovery that initially took root in close-in submarkets will broaden to harder-hit areas, such as Aurora and Arapahoe counties. Overall, however, the entire Denver metro is benefitting from these trends, which will continue to carry into the next few years, thanks to low new supply numbers and renewed attention by investors.
Construction Drought
At the heart of much of Denver’s fundamentals is the considerable slip in new apartment construction in the city, with 2011 completions forecast to fall nearly 90 percent below the metro’s 10-year annual average. Developers have begun to ramp up efforts in the metro, but with a few apartment projects proceeding after lengthy delays and the majority of those that are under way scheduled for delivery beyond 2011, new supply will remain very limited for at least another six months.
By year’s end, apartment completions in Denver will total fewer than 500 units, down from the approximately 2,340 apartments brought on line in 2010, which includes a 328-unit project in the Denver-Far Southeast submarket that was completed in the first quarter of 2011, and notably lower than the average annual addition of 1,930 units delivered over the past five years.
While more than 12,950 units have been proposed or planned for the Denver metro, construction is slated to commence on just a few projects over the next year. Furthermore, multifamily permit activity remains more than 80 percent below the levels recorded just three years ago, creating expectations for limited apartment construction in the near term.
In the Denver-South/Glendale submarket, no new complexes are under way. A 213-unit property at University Boulevard and Evans Avenue represents all of the construction currently planned in the submarket, though no groundbreaking dates had been finalized as of press time.
Still, since Denver-South/Glendale remains short on supply, renter demand surged in that submarket last year, laying the foundation for even stronger operational improvements this year. Last year’s gains were supported by robust absorption activity: Between the first quarter of 2009 and the same period in 2010, almost 5 percent of the submarket’s vacant units were leased. This healthy demand was generated by employers such as Kaiser Permanente Consolidated Services replacing workers laid off during the recession, with many newly re-employed individuals debundling into separate rental units. The metro’s foreclosure activity in the single-family market, too, will remain a major driver of renter demand, while a lack of construction will continue to benefit owners of standing inventory into next year.
Overall, this sizable shortage of supply means that Denver-area renters will continue to see rents climb through 2011. Asking rents have already increased 3.1 percent during the past 12 months, to $888 per month, as effective rents have climbed 4 percent, to $800 per month, reducing concessions to early 2003 levels. In 2011, however, tight occupancy will drive a 4 percent increase in asking rents, to $915 per month, and a 4.8 percent gain in effective rents, to $827 per month. Investor Promise
It’s not just renters and property managers who find Denver attractive these days, but investors, as well. Overall, the metro’s transaction velocity increased 50 percent during the most recent 12-month period, though it remained roughly at half the level achieved in 2007. The median price softened modestly through the recession but also increased modestly over the past year, to $64,700 per unit, nearly on par with the pre-recession peak.
For the most part, cap rates average in the low– to mid–6 percent range, down 100 basis points from early 2010. The compression can be attributed to strong buyer demand and a surge in large-property sales as REITs/institutions have left the sidelines. Rising occupancy rates and prospects for healthy rent growth will continue to encourage investors to target value-add properties and repositioning opportunities, such as better-quality Class B assets that can be upgraded to capture above-average rents.
Sales velocity will accelerate over the next year, too, as promising demographic and economic trends and strong apartment market operations encourage more investors to seek local properties. Private investors will remain the most active, but REITs and institutions will step up acquisitions ahead of a more robust up-cycle in rents, allowing owners to achieve strong pricing on top-tier assets brought to market. Similar to last year, smaller private investors will focus significant attention on the Capitol Hill area, where properties typically trade for less than $1.5 million at cap rates in the 7 percent range. Larger investors, many from out of state, have targeted the North Denver and Northwest Denver submarkets for a mix of older performing assets offering repositioning opportunities and for newer high-quality assets with strong occupancy. Cap rates for deals exceeding $10 million average 6 percent but can start in the mid–5 percent range for best-in-class properties. Investor demand for distressed listings remains strong, but the shortage of available supply is encouraging more investors to bid on performing assets in traditionally sturdy locations. The limited number of distressed properties on the market will also curb price discounting as fierce competition for short sales and REO listings pushes values to well above initial list prices. Only a few newer, higher-quality distressed properties traded recently, and banks will wait for more significant improvement in occupancy and rents to dispose of these reclaimed assets. As unsatisfied demand for these deals migrates to the traditional apartment investment market, cap rates for strong-performing properties, particularly those in close-in locations or near public transportation, have begun to decline. The most sought-after high-quality assets closed at cap rates in the 6 percent range early this year, considerably lower than marketwide averages in the low– to mid–7 percent spectrum.
With strong numbers in so many metrics, the future of Denver’s multifamily housing market looks bright.
