Not unlike the fabled bird this city is named for, the Phoenix multifamily mar-ket is rising again. The local economy looks good, vacancies are shrinking, and out-of-state investors are interested because Phoenix can give them something their home markets can't: cash flow.
Go With the Cash Flow Traditionally, about two-thirds of Phoenix investors were local companies. But in recent years, that has changed. While 34 percent of buyers of Arizona multifamily are still Arizona residents, 47 percent are from California, and 10 percent are from Illinois or Oregon. For these investors, Phoenix offers better cash flow for two reasons: lower acquisition costs and more attractive cap rates than in their home states.
In Phoenix, California investors can secure as much as four times the amount of property for the same amount of money. Multifamily investors from Oregon and Illinois have about twice the purchasing power. In addition, an 8 percent cap rate in Phoenix is good enough to ensure cash flow. That's unusual, considering that vacancies and concessions during the past two years of recession eroded revenues.
By comparison, most of California is operating under a 6 percent cap rate for properties with full occupancy where cash flow probably won't increase in the near future due to low turnover in units and rent control. Many California owners have mortgages higher than their income streams can support and are therefore producing zero or even negative cash flow. Such investors are looking for better investment opportunities in Phoenix, and the current low interest rates add incentive to make the move now.
As the improving economy helps fill Phoenix apartment vacancies and net operating income increases, value will appreciate. Because Phoenix residents are more transient than those in many other cities, Phoenix owners can raise rents to keep up with market fluctuations and maximize cash flow.
An Economy Finds Its Wings A new housing unit is needed for every 2.8 new residents moving to Phoenix, according to economist Elliott D. Pollack of Elliott D. Pollack & Co. For the last nine years, Phoenix ranked second in the nation for population growth among cities. In 2003, the Phoenix-area population grew 3.1 percent to more than 3.3 million residents.
The outlook for job growth, which has a direct impact on population growth, is promising. Possibly the biggest blip on the Phoenix economic horizon is the entrance of biotechnology and biomedicine initiatives. The largest is Translational Genomics Research Institute (TGen), a nonprofit genetic research organization. In June, the city of Phoenix broke ground on a $39 million facility downtown that by the end of this year will house TGen and serve as a magnet for other biotech-related tenants.
Also downtown, the Phoenix Civic Plaza convention center is receiving a $600 million expansion, quadrupling its size. These and other initiatives are expected to generate 55,300 new jobs in 2004 and an economic growth of about 5 percent, according to Pollack. The U.S. Bureau of Labor Statistics reports that the area added 19,000 jobs between September 2002 and September 2003, making Phoenix the third-fastest-growing job market in the nation.
Making Phoenix even more attractive are other factors, such as 360 days per year of sunshine and a business-friendly environment. In addition, the city has a relatively low cost of living, according to the American Chamber of Commerce Research Association, which annually surveys more than 300 urban areas. Usually, cost of living increases as a market grows, but in the case of Phoenix, it decreased from 103.6 percent of the national average in 1993 to 98.5 percent today. By way of contrast, San Francisco is the nation's third-most expensive city at 181 percent of the U.S. average. Los Angeles is at 147 percent, Chicago is at 131 percent, and Portland, Ore., is at almost 112 percent.
Many Good Places to Land
Because of its size, Phoenix has desirable submarkets to suit investors' different needs. Many of these areas are being transformed by the Loop 101 and Santan freeways, which are creating access to new land and opening doors for strategic commercial development.
Loop 101 is helping the Northwest Valley become one of the strongest candidates for multifamily investments in greater Phoenix because of its excellent upside potential. This older part of the Valley has carried the stigma of aging class B and C properties. But with the completion of the freeway and aggressive economic development efforts by communities such as Peoria and Glendale, it is rebounding.
Many of Arizona's top employers are in the Northwest Valley, including the regional offices of Wal-Mart, Wells Fargo, Costco, and Walgreen's. Glendale also recently became home to the new Phoenix Coyotes hockey arena, and the Arizona Cardinals football stadium is scheduled to be completed there in 2006. Already the stadium has been chosen to host the 2008 Super Bowl, with a predicted $400 million economic impact.
Multifamily investment costs in the Northwest Valley are low. Most multifamily complexes there are older. Since 1988, only four new apartment projects have been built in this area, bringing 900 new units to the market for a total inventory of 14,146 units. There are 128 units under construction and 180 units in the planning stages.
The average rent per month in the Northwest Valley is $562 for an average-size apartment of 712 square feet. The overall vacancy rate for all complexes with 50 or more units was 12.4 percent in the third quarter of 2003, down from 13.4 percent in the previous quarter. Average sales price is $38,000 per unit in 2003, up from $29,700 in 2002.
Downtown, multifamily vacancies average 9.7 percent for the last quarter in 2003, down from 10.8 percent in the previous quarter. Monthly apartment rents span $346 to $1,230, and new construction is ringing up prices. Apartment sizes range from 306 to 1,204 square feet per unit, with the median size at 750 square feet. Average sales price was $48,400 per unit in 2003, up from $42,200 the previous year.
The Camelback Corridor at 24th Street and Camelback Road is close on the heels of downtown as a desirable area to invest in, though offering a higher-end amenity base. The area recently entered the high-rise multifamily condominium market for the first time with 12-story Esplanade Place, a development of Phoenix-based Pivotal Group and GHE & Associates. Esplanade Place abuts the Ritz Carlton to its east and is part of the Camelback Esplanade office project, a development of Opus West Corp. Even in tough economic times, Esplanade Place sold out months before construction was completed. The project's 56 condominiums range in size from 2,400 to 4,250 square feet and sold for $550,000 to $2.7 million per unit.
Following this lead, many other development groups are proceeding with similar projects. Donald Trump and the Bayrock Group plan to build 100 luxury condominiums and a Trump International Hotel on an infill site just east of the Esplanade complex. The Trump project still faces many tests, including city approvals and the blessing of area homeowners.
Traditionally agricultural, the Chandler/Gilbert region in Phoenix's East Valley has become a magnet for young, affluent, well-educated renters and homeowners, and the completion of the Santan Freeway will add prime, large-scale commercial development to the mix. Gilbert alone boasts one of the highest median household incomes in Western U.S. markets. For the past 13 years, the town ranked as the fastest-growing municipality of its size in the nation. Now at more than 155,000 residents, Gilbert is expected to double in size by 2024. Combined, Chandler/Gilbert represents 370,000 residents.
Most multifamily product in Chandler/Gilbert is large, new, and well-suited to the institutional-level investor. More than half of the apartment complexes were built after 1990. The average vacancy rate in the third quarter of 2003 was 7.8 percent, down from 8.8 percent the previous quarter. Average rents are $770 per month for an average 902-square-foot apartment. Average sales price in 2003 was $80,200 per unit.
Mesa, located just north of this submarket, has been the hardest-hit multifamily sector. Though well-established, Mesa struggles with little new infrastructure and commercial construction. Rent for an average 804-square-foot unit is $622. Vacancies for North Mesa are as high as 17.39 percent, although the average for the entire city is 10.8 percent. Sale prices in Mesa decreased from an average $52,400 per unit in 2002 to $38,400 in 2003.
On a more positive note, no area of greater Phoenix is suffering from overbuilding. During the last decade, approximately 8,000 new units went up annually; for the first three quarters of 2003, only 2,600 were permitted.
Construction slowed in response to the radical decrease in absorption (6,200 units were absorbed in 2000, compared with 642 units in the first three quarters of 2003).
As the economy weakened, and especially after interest rates went into a downward slide after Sept. 11, 2001, people who could afford to buy a home did, causing vacancy rates to escalate to levels not seen in years. In 2002, newly constructed apartment complexes in Phoenix offered as much as four months of free rent to obtain sufficient leasing activity. As a result, many builders stopped building, while others postponed projects in the pipeline. Though the cost of Phoenix land remains reasonable, most builders are expected to enter new multifamily projects tentatively, as absorption increases gradually over the next three or four years.
Learning to Fly So, the balance of the Phoenix multifamily market is steady, and the outlook is good. The economy is on the rise, buyer interest is high, and, similar to the rest of the nation, Phoenix will soon benefit from a return of the renter pool as rising interest rates make it harder to purchase a home.
Even the small increases in interest rates since mid-summer 2003 created an almost instantaneous softening in the local new home market. From September 2002 to September 2003, the average home price in Phoenix increased from $145,000 to $160,000. Fixed mortgage rates are expected to rise to about 6.5 percent by year-end, bringing sales of new and existing homes down 4.6 percent nationally. An equal decline is projected for the Phoenix market. This can only strengthen local occupancy rates and allow Phoenix to deliver the coveted cash flow investors have come here for.
–Julie Vaughn is vice president at Sperry Van Ness in Phoenix.