Portland’s multifamily market has been turning a lot of heads this year, as institutional investors double down and vacancies trend below 4 percent.

About $135.2 million in multifamily has traded hands year-to-date—a gargantuan 936 percent improvement over the first four and a half months of 2010, according to New York-based market research firm Real Capital Analytics. And much of that activity has been in the Class A sector.

“I think it’s the hottest market in the U.S. right now,” says Dan McCadden, partner and managing director of development at Phoenix-based Alliance Residential. “There’s a frenzy around urban infill product—the cap rates in Portland are literally lower than Seattle because there’s just very little product, and what’s available is in the core.”

Indeed, Portland is a model of a supply-constrained, high-barrier market. The city has had an urban growth boundary as a way to combat urban sprawl for the last 40 years, which limits much new development to urban infill. As a result, vacancy rates are now below 4 percent, and are expected to fall to a miniscule 3.4 percent by the end of the year. And effective rents are expected to grow 5.6 percent this year, according to market-research firm Reis.

Transaction Velocity
There have been 14 trades in Portland in the last six months, some of which featured aggressive cap rates.

In April, Swedish pension fund manager Alecta Investment Management acquired a two-property portfolio from Equity Residential, both built in the mid- to late-1980s. The portfolio included the 373-unit Tanasbourne Terrace, which went for $38.3 million, and the 352-unit Club at Tanasbourne for $31.1 million—a blended 5 percent cap rate. And in December, the 202-unit Axcess 15 traded at a 5.3 percent cap rate when Holland Residential and TRECAP Partners paid $37.5 million for it.

Of the last 14 trades, five have been for over $30 million and two have been for more than $70 million. The two largest include the $79.4 million sale of the 332-unit Ladd Tower to Invesco from US Bank, and the $70.3 million acquisition of the 497-unit Palladia by UBS Realty, another Equity Residential disposition.

Going forward, large sales will continue to be imminent in the city. The acquisition of the 131-unit Kearney Plaza is expected to close in June after a heated bidding war—50 prospective buyers toured the property. Many market watchers expect the Kearney Plaza to have a cap rate in the 4 percent range.

Forging Ahead
Still, investors won’t find distressed pricing in Portland. Several newly built communities designed as condos have been sold by lenders lately, including the Ladd Tower, and the 123-unit 2121 Belmont. But each of those sold for more than $227,000 per unit.

And while there hasn’t been much if any cap rate compression in the Class B and C sectors, that may change soon as a trickle-down effect begins. “The real question is, when will the A assets start to pull on the B and C stuff? We’re just starting to see that happen,” says Greg Frick, a partner at Portland-based brokerage HFO Investment Real Estate. “There’s a lot of private equity coming in that doesn’t want to compete with institutions, but is looking for quality B assets.”

Firm Fundamentals
Very few new units have come online in the last few years, leading to a supply shortage that will likely continue. Only 157 units are expected to be completed this year, according to Reis.

But demand will only continue to march forward. Intel recently announced that it’s building a $4 billion plant in nearby Hillsboro. IBM has announced a 600-job expansion in nearby Beaverton. And wind-energy company Vestas is building its headquarters, a $66 million project in the Pearl district in downtown Portland.

Reis is forecasting effective rent growth of 5.6 percent this year, 5.5 percent next year, and more than 4.5 percent annually through 2014. And vacancies are expected to hover in the low-3 percent range out to 2015.

Still, there are reasons for pause. The local metro unemployment rate is still high—9.6 percent—and area median incomes are low relative to other West Coast metros. What's more, the metro has a lower average rental rate than most West Coast metros. Effective rents average about $783 in Portland, compared to $1,775 in San Francisco, or $975 in Seattle, according to Reis.