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Bloomberg News: Seattle Signals Glut Risk as Apartment Construction Rises

April 05, 2012

The biggest surge of Seattle-area apartment construction in a quarter century is threatening to undercut the growth in rents, a trend that’s also emerging in such U.S. cities as Washington and Houston.

Seattle went from “dead last” in rent increases three years ago, following the collapse of mortgage lender Washington Mutual Inc. (WAMUQ), to 13th out of 88 markets last year, according to Axiometrics Inc., a multifamily real estate research company. The construction boom spurred by rising rents is now stoking concern that revenue growth may stall as an increasing number of units compete for tenants.

“We went from almost a desert to a big pipeline” in two years, said David Young, the Seattle-based managing director who oversees western U.S. apartments for commercial broker Jones Lang LaSalle Inc. (JLL) “There will be a glut in 2013 and 2014 just because of the amount of new product.”

Encouraged by hiring at local employers such as Inc. (AMZN), Boeing Co. (BA) and Nordstrom Inc. (JWN), developers are building almost 10,000 apartments in Washington state’s King and Snohomish counties, home to Seattle and the city of Everett, where Boeing operates its main airplane-assembly plant, according to Seattle-based O’Connor Consulting Group LLC. Three- quarters of the total are in Seattle, with 4,619 of those units in or near downtown.

Seattle’s rental-housing renaissance comes as demand for apartments nationwide is the strongest in a generation because of home foreclosures, stiffer lending standards and a growing number of young adults forming households.

Increase in Construction
U.S. apartment construction is rebounding from a 50-year low reached in 2009 even as falling home prices and low interest rates begin to attract buyers back to the purchase market.

“Around the country, we are seeing this trend of development concentrated in the urban core,” said Ron Johnsey, president of Dallas-based Axiometrics. “If the operators, lenders and investors are not careful, the urban core submarkets will become overbuilt in a couple of years.”

Building permits for U.S. apartments rose 56 percent in the 12 months ended in February from the low in 2009, more than doubling in five of the six most-active construction markets -- Dallas, Houston, Los Angeles, Washington and Seattle -- according to Axiometrics and Census Bureau data. In the sixth, New York, permits rose 73 percent.

The rebound in rental properties so far has shown no sign of slackening. U.S. apartment vacancies fell to 4.9 percent in the first quarter, their lowest since 2001, Reis Inc. reported yesterday. It’s only the third time since the New York-based firm began gathering the data 31 years ago that vacancies were less than 5 percent.

Supply Growth Doubles
Reis estimates about 70,000 units will open for leasing this year, about double the supply growth in 2011. Next year, Reis forecasts 150,000 to 200,000 new units in the 79 primary markets it tracks. “Risks may manifest” in the apartment industry as more units come to market, Victor Calanog, head of research and economics at Reis, said in the report.

In Seattle, Amazon’s 2010 move to a new headquarters at the north end of the city’s downtown after outgrowing its old location on Beacon Hill helped buoy the local economy.

The biggest Web merchant relocated thousands of workers to the South Lake Union neighborhood and accelerated development beyond its new campus as landlords bet young professionals would rent instead of buy and want to live within walking or biking distance of work.

Surge in Hiring
Amazon hired 22,500 people worldwide last year, an increase of 67 percent from the 33,700 employees it had at the end of 2010, according to its annual reports. The company won’t say how many work in Seattle.

Boeing hired about 8,000 workers last year in the Seattle area, home to almost half its total 171,700 employees as of Dec. 31, said Doug Alder, a spokesman for the Chicago-based company. Apparel retailer Nordstrom last year added 7,500 people, including new employees in Seattle, expanding its workforce 14 percent.

The surge in apartment development that has accompanied economic growth may eventually hurt landlords.

“We’re starting to get a little feedback that maybe there’s too much supply,” said Brian O’Connor, principal of O’Connor Consulting. The Seattle-based research and appraisal company conducted market studies last year for more than 50 developers contemplating high-rise projects in the region. “One lender said, ‘We did five construction loans last year. We’re thinking we shouldn’t do any more.’”

Boom Through 2016
Apartment rents in Seattle will rise 3 percent a year after 2012, half the 6 percent forecast for this year, according to Dupre + Scott Apartment Advisors Inc., a Seattle-based research company that said the building boom may last through 2016.

“If in fact we come to market when there’s excess supply, we’ll just have to be aggressive on rents,” said Matt Griffin, managing partner of Seattle-based Pine Street Group LLC, which is building 654 dwelling units about eight blocks from Amazon’s main office building. “That’s our downside.”

Pine Street’s Via6 is scheduled to open in February 2013. Its apartments will be among the first of an estimated 8,900 new units coming to market next year in King, Snohomish and Pierce counties. That’s the most since the late 1980s, according to Dupre + Scott.

Growth to Slow
“We expect the next few years to be the most aggressive development cycle we’ve seen in more than 20 years,” the firm said in a December report. “With the onslaught of new construction that will begin lease-up, particularly in 2013, the rate of rent growth will slow.”

New apartment construction also is surging in other U.S. cities. In the greater Washington area, including northern Virginia and suburban Maryland, the consolidation of military- base personnel in the area, expansion by medical and education employers, and a large pool of recent college graduates have helped drive demand for rental housing, said Toby Bozzuto, president of Bozzuto Development Co.

The company, based in Greenbelt, Maryland, expects to complete 3,500 new rental units in the Washington area within the next two years, the most in the company’s 25-year history, Bozzuto said.

“Washington-area rents have risen 5 to 8 percent a year over the past two years but now we have a huge pipeline coming,” he said. “We could potentially begin to see concessions coming back into the market starting this year,” Bozzuto said, referring to such landlord giveaways as a month of free rent.

Historical Averages
Bozzuto said he expects no more than 3 percent rent growth this year and 5 percent next, in line with the historical inflationary averages in the area over the past 25 years.

Similar to Seattle, development in Houston has been concentrated close to downtown in an area that locals call “inside the loop,” the district encircled by Interstate 610, where rent growth has been strongest.

Oil and natural gas have bolstered the Texas economy. Houston is headquarters to the U.S. unit of BP Plc (BP/), Europe’s second-biggest oil producer, as well as Citgo Petroleum Corp., ConocoPhillips (COP) and ExxonMobil Chemical Co.

With few apartment projects started in Houston during the past three years, there is pent-up demand to fulfill, said Ed Wulfe, chairman and founder of Wulfe & Co., a Houston-based commercial brokerage, development and management company. He said he expects apartment rents will continue to rise even with more than 9,000 new units under construction.

Appealing to Investors
Population growth and job creation coupled with high occupancy rates and rising rents are appealing to apartment developers and investors, Wulfe said. The city is one of just a few U.S. metropolitan areas that may have a bigger increase in rents next year, said Calanog of Reis.

“They might have another year for this bull run but for most other markets, I suspect this might be the peak year,” he said in a telephone interview.

Nationwide, permits were granted for 189,158 rental units during the past year, up from 121,125 units in 2009, according to Axiometrics and the Census Bureau. While U.S. permits remain 45 percent less than the annual average of 346,829 from 1997 to 2008, Washington is just 4 percent off its long-term average, Dallas is down 14 percent and Los Angeles is off 15 percent, Axiometrics figures show.

Seahawks’ Stadium
In Seattle, Goodman Real Estate Inc. and Harbor Urban LLC, both based in the city, broke ground in March on a $95 million project with 249 units in the Belltown district. Holland Partners, a Vancouver, Washington-based developer, said it plans to build 386 units across the street from the Paramount Theater, between the downtown retail corridor and Capitol Hill to the east.

At the south end of downtown, next to CenturyLink Field, home to the Seahawks football team, Seattle-based R.D. Merrill Co. said it’s helping finance about 700 new apartment units as part of an office, retail and residential complex known as the North Lot Development.

East of downtown, Laconia Development LLC plans to build about 323 rental units in a 30-story tower in the First Hill neighborhood on a site it had planned for condominiums, said Paul Menzies, chief executive officer of the Walnut Creek, California-based company. Laconia has equity financing in place and is in talks for a construction loan, Menzies said.

“I don’t think we’re anywhere near the top of the cycle,” Menzies said in a telephone interview.

Keeping Apartments Filled
Pension funds, real estate investment trusts and other institutions have flocked to buy or finance apartments in Seattle since 2010 as they seek to invest in fast-growing regions and assets they expect to hold value, said O’Connor, the consultant. Offices can sit empty for long stretches and condominiums go unsold, whereas apartment landlords are usually able to keep apartments filled by reducing rents, he said.

While REITs including Equity Residential (EQR) and AvalonBay Communities Inc. (AVB) own apartments in and around Seattle, most of the area’s development is being undertaken by private developers.

Some investors are reducing their holdings in the area amid concern about an apartment glut. Security Properties, a Seattle- based developer that owns a 268-unit apartment complex about six miles (10 kilometers) north of downtown, and its partner Northwestern Mutual Life Insurance Co. are the sellers of the site near the Paramount Theater.

“You never know how strong job growth is going to be, how strong population growth is going to be,” said John Orehek, president and chief executive officer of Security Properties, which has built apartments in the Seattle area since 1969. While concern that an apartment bubble may develop “wasn’t the primary driver” behind the land sale, “it’s always in the back of your mind,” he said.