A Bull Market for Southend Apartments

BY TOM CAIN
Cain and Scott

Between 1991 and 1995 values declined about $10,000 per unit in the South King County apartment market as a result of overbuilding and a weak economy. This was a market that had been shunned by most investors in favor of the stronger, more glamorous Seattle and Eastside markets. But closer analysis showed a market with great near-term upside.

By the middle of last year there was concrete evidence that a Boeing build-up was underway and by early fall the rental market in South King County had tightened to a vacancy rate of less than 5 percent, a rate not seen since the late 1980s. In the fourth quarter, it became apparent that a new price level was being achieved.

For the older properties, those built before 1986, the price per unit and price per foot values were basically unchanged in 1996 compared to 1995, roughly $30,000 per unit and just under $40 per foot. The Clubhouse, a Renton 194-unit built in 1981, in a year-end closing achieved a high water mark of over $41,000 per unit and $52 per foot.

This was a market shunned by most investors in favor of the stronger, more glamorous Seattle and Eastside markets.

Investors' willingness to step up to higher values was more apparent in properties built in 1986 and later. Overall unit values increased from about $41,500 to $44,500.

There were some year-end institutional sales that broke out of the pack. Cedar Heights Estates, a Federal Way 401-unit complex, closed at $46,000 per unit and $52 per foot. Island Park, an upscale complex in The Lakes, a planned unit development in Kent, sold for $59,000 per unit and $60 per foot. Brighton Ridge, a Federal Way 264-unit complex, sold for $48,000 per unit and $64 per foot.

Few in the industry would have imagined these sale prices last January. This year will see across-the-board price increases that will have a greater impact on overall averages in the South King County market.

The Seattle area is once again enjoying the top billing it hasn't seen since its 1989-1990 boom. Landauer pegged Seattle as the number one apartment market for 1997 out of the 37 markets it surveys. Seattle was rated number 2 for 1997 for all property types by Emerging Trends in Real Estate. All this, after Fortune ranked Seattle as the best city to balance work and family life in November. Yes, it's hot here.

Buyers are feeling the pressure to put together deals that make sense. This is becoming increasingly difficult among national investors seeking apartment investments here. Historically, our prices have been higher than in most markets nationally. Now, they're getting higher, creating a widening disparity between yields here and those available in other parts of the country.

Adding to buyers' frustration is an inventory that's low in the newer, grade A properties. There has been a recent tendency among major property investors to consider older complexes. "Value-added" apartment investments are heavily sought after for those investors capable of rehabbing tired properties for quick value increases.

Many national investors are prepared to accept lower initial yields here because of the tremendous near-term potential. We estimate that 3,000 apartment units will be completed this year. This scant supply will not begin to meet the demand created by the 50,000 or so new jobs projected for 1997. Next year will see more new apartments but like this year demand will far exceed supply.

It is important to note that this future pressure on apartment rentals is starting from an extremely tight baseline. According to Property Dynamics' December survey, the Seattle-Everett SMSA vacancy rate is down to 3.1 percent. Pierce County is much higher at 7.3 percent but represents a small portion of the Tri-county population.

Tri-county volume was huge last year, close to $600 million with some year-end sales not yet accounted for. This compares to an average of $440 million the previous four years.

Again, based on preliminary figures, the average unit price rose to $43,600, up 8.6 percent and the net foot price rose to $63, up 14 percent. Gross income multipliers rose to 6.4 and cap rates declined to 8.6 percent.

Buyers have been especially aggressive in pushing up prices in the Seattle market. We have begun to see a new price level breakthrough of over $100 per net rentable foot. The 30-unit Castellan, a high quality, wood-frame project built in 1991, recently closed at $110,000 per unit and $141 per foot.

Even some older properties are breaking the $100 per foot level, although these need to have smaller unit sizes in order to do it. The Iris, a 1928 brick on lower Queen Anne, sold for $130 per foot and $70,000 per unit. The fact that this property had been rehabbed about 10 years ago helped account for its high price. Cap rates for these kinds of properties are quite low, ranging from about 7 to 7.5.

The Eastside was very active last year, registering half again as many sales as in 1995. Sales averaged close to $60,000 per unit and over $70 per square foot. Cap rates in this market are ranging from about 7 to 8.5.

The largest transaction was the 384-unit Central Park East, formerly called The Pines. It was a "value-added" sale that went for $42,000 per unit and $40 per square foot. On the higher end, the upscale 128-unit Chaparral at Klahanie, built in 1995, sold for $91,000 per unit and $91 per foot.

In Snohomish County the rental market really tightened: 3.3 percent in December versus 7.4 percent a year earlier. Boeing and navy renters were responsible for this dramatic change. Unit and footage prices averaged $42,000 and $52 respectively, up considerably from 1995. Cap rates ranged from 7.5 percent to 9.5 percent here on average.

A soft rental market caused Pierce County's values to sag. A vacancy rate of 7.3 percent in December was virtually unchanged from a year before. Values declined to $28,000 per unit and $38 per foot. The forces that are driving the King and Snohomish apartment markets are not generally present in Pierce.

Last fall in The Cain and Scott Report we predicted that apartment investments in this area were in the early stages of a bull market. Recent value increases have substantiated this. The greatest apartment boom in the past 20 years occurred in the late 1970s. Prices soared 20 percent per year on average from 1977 to 1979 in King County.

Will the value increases that are imminent in this market reach these proportions? It's not likely, but current market dynamics are similar. We are certain of one thing though, the bull market has begun.

Tom Cain has been active in apartment brokerage in the Seattle area since 1969, and for the past 20 years has been president of Cain and Scott. He is chairman for apartment values on the local Real Estate Research Committee.