
March 12, 1998

How long will this apartment boom last?

BY TOM CAIN
Cain and Scott

In the Fall of 1996 in the Cain and Scott Report we stated that recent trends in sales and rentals indicated that apartment investments were in the early stages of a bull market. The recent apartment sales volume and run up of prices have borne this out.

There is a saying among stockbrokers when advising or encouraging their clients that nobody can pick the top of the market, or the bottom, as the case may be. The apartment sales market cannot be gauged nearly as precisely as the stock market but the forces of supply and demand shape each without prejudice.

The 1990s

The first half of the 1990s here was a difficult time for many owners. Expenses had risen faster than rents and the overall rental market had been flat. In 1995, when capital gains appeared to have a good chance of passing at year-end, many owners expressed an interest in selling if capital gains passed. By mid-1996, the rental market was improving and the near-term King/Snohomish rental market looked very bright. It was obvious that the market could do nothing but go up. Most owners who were contemplating selling became entranced by the quick turnaround of the rental market and held. They had forgotten how much fun it was to own apartments.

By the beginning of 1997 all indications pointed to an exceptionally strong market with no short-term downside. For many, this was not the year to leave money on the table by selling too soon. At the end of 1997, most were surprised by the market's intensity and some of the seemingly spectacular prices. In the few years prior to enactment of capital gains treatment there was concern among investors that if capital gains passed it would lead to a surge of sellers putting their properties on the market with the result of weakening values. However, when capital gains passed in mid-1997 profit-taking was the major factor driving sales. Buying pressure was too strong to let anything get in the way of rising values.

The Booms

In the King/Snohomish apartment market, the booms have appeared like clockwork at the end of each of the four past decades. As closely as can be determined by my personal experience, their timeframes are 1967-1969, 1977-1979, 1989-1990 and 1996-? Issues pertaining to the question mark are at the heart of this article.

High Prices

There have been record-breaking sales in this current boom that were unimaginable just two years ago. One of these is Harrison Square which closed in December. This is a 147-unit, mixed-use building on lower Queen Anne that was built in 1994. After backing out the commercial space, it sold for approximately $129,000 per unit and $177 per net foot for the apartments. It appears that the purchaser paid a premium for the property because it plans to convert the property into an executive-suite program. The record-breaking Aspen Creek sale has received much fanfare since it closed in September. Its exceptionally large, deluxe units and Eastside location helped bring this 1995 garden complex $142,000 per unit and $128 per net foot.

Cain/Scott chart

The buying fever has certainly not been limited to the large institutional properties. The Los Altos and Saxonia, two side-by-side, 1927 brick buildings totaling 26 units on the south face of Queen Anne sold for $92,000 per unit and $134 per net foot. The 67-unit Marqueen, built in 1925 and located nearby, sold for $62,000 per unit for very small units and $142 per net foot. Sales similar to these two properties are running 9 to 10 times gross and cap rates ranging from 6 to 7.

The Economy

Last year's economy was spectacular. The U. S. economy expanded 3.8 percent, up from the 2.8 percent rise in gross domestic product (GDP) in 1996. Most economists are predicting a slower growth rate (GDP) in 1998 from 2.0 to 2.5 percent, mainly due to the effects of the Asian economic crisis. Private sector job growth in 1997 was 2.5 percent nationally.

Local economic forecasts call for a slowing for 1998 as well. The Puget Sound region peaked at 6 percent for private-sector job growth last year, more than twice the national average. Job growth projections for the local economy for this year and next are three percent, half that of 1997.

Asian Influence

Over the past years, Asia accounted for half of the world's economic growth. Washington's GDP is 16.4 percent with Asia, more than any other state as a percentage. Japan, with its ill economy, is our state's largest customer. Federal Reserve Chairman Alan Greenspan recently remarked Asia's economic problems aren't likely to have a large or lasting impact on the United States or the world economy. He has admitted there is "a small but not negligible probability" that the Asian turmoil "could have unexpectedly negative effects" on Japan, Latin America, Europe and eventually the U. S. He has also been reported as saying that he expects the effects will be felt in the U. S. this spring.

Asian trade is a vital part of the overall area's economic well being, but the local economy is what's driving the Seattle area apartment market. As of Dec. 31, Asian carriers had 303 aircraft on order with Boeing. Estimates for cancellations or deferrals on these planes range from 60 to up to 170 during the next few years. Boeing has announced that it will trim its work force by 12,000 through attrition in the last half of this year. Boeing will not reveal how many of these cuts will occur in the Seattle area. However, Boeing has indicated that once it has smoothed out its production problems this year, it will need less workers here.

Several publicly held, local manufacturing companies that have been doing substantial business in Asia have already changed their business planning. One recently implemented a hiring freeze and another projected zero sales to Asia.

Other Factors

U. S. inflation has fallen to the lowest level in more than three decades: 2 percent last year. If this should become a long term trend, it will erode the inflation hedge benefit of apartment investments. As you may recall, inflation played a major role in the late '70s boom.

All of the past three apartment booms were terminated by national recessions (as defined by the National Bureau of Economic Research) in 1970, at the end of 1979 and in 1990. Currently in its seventh year, this economic expansion has been long term.

Landauer, which analyzes real estate markets, has downgraded its rating on the Seattle apartment market from number one in 1997 to number four this year.

Bright Side

Things are exceptionally bright when focusing on apartment investments in the present. In the King/Snohomish market, vacancies are at historic lows and rents are spiraling. Buying pressure for most product types is very intense. Aggressive lenders with low interest rates have helped spur values. Values have been accelerating but sale prices are still well under replacement costs. New construction is relatively limited, keeping up with only half the demand. Building sites are harder to find. In fact, our area with its water, hills and mountains is being viewed very positively by national investors as one with geographical barriers to new development, becoming much more like the Bay Area.

Those who have no interest in selling need only look at the accompanying value trend graph. I can see no reason why this trend line won't continue moving upward. While admitting my bias as a native Seattleite, there is no other major metropolitan market that has greater long term potential.

The three previous apartment booms have lasted from about two to three years. We're about a year and a half into this one. The market is currently very hot; the economy very solid. Based on trends, for those owners who have wanted to sell but have held off to capitalize on this boom, it appears that this is an ideal time to put their properties on the market.

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 two local Real Estate Research Committees.