REGIONAL MARKETS: NORTHEAST & MID-ATLANTIC

APARTMENT FINANCE TODAY • MARCH 2008

Going Where the Jobs Are

Washington, D.C., apartment developers are tapping into one of the nation’s most consistent economic engines, the federal government.

By Bendix Anderson

Washington, D.C.—It used to be a neighborhood of seedy nightclubs and old warehouses, but D.C.’s powerful real estate market has made the land around the planned baseball stadium for the Washington Nationals, just south of the Capitol, into a massive development site.

“There are 30 cranes down there as we speak,” said Greg Lamb, senior vice president for JPI, an apartment developer based in Irving, Texas.

JPI has five apartment properties under construction in the new neighborhood, which the developer believes will soon become a new center of jobs and entertainment for the city. “It’s a tremendous mixed-use opportunity,” said Lamb.

JPI is one of a slew of developers planning big apartment projects in and around the nation’s capital. Even with an expanding pipeline and rising vacancy rates, they are betting on the area’s steady job growth to keep their balance sheets in the black.

Thanks to the federal government, the area’s largest direct and indirect employer, the District and the towns nearby will create 25,000 new jobs in 2008, a 0.8 percent gain, despite a slowing economy, according to the research arm of Marcus & Millichap.

“In both good times and bad, jobs continue to move into the District,” said Lamb. “We are unique that way.”

More apartments coming

As of December 2007, developers planned to finish 36,951 apartments in Washington and the surrounding suburbs over the following three years. That’s twice the 18,000 units in the pipeline at the end of 2005, according to Delta Associates, a market research firm based in Alexandria, Va.

Most of those apartments are coming to the Virginia and Maryland suburbs, but 7,126 are planned for the District, historically the most difficult part of the metro area in which to find the land to build. Developers didn’t finish any new investment-grade rental apartments in the District in 2007, according to Reis, Inc., a research firm based in New York City.

The pipeline has expanded just as Washington is clearing its plate of new condominiums put on the rental market by their individual owners. This shadow market is difficult to track, but Delta estimates that one-third of the 12,000 condominium units finished since mid-2006 were purchased by investors. That could equal as many as 4,000 condos coming onto the rental market.

The increase in rental units pushed the percentage of vacant apartments here to 3.7 percent at the end of 2007, up from 2.9 percent the year before, according to Delta.

With vacancies rising, property managers had to offer more attractive incentives to rent apartments. Concessions doubled to reach an average discount to effective rents of 4.8 percent by the end of 2007, up from 2.4 percent the year before.

As more units get built, the vacancy rate for stabilized apartments will keep rising over the next three years, eventually reaching 5.3 percent, according to Delta.

That’s an optimistic projection, considering all the pressure on the market. The Washington area has consistently absorbed 4,300 to 6,500 apartments a year over the past 12 years. If absorption continues at the top of that range and all the apartments in the pipeline get built over the next three years, that would leave the District and its suburbs with an overhang of almost 17,500 units.

Until now, though, strong absorption has rescued many projects that otherwise would have faltered. The average project in lease-up rented 17 units per month here in 2007, even when the number of projects in lease-up increased to 41 in 2007 from 20 the year before, according to Delta.

The fastest lease-ups were in the District. At 2400 M St., Equity Residential rented 22 apartments a month to fill the 359-unit property in September, making it the fastest lease-up in 2007, according to Delta.

Investors’ hungry eyes

Even with lots of competition among new apartments, investors continue to enter the market. Equity Residential now owns 37 properties in the Washington area, and is planning on raising that number as high as 50 in the near future.

“We see Washington, D.C., as a critical core market,” said Robert Grealy, area vice president of Equity Residential.

The investors that buy apartment properties agree, pushing prices higher and keeping capitalization rates, which represent the income from a property as a percentage of the sale price, low in 2007. Cap rates averaged over 12 months dropped to 5.6 percent in the Maryland suburbs at the end of the third quarter of 2007 from 5.8 percent the year before. In the Virginia suburbs those rates stayed low at 5.4 percent, up only slightly from the year before, according to reports from New York City-based research firm Real Capital Analytics.