Colorado Real Estate Journal - March 16, 2016
The Denver economy recovered quickly from the effects of the Great Recession of 2008 and 2009. Within several years both employment and population growth rates returned to, and even surpassed, the rates recorded prior to the financial and economic downturn. Denver returned to the various lists of “best of” economic and investment cities in the U.S. Developers, being opportunists in the best sense of the word, took advantage of the improved economic and market conditions. With speculative commercial construction difficult to finance, developers initially turned to apartments. Declining vacancy rates due to increased demand helped to justify increased rental rates and that resulted in a boom in new construction. Things were quite favorable for investors, lenders, developers and brokers. But recently the horizon has started to show some darkening clouds. Investment real estate goes in cycles. Good times are not guaranteed. Now the Denver market is showing signs of reduced demand and an oversupply of new construction, especially at the upper end of the rental rate spectrum. This also is evident in certain submarkets, especially in central Denver and along the southeast corridor between the Denver Tech Center and Lone Tree. Consider, for example, these indicators: • Job growth locally, while still positive, has slowed considerably. During the recovery years, net employment in metro Denver was increasing about 2 to 3 percent per year. That increase fell to under 1 percent in 2015, not bad by historical standards (and above the national rate) but still evidence of a slowdown. • Since employment drives much of the demand for housing, apartment net absorption followed suit. We expect that actual net absorption in 2015 was about 6,000 units. In fact, the Apartment Association of Metro Denver’s quarterly report actually stated net demand of under 1,000 units for all of 2015, including a stunning negative net absorption of over 4,000 units in the fourth quarter. That level of sudden decline is difficult to fathom so we believe the “normal” Denver net absorption history of 6,000 units to have been more likely for 2015. • Development is exceeding demand, causing vacancy rates to rise. During 2015 developers added 10,952 new units to the metro Denver market, well in excess of net absorption, causing vacancy rates to trend upward. This is particularly evident in the submarkets where much of the new construction has occurred. • Softening market conditions put pressure on rental rates. After years of rising rental rates (often exaggerated in the media), many apartment communities are offering concessions and incentives to attract and retain residents. This is particularly prevalent in properties with the highest rental rates. Conversely, the demand for low- and moderate-income housing remains unmet. So after five years of sunny skies the storm clouds are rolling in. We expect that the metro vacancy rate already is in the 8 to 9 percent range, well above the numbers cited by some apartment market boosters. To make matters more challenging, construction is not slowing. At the end of the fourth quarter of 2015, there were 18,989 units under construction in metro Denver and another 20,411 units proposed. Since that time even more projects have been announced. In addition to the 10,952 units completed in 2015, we anticipate that another 10,000 units may be added to the market this year. Should demand not accelerate, metro vacancy rates may exceed 10 percent by the end of the year and could be much higher in certain submarkets. Denver’s situation is not an outlier. We are seeing similar trends evident in some of the nation’s other popular growth markets, including Atlanta; Austin, Texas; Charlotte, North Carolina; Dallas-Fort Worth; Portland, Oregon; RaleighDurham, North Carolina; San Diego; San Francisco; Seattle; and Washington, D.C. There has almost been a feeding frenzy among apartment investors, driving per-unit prices higher and resulting in very low capitalization rates. Of interest, though, is that some of the nation’s most savvy real estate investors are now sellers, not buyers. Sam Zell of Equity Residential fame, for example, recently sold a large portfolio of his apartment properties, including communities in metro Denver. Fortunately, the clouds will ultimately pass and the apartment market will rebound. It is a simple matter of market fluctuations and cycles, something that occurs with regularity in real estate. Denver also is well situated for long-term growth. The citizens have invested in civic and infrastructure improvements, including major projects such as the Regional Transportation District FasTracks light-rail and commuter rail system, Denver International Airport expansion, the Denver Center for the Performing Arts, History Colorado Center, the Denver Art Museum, Colorado Convention Center, the National Western Center and the beautifully restored Denver Union Station. Denver attracts newcomers not only because of its economy and natural setting but also its welcoming attitudes. If we are entering an apartment market bubble, the best result will be for slow deflation instead of a sudden “pop.” This means a reduction in development, something not yet evident. It is important to acknowledge the situation and not fall victim to puffery and “it can’t happen here” exuberance. Denver’s been through many cycles in its history and they will happen again. In the meantime, we suggest caution and skepticism.