As appraisers, a common question we receive is why a specific sale was excluded/included. Many decisions come down to investor profile. The graphs herein illustrate why this is critical. The substantial price differences based solely on number of units at the property is a difficult metric to disregard. Any of your thoughts on this topic are appreciated.
With all apartment sales through the first half of 2018 now accounted for, how is the year shaping up? In short, the mixed signals continue. Rents are up, per unit and per Sq. Ft. values are down, cap rates are down, and vacancies are up. None of this has slowed sales, as we are on pace to reach 190 transactions, or close to 2017. Lastly, YTD 2018 annualized construction permits are down 25% from 2017, which means apartment completions will likely accelerate for the balance of 2018 and in to 2019.
It's also become increasingly difficult to enter the market for less than $100,000 per unit, no matter where you are in the four county metro area. In 2015, there were 124 sales for less than $100,000 per unit. This dropped to 84 in 2016, 33 in 2017, and only 11 for YTD 2018.
There are countless indicators to judge the health of an apartment market, though many are difficult to understand or provide too much detail for the average participant. Below are four macro indicators that we track to judge the overall health of the market, and only one is apartment specific. We’ve also added some commentary on how they apply to the Portland apartment market.
- Interest rates - I think most agree that interest rates are not going down. Eventually rising interest rates will begin to push cap rates.
- Employment - Portland MSA employment remains very strong. We have gained 31,000 jobs year over year, and unemployment remains at record lows
- Home ownership ratio - Exact figures are tough to nail down, but there is a general consensus that home ownership is increasing, which hurts apartments, especially apartments with high rents. Keep in mind that a 1% increase in home-ownership in the Portland MSA means 8,000 fewer households in the market for rental housing
- Apartment Construction - Portland has reached peak levels of apartment construction not seen since the 1970’s. Some oversupply is likely in the near term.
While I've continued to track apartment construction since my last report in 2016, finding the time to compile the information for a report hasn't occurred. Well...I found the time and here is my latest report.
The following report attempts to summarize Portland metro's current supply of construction (both proposed and under construction), and also addresses where prices have come in on both completed apartments and apartment land.
The Portland Apartment market is sending a few mixed signals for YTD 2018. As more transactions close, we expect better clarity as to how buyers and sellers are reacting to our transitioning market.
The Portland apartment market has been on an unprecedented run since 2014. However, the reality of a "normal" market may be setting in as we see increased vacancies, flat or modest rent increases, peak apartment completions, and rising interest rates. But, up to this point, values have barely flinched, jobs growth remains strong, wage growth is finally happening, and long term prospects for Portland remain strong.
We recently published our Annual Barry Apartment Report. We've summed up what occurred in 2017 and where we see things headed in 2018.
Now that the dust has settled, how did the Portland Apartment market fare in 2017? There are a few ways of approaching this question.
- 2017 Sales Volume - $1.7 billion - Portland apartment sales volume decreased by 48% from 2016, which sounds a bit frightening on the surface. However, 2017 will be the third largest year ever for apartment sales volume.
- 2017 Transactions - 192 Sales - The number of Portland apartment transactions was down 27% from 2016. Despite the sharp decrease, 2017 was one of the top 10 busiest years ever.
- Median Price Per Unit - $149,000 - On a per unit basis, values haven't skipped a beat. On a year over year basis, values were up 25% per unit, which is quite staggering.
- Median Price Per Sq. Ft. - $164 - When considering the median price per Sq. Ft., values were up 26% from 2016. Another staggering increase.
- Overall Capitalization Rates - 5.45% - Cap rates were flat from 2016. This would suggest little change in values if the net income were flat. However, income and net income has generally been increasing.
Despite sales volume and the number of transactions being down from previous years (which were all-time highs), the Portland apartment market is showing little signs of weakness. Values were up across all sub-markets and investor demand remains high.
However, some concerns are out there with regards to increasing vacancies, a slow down in rental rate increases, a large volume of new units hitting the market in 2018 and 2019. I will address these issues in a future post.
The US Census Bureau has released their final figures for housing permits issued. The Portland four county metro area issued permits for 10,319 multifamily units in 2017. This is over 3,000 more units than 2016 and will represent the busiest year ever for Portland apartment construction. Keep in mind these are not applications or inquiries, but actual permits issued.
Multnomah County has by far the largest share of permits issued, with Clark and Washington County following behind. Clackamas County remains slow. This surge of permits is partially due to enactment of Inclusionary Zoning (IZ) in the City of Portland, which pushed developers to apply for permits prior to February 1, 2017. Very few of the permits issued in 2017 were participating in the IZ Program. Pre-IZ permits will continue in to 2018 as these projects work their way through the system.
The City of Portland is in the final stages of passing a mandate that requires owners of Unreinforced Masonry (URM) buildings to complete extensive (and expensive) retrofits. While some uncertainty remains, the bulk of the retrofit requirements and incentives appear to be set.
We’ve completed a number of recent appraisals of URM and physically similar non-URM buildings. We’ve analyzed all of the relevant value indicators, and are seeing about a 5%-10% discount, which is at the low end or below the potential cost impact. However, due to the very limited number of current sales, it can be difficult to identify exactly what is driving the discount (location, condition, income/expenses, overall market conditions.....or the URM status).
There are a number of potential reasons for a lack of discount.
- The possibility of having to comply with more stringent regulations and thus face additional costs is a new phenomenon that has not been readily apparent until recently. The City of Portland introduced potential retrofit requirements in December 2014, though it was not until April 2017 when a report was provided detailing potential requirements and potential costs.
- Very strong investor demand for well-located urban properties, and investors possibly discounting future risks based on the strong urban location of most URM buildings
While some form of mandatory compliance is likely.
The final mandates have not been approved by Portland City Council
The timing could extended out as far as 25 years
There is uncertainty on the financial benefit of the incentive offered
With the final mandates likely to be approved, and cost estimates floating around, we think the discount will grow. Retrofit estimates are $20-$70/Sq. Ft., or maybe 7%-25% of value. I've spoken with some owners who believe the actual costs will be higher. The City of Portland has proposed many incentives, but there is uncertainty on the financial impact. We are watching this issue closely both on the regulatory requirements and the sales.
Anyone familiar with the Portland apartment market is well aware of the friction between tenants and building owners that arose in recent years. There are many underlying factors that contributed to these tensions that I will not dive in to. But, I believe this one graph perfectly sums up when and why the tension began.
The chart below from CoStar tracks Portland Rent Growth vs. Income Growth. From 2006 to mid-2014, rent growth and income growth moved mostly in tandem. However, starting in mid-2014 things changed and rent growth increased much faster than income growth. The graph shows an obvious divergence from mid-2014 though mid-2016. When looking at this graph, the anger felt by tenants in understandable.
According to CoStar, as of mid-2016 the trend appears to have reversed itself with rent growth dipping below income growth. However, the damage has been done and the tension between tenants and building owners doesn't appear to be going away anytime soon.
For a period of time during 2014 through 2016, Portland was making lists of cities with the highest rent growth. Portland saw limited apartment construction from 2008 to 2013, despite steady increases in population. Developers answered the call for new construction in a big way. Now as we enter our fifth year of sustained apartment construction, the impact is finally being seen in rents.
Based on information from CoStar, 2017 rents have decreased or remained flat for all unit types across Multnomah, Washington, Clackamas, and Clark County. It's worth noting that Multnomah County, which has seen the highest rates of construction, shows limited rent increases since late 2015/early 2016.
In addition, effective rent growth across the entire Portland MSA has dropped 1% according to CoStar. This is a drastic change from year over year increases of +10% during portions of 2015 and 2016.
Very interesting article about how other cities are making housing more affordable and encouraging development. Portland could probably steal an idea or two from this list.
In the process of completing some appraisals for proposed apartments, I stumbled upon a great map from Berkadia that I thought was worth sharing. This map shows apartment projects across the Portland MSA which are in lease-up, under construction, and planned. The detail is pretty incredible. However, this map appears to exclude projects under about 50 units, which make up a large cross-section of current construction.
The City of Portland has issued their draft Unreinforced Masonry (URM) Building Policy Report. Preliminary city cost estimates range from $20 to $112 per SF of gross building area, based on the extent of retrofitting required. The requirements in this report will be considered by the Portland City Council in early 2018.
These are huge costs and could have a major impact on apartment owners if passed. While incentives are being finalized, most owners say the available incentives aren't close to covering the costs. See if your building is on the list.
Last week, Multifamily Northwest published their Fall 2017 Apartment Report. This report includes a very detailed vacancy and rent survey which covers 20 sub-markets and seven unit types. The Fall 2017 survey includes 52,500 units across more than 750 properties. The findings of this report include an increase in vacancies from 4.01 percent in the Spring of 2017 up to 4.37 percent as of Fall 2017. This survey also reports that rents increased from $1.50 to $1.57, or 4.7 percent, from spring to fall of 2017. However, it should be noted that properties less than two years old are not included in this report.
Portland Metro vacancies bottomed out in Fall 2015 at 2.9 percent and since that point have slowly crept up. At 4.4 vacancy rate, the market is shifting from a landlords market, to a market in balance. If you're interested in any information on specific sub-markets or unit types, don't hesitate to reach out.
We recently wrote an article for the fall 2017 edition of the Multifamily NW Apartment Report, which is available here. While apartment permit activity has slowed down, there are an incredible number of projects in the pipeline with pre-IZ entitlements. 2017 will likely be a record year in apartment construction and there are few signs of slowing in the near term.
Multnomah County just released property taxes for the 2017-2018 tax year. The property taxes include the increase from the $790 million bond measure passed in May. In general, properties taxes are up between 9 and 10 percent. Use the "Guest Login" at the link below to see your new taxes.
There is no question that apartment values have seen incredible increases since 2013. The increases are unprecedented in Portland. The annual value increases since 2013 are by no means sustainable, but have the underlying fundamentals of the Portland rental market shifted, and maybe THIS TIME IS DIFFERENT.
It's a difficult question to answer. Real estate is a cyclical industry and most of the time, a reversion to the mean is a predictable outcome. But to many, Portland feels different this time around. However, quantifiable data to help support this shift in underlying fundamentals has been hard to come by.
Josh Lehner, an economist with the State of Oregon, recently published an article which helps support this notion. In the process of looking around the country for cities that may be the "Next Portland", he has revealed a shift in the underlying fundamentals which impact the Portland rental market. He notes the following major changes.
- Since 2007, Portland moved from 32nd to 19th in highest median household income among large metros
- Portland has a unique ability to attract and retain talent. Our migration rates among young college graduates now compares with San Francisco, Denver, Raleigh, DC and Seattle
- Since 2007, Portland moved from 27th to 16th in highest share of working age residents with a college degree (34% in 2007 vs. 40% today)
- Since 2007, Portland high wage jobs have increased 35%, or 5th best in the nation
- The college educated migrants coming to Portland have STEM degrees, which is a shift from arts/humanities degrees
If you're interested in the full report (2 pages) and accompanying slides, they are included at the link below.
Portland in Transition:
The region is far from over; there is no “Next Portland."
Oregon Office of Economic Analysis
September 28, 2017