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The US multifamily housing market is continuing to gather strength as the home-buying and condo-conversion markets cool in the wake of higher costs and rising interest rates. Keith Misner, senior managing director in the Washington, DC, office of New York-based Cushman & Wakefield, agrees that the apartment market is improving, with varying degrees of recovery in cities and submarkets. Looking ahead, the majority of sources anticipate a positive outlook for the market into 2007, featuring slow, steady growth. Multifamily is an active and aggressive lending market. Lenders realize that the apartment sector is poised for solid growth, so they want to be in the market. Washington, DC, is one of the nation's strongest apartment markets, fueled by steady job growth and economic expansion. Denver is an apartment market on the road to recovery following fallout from overbuilding and the dot-com/telecom meltdown. Houston's apartment market has made a dramatic turnaround in the wake of Hurricanes Katrina and Rita.

The nation's multifamily housing market is continuing to gather strength as the homebuying and condo-conversion markets cool in the wake of higher costs and rising interest rates. * The consensus is that significant improvement has occurred on a market-by-market basis for apartments, even though some pockets remain weak. * At the bullish end of the scale is the view offered by Washington, D.C.-based National Multi Housing Council (NMHC). The group reports that apartment market conditions are continuing to improve, although the record-level sales transactions of 2005 may cool a bit. * In a February 2006 survey, the NMHC said fully 70 percent of its respondents reported improved demand for apartments, measured by lower vacancy rates, higher rents or both. * In an earlier July 2005 report, NMHC President Doug Bibby said the apartment market had completed its recovery. At that time, Bibby noted that economists generally distinguish between the recovery phase and the expansion phase of an economic cycle. Deeming the apartment market "recovered" nationally is not meant to suggest that the industry is doing as well as it did at the height of the previous expansion in 2000 and early 2001.

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Linwood Thompson, managing director of the national multihousing group in the Atlanta office of Encino, California-based Marcus & Millichap, agrees about the distinction between the recovery phase and expansion phase. But he disagrees on the point of the apartment market being in complete recovery.

"The majority of the market has turned in the right direction, but recovery is not complete. It's an ongoing process and not finished yet," Thompson says. "But if you define recovery narrowly as 'has the downward plunge and the bleeding stopped,' in that sense there is recovery." He pegs the national vacancy rate at 6.5 percent in late 2005, compared with 7.1 percent in late 2004.

John Cannon, senior vice president and managing director of Horsham, Pennsylvania-based GMAC Commercial Mortgage Corporation, sees modest recovery nationally, but points out there are still weak pockets on a market-by-market basis.

"Landlords have cut concessions, and there's been a reduction in supply," Cannon notes. "In addition, condo conversions and increases in interest rates have stemmed the tide for single-family home purchases. Supplies may increase, though, because many condo owners will be forced to put units back on the market as rentals."

See varying recovery

Keith Misner, senior managing director in the Washington, D.C., office of New York-based Cushman & Wakefield, agrees that the apartment market is improving, with varying degrees of recovery in cities and submarkets.

"The market is getting closer to equilibrium, and jobs growth helps," he observes. "Economic expansion is having a positive effect on the fundamentals of apartment rentals."

Kenneth Danter, president of The Danter Company, Columbus, Ohio, national real estate consultant, sides with Misner that the market has recovered to some degree, but recovery is still under way. "Recovery has been more at the class-A high end than the low end," he says. Danter puts the national vacancy rate at 9 percent to 11 percent in third-quarter 2005.

Jamie Woodwell, senior director of commercial and multifamily research at the Mortgage Bankers Association (MBA), Washington, D.C., says recovery is still in the early stages. "Vacancy rates peaked at the end of 2003, and we've seen good, steady progress since then," he says.

"Development of new units has remained tame, and condo conversions have led to a decline in supply in some markets. With household growth, more demand is expected," adds Woodwell.

The widespread effects of Hurricanes Katrina and Rita have been well-documented, but what impact have the storms had on the national apartment market?

Most sources agree there's been significant local and regional impact on areas hit by the storms and also on major target cities for evacuees, but no major effect on the overall apartment market.

Thompson remarks, "The devastation raised occupancy rates in buildings relatively close to the disaster areas, but occupancies in other cities have also been affected as evacuees from New Orleans fanned out across the country seeking housing."

Danter says it's been mostly a regional effect. "As the immediate catastrophic levels filter out, there's less and less impact, and there's not much effect on the national market," he says.

Misner says Katrina presents a great opportunity for the multifamily industry to rent apartment blocks in Houston as corporations set up shop there. Cannon observes that Katrina and Rita will impact the apartment market from Texas to Florida with displaced people needing shelter.

Positive outlook into 2007

Looking ahead, the majority of sources anticipate a positive outlook for the market into 2007, featuring slow, steady growth.

Real Estate Research Corporation (RERC), Chicago, quotes an estimate by the Chicago-based National Association of Realtors® and Boston-based Torto Wheaton Research that apartment vacancy rates will drop to 5.2 percent by the close of 2006, compared with an estimated 5.7 percent at the end of 2005.

Thompson says the outlook is positive from the standpoint of growth in operating income. "Concessions are burning off in most markets, occupancies are starting to increase and rent growth is back," he says.

Cannon anticipates gradual, slow improvement. "The rental market will reflect the overall economy," he says. Danter expects the upper end of the market to strengthen as long as there's not much new construction. Woodwell sees continued overall improvement because of increased demand in the face of stable supply. "All signs point to slow, steady growth," he concludes.

Misner, though, says the outlook is still cloudy. "It's a mixed bag. On the positive side are job growth, economic expansion and improving fundamentals. But increased condo sales and higher operating budgets for energy could have negative effects."

Another statistical barometer of the apartment market is the series of quarterly assessments of U.S. property markets entitled CMBS: Red-Yellow-Green(TM) Update, issued by New York-based Moody's Investors Service.

These reports gave the apartment market generally high marks through 2005, although they noted some pockets of weakness persisted.

Sally Gordon, senior vice president at Moody's, comments that apartments are at "the high end of the comfort zone," and says the outlook for growth is favorable.

Thompson makes the point that even though condo sales and conversions reduce the size of the competitive pool, it's still a plus for the apartment market. "Rental units may go away, but renters don't go away," he says. "When supply is taken out of the market, demand is not reduced as much as supply."

Cannon concurs. "Condo fever has impacted the apartment market, but it's had a positive effect by taking away surplus supply and bringing overbuilt markets back into balance," he says.

Sources agree the booming single-family housing market has taken a large bite out of the apartment market.

Danter says single-family has had a "huge impact," offering a more affordable product that has pulled renters out of the apartment market. Thompson says it's created a challenge for the apartment market by allowing renters to become homeowners. "Low interest rates and relaxed credit standards are the causes," he explains.

Misner agrees that single-family has put a damper on the demand side of the multifamily market. "The low cost of capital has made single-family housing more affordable. The class-A apartment market has been more negatively impacted, but it's not a devastating impact," he says.

As for demographics, sources agree that one of the major trends ahead will be the impact of the echo boomers (sons and daughters of baby boomers) on the rental market. "These people in the 20-to-35-year-old bracket are entering their prime rental years," Thompson remarks.

The NMHC's Bibby says another key group is immigrants. "Immigration is continuing at high levels, and recent arrivals are much more likely to rent rather than own their housing," he notes.

Active lending market

Multifamily is an active and aggressive lending market. Thompson says lenders realize that the apartment sector is poised for solid growth, so they want to be in the market. "They're not lowering underwriting standards, and there's a lot of capital available on both the equity and debt sides," he adds.

Misner agrees. "Lenders are not pulling back. There's a lot of interest and desire to place money in multifamily assets. The market is very competitive and aggressive."

On the investment side, it's an equally favorable market.

New York-based PricewaterhouseCooper's Korpacz Real Estate Investor Survey® from 2005 says fundamentals continue to improve throughout the national apartment market, quoting one participant as saying, "The apartment sector is doing well because demand and supply are becoming more in balance."

Cannon says, "Multifamily is the most competitive type of commercial property on which to lend or buy. We're seeing up to 50 bids on a typical class-A property, and in many cases brokers are not putting asking prices out there, but asking investors to bid blind."

Thompson notes more buyers are chasing fewer properties, competing against condo converters who want apartment properties as well. Misner agrees that apartment properties are attracting multiple bids, and says Cushman & Wakefield recorded $5 billion in apartment sales in 2005 versus $2.2 billion in 2004.

Not surprisingly, the major concerns of apartment owners and operators in 2006-2007 revolve around how to control costs and preserve property values. Rising energy costs are cited, as are concerns about how to maintain value at the bottom half of the market-those properties that are functionally obsolete.

Mortgage Banking interviewed lenders in three representative markets: Washington, D.C. (strong); Denver (in transition); and Houston (dramatically impacted by the hurricanes) to get a better sense of market conditions.

Here's what we found.

WASHINGTON, D.C.

Washington, D.C., is one of the nation's strongest apartment markets, fueled by steady job growth and economic expansion. The federal government provides the foundation for a rocksolid economy that never suffered the downturns experienced by some other areas.

"We've had steady job growth for the past several years. The apartment market has also benefited from the appreciation of single-family home values, which has [priced] many people out of the single-family market," says Lamar Seats, senior vice president and head of national production of McLean, Virginia-based Reilly Mortgage Group Inc., specialists in multifamily financing.

"The median price of a single-family home is $390,000 in 2005, compared with $178,000 five years ago," Seats says. He pegs the overall metropolitan vacancy rate for apartments at 3.6 percent at the end of 2005.

Andrew Little, principal with Richmond, Virginia-based John B. Levy & Co., and Stephen Rozga, principal of McLean, Virginia-based Gimbert Associates LLC, are among those who agree the market never was in recovery mode (because it wasn't in decline to begin with). They note demand for apartments is increasing with more people moving here.

Rozga, who is also president of the Mortgage Bankers Association of Metropolitan Washington (MBA/MW), puts the metropolitan vacancy rate at 3.5 percent across the board as of late October 2005. He cites a Bureau of Labor Statistics report stating that 78,800 new jobs were created in Washington, D.C., in 2004. Local economist Stephen Fuller, director of the Center for Regional Analysis at the George Mason University School of Public Policy, Fairfax, Virginia, projects 80,000 new jobs for 2005.

Ryan Pinson, vice president-producer in the Tysons Corner, Virginia, office of GMAC Commercial Mortgage Corporation, says the apartment supply shortfall is expected to continue. He puts the class-A vacancy rate at a meager 2.5 percent in 2005.

Chuck Blessing Jr., acting regional manager in the Washington, D.C., regional office of Marcus & Millichap, notes that demand here is always relatively strong for rental housing.

What's ahead

Not surprisingly, sources predict a tight apartment market in 2006-2007. Little says, "We'll continue to see no increases in vacancies, and rental rates will go up. With virtually no concessions and no down time, it's a landlord's market."

Seats foresees strong job growth with demand continuing to outstrip supply. "Land values are so high that costs don't justify new construction. It's hard to make the economics work," he says.

Rozga agrees on job growth and points out the factor of economic expansion from industries that want to be near the federal government. Pinson and Blessing join the others in forecasting strong job growth.

Marcus & Millichap, in its October 2005 Apartment Research Report for the Washington, D.C., metropolitan area, says steady job growth and population gains have stimulated improvement in the D.C. apartment market.

A report published by Realpoint, the research division of Horsham, Pennsylvania-based GMAC Institutional Advisors LLC, underscores the apartment shortfall. According to Realpoint's 2005 Marketview report, only about half of the 17,000-plus new units scheduled to come online in 2006-2007 will be rental units. The rest are condos.

Now that mortgage rates are rising and home prices have climbed into the unaffordable range, the single-family housing boom is actually having a favorable effect on the apartment market, sources say.

In terms of demographics, D.C. is experiencing continued population growth with a mixed, diverse market for apartments, including foreign immigrants.

As might be expected, D.C.'s apartment lending market is robust and highly competitive. Rozga says, "Multifamily is the No. 1 asset class for lenders, and all are competing for the same business. They're comfortable with our market and are willing to get more aggressive on underwriting and pricing."

Seats says, "There's a lot of competition for a limited number of opportunities. Lenders like the stability of the market, our recession-proof economy and job growth. Underwriting standards are not being compromised."

Pinson says there are more lenders with greater allocations that they want to get out. "Underwriting standards have loosened a bit, but there are no problems yet," he notes.

It's much the same story on the investment side with strong demand, a large supply of capital and more buyers than sellers. Pinson says it's a seller's market with multiple bids on every apartment property. Little agrees, and says, "We very rarely see asking prices. Properties are put up to market for what they will bring."

Rozga points out that investors are competing with developers that are buying apartments to convert to condos.

DENVER

Denver is an apartment market on the road to recovery following fallout from overbuilding and the dot-com/telecom meltdown.

Sources say the turnaround began as job growth improved and demand started to burn off some of the vacancy overhang caused by overbuilding in the early 20003.

As a result, Denver's apartment market recovery is now on track, and the market is positioned for continued improvement, according to Marcus & Millichap in a 2005 Apartment Research Report for Denver.

Marcus & Millichap says new construction is falling from previous highs in 2002 and 2003, and Denver's economy is expected to grow at a healthier pace. Vacant stock from the most recent downturn is being absorbed quickly as employment and income gains fuel demand.

Well-positioned market

The Denver market is well-positioned for strong asset appreciation. Fundamentals are forecast to steadily improve, and per-unit prices are still relatively inexpensive compared with other growth markets, Marcus & Millichap notes.

Kevin McCormack, senior vice president and co-branch manager of GMAC Commercial Mortgage Corporation's Denver office, comments, "We've had an economic hangover in the wake of the dot-com/telecom collapse, but we're rapidly improving, now nearly 75 percent recovered in the apartment market."

Brian Tanner, a senior loan officer at Denver-based Western Financial Inc., mortgage banker, agrees. "We're 75 percent on the way to recovery. The supply of new construction is not being replaced, and some demand has increased absorption. The rest of the way will be influenced by the rate of economic growth, which is further impacted by Hurricane Katrina costs and gas prices," he says.

Greg Benjamin, senior vice president in the Denver office of Bloomington, Minnesota-based NorthMarq Capital Inc., says, "We're well along to recovery, aided by steady job growth and a slowdown on new construction." He estimates the physical vacancy rate at 7.9 percent as of fourth-quarter 2005, compared with 11 percent a year earlier.

Dan Woodward, senior investment associate in the Denver office of Marcus & Millichap, takes a more conservative view. "We're just starting recovery following a flat market in 2004 and early 2005," he says.

In a 2005 Marketview report, Realpoint notes the slowing of new product development is allowing vacancies and rents to stabilize.

Sources agree the Denver apartment market will build on the momentum of 2005 to generate further gains in 2006 and 2007. Benjamin terms the outlook "quite bright," a sentiment echoed by Tanner, who says it's "very favorable." McCormack foresees a market in equilibrium by late 2006.

Woodward says, "The 2006 outlook is strong and into full recovery. With new construction down and continued job growth, we're seeing positive absorption. In addition, rising single-family home costs will help the apartment market."

The long-term outlook is seen as equally favorable, subject to continued job growth.

Sources here concede the single-family market has cut significantly into the apartment market, but McCormack points out that the major impact is at the entry level. "Apartments are still holding their own at the higher levels," he says.

Several demographic groups in the Denver area are expected to boost the apartment market's prospects in coming years, including echo boomers, young high-tech professionals and a growing Latino population.

Lenders are cautious

Denver doesn't share the go-go lending environment of some other markets. Woodward points out that lenders are cautious and tightening their underwriting standards. "They're still willing to make loans, but not as high-leveraged loans as before. It's getting harder to finance deals because institutional buyers are either paying all-cash or doing internal financing," he says.

Tanner says lenders are cautious on new construction, but good projects can be financed.

Benjamin says, "With the softness in the office market, lenders looking for an alternative see multifamily as the next best outlet. They feel the apartment market is more predictable and secure." McCormack calls multifamily "the No. 1 preferred asset class for lenders." He says it's a very competitive market, with a few lenders relaxing underwriting to win business but most adhering to the standards in place.

On the investment side, Benjamin points out that Denver had a record-setting $1.6 billion in apartment sales for 2005, reflecting a strong and active investment market.

Tanner, though, says investors continue to be cautious, especially on projects of less than $5 million. "There's a generally slow market for these properties, and the motivation to buy them isn't there," he says. In Woodward's view, investors are retreating because they can't get the loan-to-value (LTV) ratios they want.

HOUSTON

Houston's apartment market has made a dramatic turnaround in the wake of Hurricanes Katrina and Rita. The combination of evacuees from the hurricanes and corporations leasing blocks of apartments created a landlord's market, almost overnight.

A total of more than 17,600 apartment units were absorbed in the month of September 2005, following Labor Day, according to Houston-based O'Connor & Associates, a real estate research firm. That's in contrast to 6,500 units absorbed in the entire first half of 2005.

Many apartment owners aided the process by expediting the signing of leases, allowing short-term leases, reduced deposits and application fees, and relaxing other requirements.

No one knows how long the units will stay leased, as some evacuees can be expected to return to New Orleans or other Gulf Coast areas, but the spike in leasing is exerting upward pressure on multifamily sales pricing. The increased leasing activity is also expected to hike rents, enabling property owners to dictate terms for the first time in a while.

Even before the hurricane impact, a turnaround was beginning for the market, according to Marcus & Millichap in a 2005 Apartment Research Report for Houston.

Marcus & Millichap says property revenues were on the rise for the first time since 2001, with renter demand for apartments improving, new supply on the decline and rents increasing.

O'Connor & Associates pegs the overall occupancy rate at 90 percent in the wake of the hurricanes, with class-? occupancy standing at 92 percent as of Sept. 30, 2005.

Matt Franke, vice president of Houstonbased Kinghorn, Driver, Hough & Co., mortgage banker, puts the overall occupancy a shade higher at 91 percent compared with 87 percent to 88 percent prior to the hurricanes. "We're also seeing a significant decrease in concessions, especially in class A," he notes.

Bill Luedemann, managing director in the Houston regional office of NorthMarq Capital, says, "The apartment market here tightened up overnight with class A basically filled up and landlords not offering concessions on new leases," he says. "Two-thirds of the evacuees are expected to stay in Houston, but even if some return to New Orleans we should be able to absorb vacant units through normal job growth,"

Arnie Azios, president and chief operating officer of The Houston Group/Realty Advisors Inc., Houston, mortgage banker, agrees apartment occupancies went up dramatically as a result of evacuees coming here and bringing corporate leasing as well. "Class-A, -B and -C properties are in high demand," he says.

John Fenoglio, president of Houston-based Live Oak Capital Ltd., mortgage banker, concurs that the apartment market "greatly accelerated" as a result of the hurricanes.

Soaring occupancies, though, represent only one part of the multifamily picture in Houston. Another major factor is robust job growth, which is fueling further strength in the market.

The Texas Workforce Commission reported the creation of 30,600 new jobs in Houston from August 2004 to August 2005. Barton Smith, director of the Institute for Regional Forecasting at the University of Houston's Center for Public Policy, forecasts 44,068 new jobs for 2006 and an additional 66,244 for 2007.

Given this scenario, it's no surprise that sources foresee a strong outlook for the apartment market in 2006 into 2007.

Job growth is being coupled with a reduction in the rate of new construction. Realpoint, in a 2005 Marketview report, notes 4,000 new units are scheduled to be delivered in 2006, virtually all of them apartments versus condo/townhouse projects.

Strong lending market

Not unexpectedly, Houston's apartment lending market is strong and active. Fenoglio says, "There's a tremendous amount of capital available from all sources, including fixed-and floating-rate lenders, structured financing sources and the government-sponsored agencies. The pressure point is on pricing, and underwriting is very tight."

Azios points out that multifamily is the No. 1 preferred commercial property type by lenders, while Franke notes that some are pushing the envelope in an effort to win business in a highly competitive marketplace.

It's much the same situation on the investment side. Azios says, "Investors are coming here from all over the world. It's an extremely active and aggressive market."

Fenoglio cites record sales volume of multifamily properties, up 60 percent to 100 percent in 2005 over 2004. "There's a tremendous appetite for apartments now, and in many cases properties are coming to market without asking prices, being sold at de facto auctions. They're attracting multiple bids," he says.

The nation's apartment market conditions vary widely. The key to the health of individual markets and their future prospects is continued job growth. To the extent the economy continues to generate more jobs, apartment markets are bound to make additional strides.