This post are notes from Lon Welsh, founder of Your Castle took during a four hour webinar hosted by the CO RE Journal to discuss the trends for the apartment market.

Big Takeaways

Pace of new apartment permits has been slowing since 2016/17

• Pace of completed apartments peaked in late 2017 and also declining
• Increases in construction costs, land costs, and labor shortages all contributed
• Turned out to be a great thing; now that we have the demand shock, we don’t have a glut of inventory.
• COVID led to increases in concessions, a slight decline in rents, and a slight increase in vacancy
• Older buildings / smaller complexes less decline in rents; newer buildings / bigger projects have had more decline in rent.
• Renters in units are paying rents as scheduled; almost no change from last year. 

Rents in CO Springs are 25-30% less than Denver

• As a result, adjusting for population, COS has a lot less (< 50%) of the new apartment construction in process
• This has supported rents
• Vacancy and rents stable (actually improved to landlord’s favor a bit!)

North Colorado rents are just a little less than Denver

• So as you’d expect, there’s been more new apartment construction per capita than COS, but less than Denver
• Rents down less than in Denver

Sales

• Immediately after COVID saw a few deals at a 10% discount to just pre-COVID
• Then within a few weeks, that discount narrowed to 3-6%
• Most recently properties only a 0-3% discount

Next for rent / vacancy?

• Hard to predict, but we’ll probably see vacancy grow from ~6% to ~8% in Denver; rents could be +0% to -3%
• CO Springs vacancy will likely be flat; not much change to rents
• North CO will be somewhere in between.

Investor apartment demand / recent deals

• There are contracts to close soon that will set new records
• Prices going up due to low rates.  < 3% rates help a lot!
• Nowhere else to put money, so lots of investor demand, still.
• Still upswing for apartments in Denver for institutional class assets
• People that did invest in retail and hospitality…. Now investing in multifamily

Stats from Cary Brutig – appraiser for big apartment complexes

• Denver down 160,000 jobs in April; now recovered 50,000; so down net 110,000
  • 1990s: 10 jobs added / apartment
  • 2000s:  had job losses, net, but added some apartments
  • 2010s:  5 jobs added / apartment (that’s a normal ratio)
• Our recent mania for building apartments is about right level relative to jobs added 2010 – 2019
  • Lots of projects in pipeline
  • But apartment starts off -30% from peak in 2018.  It’ll decline more by year end.
• # of new permits relative to inventory….. close relationship

You can see the permits maxed in 2017, declined since.  And the completed lag 24 months behind, they maxed in 2018, and now declining. 11,000 to complete this year, and less in 2021.

Big Points

• Supply
• Population change
• Employers + change in economy
• Sales + investor demand

Apartment Supply Denver

• Under construction now: 22,100 units
• Around 25% downtown; about 5% more than historical trend.  Big amenity buildings… but the amenities are shut down at the moment.  Not so exciting.  So no need to live in fancy new build – live in older, cheaper building without the overheads (that you can not use anyway)
• Big decline in permits.
• Once we get thru the 22,000 units in progress; smaller pipeline behind that (probably).
• DSF for sale permits are down, too.  Price still up!
• Hard for renters to exit renting since it’s a big price barrier to purchase.

Apartment Demand Denver

• 3.33 MM people in metro Denver.  1.5% annual growth for decades.  Thought that is expected to slow down.
• 5.90 MM in Colorado.
• Which metros are mostly likely to get an out-of-market rent search – #1 is Denver!
  • Followed by Baltimore (?) and San Diego
  • We get lots of searches from CA, Chicago, DC, FL
  • Who actually moves here (2012-19)?  NY, LA, Chicago, DC, Dallas, SF, Atlanta, Philly, Miami, Boston
• We look more favorable post-COVID.
• Who is coming?
  • Millennials – we attracted more than any other big city

Most – their employees have not gotten here yet – still in progress of moving.

Work at home plays well w/ the lifestyle here.

Examples of companies using less office space WHILE hiring more people. 

Another big company coming here soon – signed a big lease – announced soon – NW Denver metro.  Picked Denver to work from home.  Work from home some, work in office some.

18% of Denver economy impacted by COVID shut down.  82% more or less not impacted. 

New office space being delivered over last few years.  Still a few in queue.  That slowed down pace of big co to move here- no where to put them.  However, we might have a bit more office space downtown than we need for a while.  There are more sublease spaces open now than in last decade.

This available space – makes it easier to recruit companies here.  WeWork was though to take 700,000 SF…. Oops, not taking it now. 

Investor Demand / Recent Deals

• There are contracts to close soon that will set new records
• Prices going up due to low rates.  < 3% rates help a lot!
• No where else to put money, so lots of investor demand, still.
• Still upswing for apartments in Denver for institutional class assets
• People that did invest in retail and hospitality…. Now investing in multifam

Debt Panel

Debt service reserve requirements

• useful while we learned that rental collections stay strong
• easing up on the requirements as multifam has proven it’s a strong sector
• strong sponsors with lots of liquidity also may not need to have the reserves
• if <140% DCR, then 9 month reserve
• if <155% DCR, 6 month reserve
• sounds like some items are getting a bit more lax
• when to release the reserve? 
  • Initial due diligence reports are checked
  • Loan performing OK; at the DCR that was planned
  • Lift any state / local emergency declarations
• Lender 2, 12 months of reserves at the moment.  Minimum 9 months.

Buyer Panel

How has your investment approach changed since COVID?

#1

• Not much has changed
• No change to target returns from fund; client (investors) expectations have not changed
• His job as a fund manager got a little tougher. 
• Still actively looking to buy.
• Amount of capital to chase deals has made it difficult to find good opportunities

#2

• Looking harder at underwriting, but metrics and most assumptions – no change
• Rent growth will be lower in future
• He’s a developer so the time horizon is so long, COVID just not that relevant

#3

• Assumptions are a bit different; he has a lower hold timeline (not a developer)
• Lower rent growth assumptions; more for vacancy
• What if 0% or slightly negative rent growth for 18 months?
• Ops in the buildings he owns now have not changed much
• Didn’t think he’d buy a deal for 9 mo; but actually found one to put UC.  Worked even w/ low rent

#4

• No change to approach; still likes Denver a lot. 
• Coastal gateway markets (e.g., CA) – seem less desirable to him , so more in mountain states and sunbelt states
• Still workforce housing, class-B assets.  Still likes value add but thinks that’s limited for 12-18 mo
• 3-5 year holds are now 5-7 year holds
• Thinks uncertainty will wrap up in 12-18 months

Assumptions

• Now: 11 to 14% for econ vacancy, so up a bit.  Pre-COVID was 7-10%
• May not impact residual IRR …. But will impact ops and cash flow while own the asset
• Dig into: what leases are actually getting signed at

Everyone is looking at more suburban projects

How will 2021 compare to 2020?

• Transaction volume will be a lot higher in ‘21
• There is a lot of supply coming on line (new build) in Denver and many other similar cities. 
• Not sure how that change in COVID demand work impact it.
• A lot of groups are selling assets not – not cheap pricing – ‘we want to take chips off table expecting a slow down next year’