Colorado Real Estate Journal - September 2, 2015
There are over 18,000 market-rate units currently under construction in the Denver metro area, according to ARA Newmark’s second-quarter construction report. In addition to the initially alarming number, there are another 11,500 units proposed. While some rise in vacancy is expected and curbing extreme rent growth and preserving Denver’s affordability is positive, there are three big trends that are tempering new deliveries, which will keep apartment vacancy from rising to overwhelming levels – construction delays, rising construction costs and the ability to obtain financing. The general trend that surfaced over the last several years is that developments are taking significantly longer than expected to reach full completion. The construction timeline for an average urban development over 100 units that commenced in 2011 was 19 months. Two years later, the same developments are coming to completion after 27 grueling months of construction, an average extension of eight months. (Note that this trend is amplified in denser product types). The same can be said for garden developments, as garden developments that previously took 17 months to complete, now take 22 months. While the construction schedule delays have pained developers, they are key to sustaining low vacancy rates. The 2014 construction report from ARA Newmark predicted that approximately 11,000 units would be delivered last year. In reality, only 7,000 units were delivered, mainly because of overbearing construction delays. That number was just below Denver’s absorption for the year, which allowed vacancy to fall for the sixth consecutive year to 4.13 percent, according to Apartment Insights. Delays routinely are blamed on labor shortages and the new frustration is that general contractors have no capacity to take on additional work. For example, one national developer requested bids from three well-established general contractors for a suburban garden-style community proposed in north metro Denver. All three contractors declined the opportunity to prepare pricing, because they did not have the capacity to complete a bid, let alone perform the work. The rising cost of construction is contributing to fewer multifamily housing construction starts. Consider that two years ago the average suburban, three-story garden community could be built for an all-in cost of $160,000 to $170,000 per unit. The same developments, in our current construction environment, cost from $200,000 to $210,000 per unit, which dramatically changes developers’ proformas. While skyrocketing rents in prime metro Denver submarkets easily will justify the increased cost and subsequent development, many will stall before shovels are put in the ground. However, the increased timelines and costs have not discouraged seasoned developers. In many cases, developers are charging forward but resigning to the fact that timelines and budgets are simply outside of their control. “Construction costs and timelines have increased significantly,” said Andy Mutz, senior vice president at AMLI. “We are working to address these concerns for our developments, but the marketplace is driving the ship right now.” Undoubtedly, the most critical influence to Denver’s apartment pipeline is the flow of equity investment that allows proposed developments to go vertical. It is an open spigot, but will quickly run dry if Denver’s record-breaking absorption statistics slow. Big money is begging to be spent in Denver, but many investors are holding their breath in anticipation of the next quarterly market report to validate continued investment. Well-planned developments still make sense in the metro area. The unmet demand for apartments has yet to be satiated due to Colorado’s in-migration and absorption. Slower timelines and financial hurdles for development mean Denver’s vacancy rate will remain manageable. If the current construction pipeline progresses as we expect, and absorption slowly tapers, vacancy could end up at about 6 percent in 2018. Of course, there is always construction defect reform that could impact Denver’s apartment market, but that is a topic for another day.