CREJ - Multifamily Properties Quarterly - October 2015
Over the last six months, almost on a daily basis, I am asked, “How much longer is this apartment development craze going to go on?” The questions are coming from not only buyers and sellers of property but also from many everyday friends and acquaintances who are businesspeople and young renters alike. This apartment boom is something most of us aren’t accustomed to experiencing, and it doesn’t look like it is losing steam. I reached out to some of my “old school” real estate mentors who saw a big boom in multifamily development in the late ’60s and early ’70s to get their thoughts. Many of them do not have concerns of overbuilding. “Where else are these kids going to go?” seems to be the common comeback. In the ’60s and ’70s there was equilibrium of apartments and condos built. Today, most renters don’t have a choice. It is quite unbelievable that our state’s lawmakers cannot come to a suitable comprise on the builder’s defects laws that protects both the consumer from real (nonlawyer-driven) defects and the developer from (lawyer-driven) frivolous lawsuits. The current Colorado laws force the developer to be personally and professionally liable for all construction defects, which created a frenzy of litigation. Lawyers, developers and banks will tell you that almost 100 percent of all condominiums built in the last 15 years have or will encountered litigation. This frenzy almost stopped for-sale condominium development in Colorado. With few options, many consumers are forced to remain in the renting mode for the foreseeable future. The demand to purchase is in the marketplace. The city of Lakewood and some other municipalities passed measures to promote condominium development. However enticing that may be, many developers don’t want to be the first test case. There are a few developers out there who are gearing up to capitalize on the demand but not many. There are currently 20,000 apartment units under construction and an additional 25,000 units in various stages of planning in the metropolitan area. The good news is the units are being absorbed. A strong, booming Colorado economy and the outstanding lifestyle are the driving forces for this demand. But there are constant concerns that wages aren’t rising as fast as rental rates. There has been a slight increase in recent reports that wages are rising, but leasing agents will tell you that many of the renters are paying housing costs that are reaching 40 percent of their total annual income. Reports also state that there are more roommate situations than in the past because of the high cost of rent. Construction costs continue to rise. Concrete, steel and wood pricing is continuing to rise, which, along with the labor shortage, is causing concerns for many developers who are trying to underwrite development deals to a financeable yield on cost. Developers, rightly so, are concerned that there may be risk in continuing to increase projected rents in an attempt to justify construction and land costs. The continued increase in costs may cause some slowing in apartment construction. Also, infill projects on smaller land parcels are struggling to pencil due to costs associated with parking. Although the city planners have offered limited parking counts in the zoning code, the market still wants to see plenty of parking. Smaller zone lots are more difficult to develop because the projects needs parking, yet in order to justify the cost of the land, the developer must maximize the zoning, which requires structured parking that is costly. Developers and contractors say the price of concrete has skyrocketed in the past three months by about 30 percent, which effects underwriting on many projects, small and large alike. However, this price increase is easier to swallow for larger projects because the cost is spread over more units. But small infill sites struggle. Developers and contractors alike are experiencing frustrations with most municipalities over the timing of entitlements and building permits. Most cities are under such tremendous pressure with the amount of projects in their municipalities that getting a response in a timely fashion becomes a factor in the underwriting process. Rising costs and the window of opportunity will have an impact on some of these future planned developments. Capital sources, although becoming a bit more conservative, still seem to be abundant for new projects. Denver remains in the top-ranked apartment markets in the country. Interestingly, central Denver core developments aren’t the only projects attracting attention, as was the norm a few years ago. Suburban projects are catching fire. A year ago, suburban projects had to have a light-rail component to it to entice equity. However, that doesn’t appear to be the case today with capital sources chasing more suburban projects. Land prices continue to rise. While zoning constraints and the number of units that can be built on the site will have an impact on pricing, we continue to see land transactions that trade on a price per square foot that, even as a broker, make us wonder, “What are they thinking?” When land in central Denver reached $50 per sf, buyers were baffled; then, for a time, $100 per sf seemed to be the norm. Now we are seeing $150 per sf becoming the standard on properties not located in Union Station. Good locations and favorable zonings continue to attract developers, but the lack of availability, especially for larger sites, will continue to drive demand. “These are the best of times” is what a client of mine tells me all the time. However, many of us still have 2007 in the forefront of our memories and continue to ask, how long will this continue? One of those old-school mentors of mine told me he changed his paradigm often throughout his 70-year career, saying nothing stays the same. There is a paradigm shift in Colorado multifamily real estate that has happened, whether we believe it or not. We still need to be cautious and stick with the fundamentals of real estate because it can sometimes look too rosy when we are living in the best of times.