CREJ - Multifamily Properties Quarterly - May 2022
As I went to write this article, I couldn’t help but think about how different the world feels in April as compared to last October, when I wrote a similar article on the Northern Colorado Class A apartment market. There appears to be much more volatility in nearly every commodity and market than there was just six short months ago given inflation and geopolitical concerns with Russia’s invasion of Ukraine. The 10-year U.S. Treasury yield has jumped from 1.5% to nearly 2.75%. According to the U.S. Bureau of Labor Statistics, U.S. inflation (as measured by the consumer price index) reached a 40-year high in March with the year-over-year data showing an 8.5% increase in the CPI. This can be felt throughout the U.S. economy, whether that’s at the gas pump, the grocery store or a restaurant, or in building materials, labor, housing costs, etc. With all this uncertainty in the world, the Class A, institutional size and quality, apartment market in the Northern Colorado region appears to remain extremely strong.
The strength of the market is reflected in our biannual survey, which was just completed. Stabilized communities in Larimer County experienced a year-over-year increase in average asking rents per square foot per month of approximately 13.47%, with that rate climbing from $1.66 to $1.89. Occupancy increased slightly during this period, moving from 95.46% to 96.03% year over year. In the northern Weld County area (Greeley, Evans and east Windsor), occupancies also increased slightly, moving up from 94.52% to 95.3% year over year, and average asking rents per square foot per month were up even more dramatically than in Larimer County, increasing from $1.42 to $1.71 year over year, for a growth rate of 20.23%.
Concessions remain extremely low (one month’s free rent maximum and only in very select instances) or nonexistent in the market. Delinquencies also remain extremely low. This strength in the market and the in-migration into Northern Colorado from other states, regions and even the Denver metro area has led to significant ongoing demand for quality institutional apartment community development sites, and rightly so, as there are less than 1,000 units within Class A, institutional communities currently under construction in the entire region. This as compared to nearly 3,000 units that were under construction and in lease-up in the time period approximately 18 to 42 months ago.
The market remains very strong, and demand appears to be steady, if not accelerating. However, there are many headwinds that make it increasingly challenging for apartment developers to bring projects out of the ground. The rampant inflation on material costs and labor, as well as the volatility in the financial markets and rapidly increasing interest rates, are relatively new challenges developers are facing in addition to those familiar and persistent challenges, which continue to include: sourcing quality development sites in municipalities/districts with cost-feasible impact fees and/or favorable raw water situations; continually rising development impact fees and raw water dedication costs in nearly every municipality; longer entitlement and construction timelines due to lack of staffing in planning departments; supply chain/material procurement challenges; and lack of construction labor/trades. Some municipalities also have raised their cash-in-lieu of raw water fees and/or other impact fees, which exacerbates the challenges related to delivering new attainable or affordable housing to the market. In some cases, the raised fees hamper delivery of new market-rate units, which also negatively impacts overall affordability of housing in those areas. We are seeing more activity and proposed projects in the region, but with the headwinds noted above, my expectation is that, while many of the proposed projects will come out of the ground at some point, the pipeline likely will be delivered over a number of years, and some projects may be put on hold indefinitely.
Assuming demand for new apartment units remains strong and the challenges to develop new apartment communities persist, I expect to see strong rent growth over the next 12 months. Rising home mortgage rates pushing some would-be homebuyers back toward being renters for the foreseeable future may serve to further reinforce the demand for new apartment units. At this point in the market cycle, and with what has happened in the financial markets in the last six months, a much more difficult piece of the value equation to predict is cap rates. We have seen cap rates in the region compress down to the high 3% or low 4% range for the best Class A, institutional assets. Cap rates don’t appear to be rising at this point, likely due largely to the tremendous amount of capital chasing Class A apartment assets in attractive markets like Northern Colorado, but we are watching them closely.
While there is much uncertainty in the world and the financial markets, it appears very likely that the Class A apartment market in Northern Colorado will remain robust for the next 12 months, and likely beyond, as the rapidly rising costs and interest rates will hold supply in check to some degree over the next few years, and unless demand drops off a cliff, vacancy should remain quite low. I expect that rent growth will be quite strong. Again, the major wild card will be cap rates over the next few years. If rent growth remains strong and cap rates don’t rise significantly, we should continue to see increased apartment valuations in the foreseeable future. But if cap rates were to rise significantly, rent growth may be necessary simply to hold valuations relatively steady over the next few years.
"Despite Headwinds, Keep Betting on Northern CO", written by: Jake Hallauer, CCIM, President, NAI Affinity