WESTERN SNAPSHOT, APRIL 2005

Las Vegas Multifamily Market

This will be a year of improving fundamentals and movement from a condition of market equilibrium at the start of the year, to the beginning of a shortage by the latter part of the year.

Quite plainly, there has been and continues to be inadequate production to match the growth of demand in the market. Currently, there are only limited concessions in a market that averages over 96 percent occupancy. This is different from 1 year ago, when owners were typically giving 1 to 2 months free. Apartment markets, typically, cannot move much beyond 98 percent, because there needs to be some down time to make vacant units “rent ready.”

We at Picerne Development Corporation believe rents will increase 7 to 10 percent during 2005, depending on the market segment and market area. This would represent the greatest 1 year increase of rents in over a decade, but pales compared to the appreciation in home prices and land values since 2003.

Demand for apartments should equal approximately 5,000 units for the year. There are only a few thousand units expected to be added to the apartment inventory in Vegas. It is difficult to say precisely the exact number, because much of the new construction might alternately be sold as for-sale condominiums. Indeed, the impact of condominiums on the availability of apartments is even further affected by condominium conversions from existing apartments. Some estimates have as many as 11,000-plus units being converted in 2005 and 2006.

Conventional wisdom says that 2005 is likely to be a time of increased interest rates and decreased sale housing affordability, and that the excess demand will migrate to the apartment market. While it is true that there will likely be more demand for rentals, the market has an abundance of alternatives. Buyers of condominiums are often investors who utilize the units as rentals. Similarly, an estimated one-fourth of the single-family sales in 2004 were to investors — and many are using their investments as rentals. Nonetheless, we have evidence from the operation of our properties that these alternate rental sources are not yet making a serious impact on the apartment market, though the balance of options in the Vegas rental market will change over time.

One would expect that with the tightening of the apartment market there would be many new units in the pipeline. Actually, this is not the case for several interconnected reasons. Land costs have escalated to the point that apartment developers cannot easily compete with homebuilders and land speculators. Even though rents are increasing, they are only modestly higher than those of a few years ago. Apartment rents have only averaged a 2 percent increase during the past decade. While there appears to be “room to grow,” the projected return on costs for new construction is at the lowest level in a generation. Alternate developments such as condominiums seem to offer much higher returns for developers. Picerne is bullish about the Vegas apartment market because we believe the apartment net operating incomes will increase significantly in that interval by 2007 and 2008. Since these are long-term wholly owned Picerne internal investments, we are able to “bet on the come” and take a lower initial yield. Most developers who solely use outside investors cannot show a strong enough return to attract capital. Eventually, this will change, but for now, there is not enough momentum in the Vegas apartment market to generate significant new developments.

Total development costs for new Class A product is now approximating $105,000 to $110,000 per unit for our new projects, which will start in 2005. For those developments completed in the last year, costs per unit were in the low $80,000s. Clearly, the incomes generated by these properties have not escalated as quickly as costs. Our new developments are now exclusively three-story product, whereas the previous projects were two stories. Higher apartment densities are a permanent reality in Vegas. We will not, however, see many mid-rise or high-rise rental apartment developments in the foreseeable future until rents increase enough to justify the much higher construction costs of these very high-density configurations.

We expect the pace of sales of existing apartment communities to slow down during 2005. There will be fewer proposed condo conversions. Sales to converters, to some extent, drove the market to new heights during 2004. The cost of long-term acquisition capital should also increase, making cap rates go up. We would expect the increased property operating incomes and higher cap rates to more or less offset one another, so that sales price increases of apartment communities should level off, at least temporarily.

Overall, Picerne is optimistic about the future of the apartment market in Vegas. Rents can only increase as much as the ability of renters to pay higher rents, so even though there will be pressures to increase rents, there will be practical resistance until income levels also begin to increase at a rate exceeding inflation. The upcoming year will, we believe, mark the continuation of a long-term positive trend, which first became clear in 2004.

Andy Miller is a senior vice president at Picerne Development Corporation.

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