WESTERN SNAPSHOT , AUGUST 2005

Denver Multifamily Market

Hawks

After 10 years of the most dramatic growth in the country, the Denver apartment market changed in 2001 into the worst apartment sector in the country. Doubling in less than 12 months, vacancies rose to a 14-year high of more than 13 percent. Almost nonexistent in the 1990s, concessions jumped to at least 3 months free rent on a 12-month lease. The metro Denver apartment market, which prided itself on a decade-long occupancy level above 95 percent, found itself staring at economic occupancy of less than 70 percent. As if to add an evil Hollywood subplot, this trend was taking place as the Denver market added more apartment units in a year than it had since 1987.

Fortunately, if you are looking for a happy ending you may not have to wait long. Mid-year 2005 finds the metro apartment vacancy at 9.3 percent. This means that there are only 25,000 vacant units out of the 278,000 making up the metro Denver apartment base. In the past 10 months, the market has absorbed a net 10,171 units. For the entire metro Denver apartment market to get back to a 95 percent occupancy level, all the market would have to do is to continue to absorb at that same rate for the next 10 months. It is safe to assume that as the market moves back to 95 percent occupancy, the concessions still present in the market — currently, 15 percent — will continue to decline.

Job growth and lack of supply account for the dramatic recovery. From April 2004 through March 2005, metro Denver created more than 30,000 jobs, ranking in the top 10 in the country. While the demand rose, the delivery of new apartments has dropped to 28 percent of the 2002 levels. More importantly, there are no market-rate, suburban garden-style apartments currently under construction in metro Denver. If it were not for a few tax-credit properties and TOD (transit-oriented developments) properties, there would be no building at all.

All this is taking place as the single-family home prices have continued to climb to one of the top levels in the country. Denver has the highest average home sales price of any U.S. city not on the coast. In March, the average home sales price jumped above $300,000 for the first time.

These current market conditions have the national investor community sitting up and taking notice. As if sent by the prince to see if the glass slipper fits, the institutional and private investment groups are coming to Denver hoping they are not too late to “take Cinderella to the ball.” The most common remarks heard in Denver by these potential suitors: “We missed Seattle, Las Vegas and Phoenix. We think now is the time to move into Denver before it follows those other markets.”

The good news and the bad about the present apartment market are the concessions and the cap rates. Most new investors to the Denver area are stunned to learn that Class A properties are trading at sub-5-percent cap rates. However, they are quick to learn that these cap rates are being applied to in-place concessions and vacancy of at least 25 percent. After researching the fundamentals of the market, most current purchasers project their going-in sub-5-percent cap rate to end up being a leveraged 5-year IRR of 17 to 20 percent.

With this kind of potential, it is easy to see why national investors have placed the metro Denver apartment market on their wish list. A new group of investors, which has never before come to Denver, is the “rehab” opportunity funds. It seems like the Colorado stars have aligned for this type of multifamily investment. Almost 50 percent of the 278,000 apartment units in Denver were built between 1965 and 1979. Because of the historically high prices paid for these assets and the low cost of construction, there has never been a time when the renovation of these older properties made economic sense. Today, with high concessions to force down the price per unit and record construction costs, the spread between the purchase price and the replacement cost is more than $60,000 per unit ($55,000 to $115,000). Several of these “rehab” opportunity funds are beginning to buy 30-year-old product and do a $10,000- to $25,000-per-unit rehab. This places the asset at a competitive advantage over other 30-year-old product as well as new apartments.

The biggest problem for a potential purchaser in the Denver apartment market is finding a property to buy. Denver traditionally has very low transaction volume. During 2004, there were only 21 sales of apartment communities exceeding 100 units. During the same period, Dallas and Phoenix did more than six times that number. This is not an isolated case. Over the last decade, Denver has averaged only 25 sales per year. With the stoppage of new merchant-built product, these numbers could decline in the next few years.

The bottom line is that Denver is back or at least poised to get back quickly. So consult with you fairy godmother, put on your dancing shoes and get to the dance quick before all the partners are taken.

Jeff Hawks is a principal in the Denver office of Apartment Realty Advisors.

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