WESTERN SNAPSHOT, MAY 2006

Albuquerque Multifamily Market

Romero

Historically low interest rates have fueled the Southwest’s real estate markets and pushed equities to Albuquerque via tax-deferred exchanges. As a result, demand for all multifamily unit sizes remained very high, levels that have not been seen since late 1998 and 1999. This overwhelming demand was heightened primarily by out-of-state investors who discovered that multi-housing properties could be purchased with significantly higher returns compared to markets like California. For example, a typical investor on the West Coast would expect a yield or return hovering around 4 percent on his investment. In the Albuquerque metro area, many investors are achieving returns in the 7-to-8-percent range.

As would be expected, this surge of activity on existing metro inventory has created a shortage of readily available opportunities. To adapt to this shortage, many investors are taking on additional risks in order to find suitable replacement properties. As a result, the market has seen an increase in deals that involve renovations of properties that have been functionally obsolescent and or mismanaged. The strategy is to reposition the asset and achieve a new level of income per square foot for the renovated units. For example, numerous properties in the metro area are passing on the utility costs of gas, electric, refuse and water to the resident. The “RUBS” program, or ratio utility billing system, charges each tenant for their pro-rata share of utility usage, including a portion of the common area. The amount is then billed back by the management company to recaptures costs that the landlords have traditionally paid in the past. This recapture will be filtered through to the bottom line and substantially increase equities over time.

As the second quarter of 2006 progresses, a slowdown of residential home buying is expected due to rising interest rates. These rising interest rates will have the biggest effect on first-time homebuyers in the Albuquerque metro area because starter homes, below the $120,000 level, have experienced the highest demand from buyers throughout much of 2005, a trend that has continued in the first quarter of 2006.

This market movement has been the biggest challenge and threat to multifamily landlords. However, this phenomenon is changing in favor of the multifamily investor. The result of rising interest rates affects the first-time homebuyers negatively because many will no longer be able to qualify for the purchase and will be forced to become tenants. This effect will tighten the overall metro occupancy of existing apartment product and gradually raise rents to further strengthen the returns for investors. The current overall occupancy of the metro area is hovering around 94 percent.

Another important factor fueling positive occupancy growth is the diminished amount of new multifamily construction. The Albuquerque metro area can typically absorb approximately 1,800 units annually to keep up with demand. In the last 2 years, the metro area has only delivered 137 new multi-housing units. When looking at the construction pipeline from a building permit standpoint, only 909 units have been permitted for 2004 and 2005 combined. This is way off the mark for traditional conditions in the metro area. The biggest reason for the lack of new multi-housing construction is a shortage of available land zoned for such uses.

Most of the remaining opportunities for multifamily developments are less than the desirable size required to maximize densities. Further delaying the supply of new units are rising construction costs. Like other areas in the country, construction costs have increased at least 30 percent for all raw materials over the last 2 years. The probability of new units being erected has been substantially reduced. Current rental levels do not appear to justify the cost of new construction. It is expected that current owners should experience a continued tightening of their existing inventory and a gradual increase of the rental rates. This will further strengthen the expected return on their investments.

In the second quarter of 2006, demand for all unit sizes is expected to remain high while capitalization rates should stay stable or increase slightly. The supply of suitable opportunities should remain scarce throughout the year. This low supply will be further depleted by improving fundamentals in the market’s overall demographic and rental arenas. As a result, occupancy rates in all areas are expected to dramatically increase during 2006. It is also expected that higher rental rates will be achieved for landlords as a result of higher occupancies and lower operating expenses. With the Albuquerque metro area providing sound portfolio diversification for investors, the market should remain in the seller’s favor for the next several quarters.

Joe Romero is a senior vice president and principal at Grubb & Ellis|New Mexico in Albuquerque.

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