Vacancy up, rents down for Class B apartments in region

July 28, 2013

The halfway point in 2013 brought a rise in vacancy for the mid-tier (Class B) apartment market compared with this time last year. Rents fell as tenants showed more interest in upper-tier, or Class A, properties.

Vacancy increased to 4 percent metrowide from 2 percent at this time last year. Vacancy increased in the suburbs, but decreased slightly in the District. Of note, vacancy did decline marginally, from 4.4 percent, from March to June 2013.

The average metrowide effective rent (after concessions such as free rent) dropped 0.8 percent from one year ago to $1,570. Effective rents increased over the year in some submarkets but decreased over the year in others. Suburban Maryland rents are down 0.1 percent, and rents in Northern Virginia are down 1.4 percent. However, rents in the District increased by 0.3 percent over the year.

Several contributing factors will likely keep vacancy low, but will put downward pressure on rents through 2014:

1.In our view, continued economic uncertainty and the implementation of federal budget cuts have contributed to an unwillingness or inability on the part of property managers to raise rents. However, we expect job growth in modest-wage industries to bolster the Class B apartment market in the coming year. Lower-wage jobs are expected to grow at a healthy pace, particularly in the retail trade and construction sectors, increasing demand for Class B apartments.

2.House prices in the Washington area increased 9.2 percent in the 12 months ending March 2013. High home prices force many people to rent instead of buy. The ratio of renters relative to owners has increased substantially in the Washington region over the past few years. This should continue to keep vacancy fairly low and support demand for Class B units.

3.As a large pipeline of Class A product is delivered in 2013 and 2014, pressure on the Class B market will likely mount. More generous concessions may be introduced in the Class A market to lease new projects quickly. To keep pace, Class B rents will likely edge down further. Concessions as a percentage of asking rents are up to 2.1 percent in the area, compared with 1.1 percent at mid-year 2012.

Class B investors are seizing upon this moment in the cycle to upgrade their holdings. Nearly 35,000 units are in renovation at this writing, up 1.9 percent from the year prior, at an average renovation budget of $22,000 per unit.

The differences in rent rates between Class A and Class B properties in specific submarkets continue to favor the investor who takes advantage of renovation and repositioning opportunities. In our view, these opportunities can be the most profitable where the rent spread is widest between Class A apartments on the one hand and Class B or even Class C apartments on the other hand. When Class B or C units are renovated, rents can be raised correspondingly and still represent a discount to the prospective tenant compared to Class A rents.

Philip Tilly is an associate at Delta Associates. Staff at Delta Associates contributed to this article. For more information, please visit www.deltaassociates.com.

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