The residential market in Seattle has been very active in recent months, and many companies are trying to keep a pulse on the continuous activity throughout the Puget Sound region in 2018 and beyond.
We recently spoke with the Kidder Mathews Seattle multifamily team-which consists of Giovanni Napoli, Philip Assouad, Ryan Dinius and Sid Warsinske-about current market trends in Seattle and the greater Puget Sound region, and what the team foresees for the year ahead.
The Kidder Mathews Seattle multifamily investments group specializes in the sale of multifamily properties and focuses on large private capital and private small- to mid-market transactions. The team works with institutional and local investors and developers, and has collectively sold over $1.2 billion of apartments and development sites in the past two years.
What can you tell me about the services that the Kidder Mathews Seattle multifamily investments group provides in the Seattle area?
Our core business is listing and selling multifamily properties and multifamily development sites in the Puget Sound, ranging from new construction to suburban garden communities. Secondarily, we provide services such as helping our clients place debt for their purchases or refinance their existing properties, as well as raising equity to purchase or build an apartment community.
We regularly conduct market analysis for our clients on hold versus sell [strategies], underwriting and analyzing a few billion dollars' worth of real estate every year. We also provide customized research for our clients as it pertains to their assets, such as sales comps, rent surveys, development pipeline and other economic research reports.
Looking back on 2017, how did the year unfold? In broad terms, how would you characterize 2017?
An imbalance of supply and demand for multifamily sales. For larger apartment buildings (50-plus units), there were 40 percent less transactional sales in 2017 compared to 2016. Volume for all 5-plus unit sales was down almost $1 billion and approximately 8,000 less units traded last year compared to the previous year.
However, the flow of capital continued to increase in our market, which created a scarcity premium. Investors wanted to, and in some cases had a mandate to plant their flag in our market. As a result, we saw pricing increase 15 percent to 20 percent, depending on which value metric you use.
Were there any particularly noteworthy multifamily sales or transactions in 2017, and what was the significance of these sales in terms of the market in 2017?
There were several noteworthy sales in 2017, mostly in the new construction Class-A space, and from those sales there were two main takeaways:
Publicly traded apartment REITs were the most active in purchasing in our core markets since 2014. Apartment REITs are great buyers to track because they're at the forefront of investment sales given their large portfolios (they can track real time market trends and react quickly) and their niche focus is on one product type (multifamily) rather than several different ones. They were the first to buy back into the apartment market in 2010 when most investors were still on the sidelines.
After feeling priced out over the last few years, apartment REITs made strategic plays in Seattle by purchasing in high growth submarkets where they didn't yet have a presence, but wanted to own long-term, such as South Lake Union, Downtown Bellevue and the U-District, despite the glut of new construction deliveries in those markets. That illustrates their confidence in the region despite maybe some skepticism from them in the past few years that the market had peaked.
Family offices and private individuals also made some significant Class-A purchases, in a space that's typically dominated by institutional buyers. Some of these investors were new to the market and new to multifamily, selling out of the declining retail sector and opting for lower returns for the stability and growth of our market. Other investors were already in the multifamily space, but typically bought either workforce housing or in secondary markets. These purchases illustrate the long-term confidence in Seattle despite the short-term supply concerns, as these atypical investors looked to upgrade/change their portfolios.
Over the past couple of years, Seattle-and the broader Puget Sound region-has become a hotbed, with many people looking to relocate here. What did you see in 2017 and what do you expect for the market in the year ahead?
In 2017, we saw continued population growth, however, at a slightly decreasing rate. The amount of new Washington State driver's licenses issued declined from 202,000 in 2016 to 186,000 in 2017. This isn't the be-all end-all stat, since not everyone moving here gets a driver's license, but it's definitely a telltale sign. In 2018, we expect population growth in Puget Sound to slightly decline from 1.5 percent to 1.4 percent, which are still strong numbers compared to most major metro areas across the country.
In terms of population trends, of those new driver's licenses 21 percent were from California. Outside of Seattle, Kirkland had the second highest population growth and the largest growth on a percentage increase. Waterfront and beachfront communities such as Kirkland and West Seattle will continue to attract Californians. Outside of that, five of the top ten cities for population growth were in the south-end, such as Kent, Burien, Renton and Tacoma. Because the south-end has more mass transit options compared to the north-end, residents are flocking to these locations as traffic continues to be an issue in our region. This trend will continue as investors look to buy or build near existing or future transit stations.
What factors do you think will drive demand for multifamily property in Seattle in 2018? Where do you think we are in the cycle right now, and do you have any predictions about the strength of the market in 2018?
The suburban markets will continue to drive multifamily in the region, particularly affordable B and C product. The suburbs don't have nearly the same new construction supply as the core. Of the 25,000 units under construction in the Tri-County region, 21,000 of those units are in Seattle and the Eastside. New construction rents in downtown Seattle are $3.34/sqaure foot with average rents of $2,425. By comparison, Lynnwood new construction rents are $1.85/square foot or $1,720 on average, and Renton new construction rents are $1.87/square foot or $1,676 on average. This translates to over a 40 percent discount while being only 10 to 15 miles out of the CBD. Therefore, the suburbs have more runway compared to the core, and we'll continue to see them outpace core rent growth as we have the past couple of years.
In terms of where we're at in the cycle, it's hard to tell. We thought we were in the eighth inning three years ago, yet the market has continued to outperform everyone's expectations. We have such a unique dynamic with Amazon that's never been seen before, so we can't rely on history to forecast the future. With that said, we're definitely in the later stages of the cycle, it's just a question of whether we have 1 to 2 years left or 3 to 4 years.
How would you characterize the strength of the multifamily market throughout the Puget Sound region? Will certain counties in particular (e.g. King, Pierce or Snohomish) come to the forefront over the coming months?
The overall state of the Puget Sound multifamily market is still extremely strong, maybe the best in the nation, but as mentioned above, growth is normalizing. Suburban product will have the most activity and experience better growth. In terms of a particular submarket on the forefront, it would be Snohomish County. A lot of investors are excited about the new commercial flights at Paine Field because of the economic impact it will create with new jobs and ancillary businesses in the area.
Over the last couple of years of particular, there have been lots of new units coming online in Seattle and the surrounding region. Are there any concerns about oversupply in 2018?
The region has been resilient in absorbing the new supply in this current cycle. It's not only the robust job and population growth, but the demographic shift with millennials waiting longer to form households and enjoying the flexibility of moving around to different neighborhoods. In addition, Seattle's for sale housing stock is amongst the lowest in the nation when it comes to A) new construction starts and B) inventory/available listings. Renters are renting longer because of lifestyle choices and because of lack of for sale options.
With that said, we're seeing rent growth decelerate in the core markets and concessions in the winter have increased. Investors are most concentrated on the high-rise development. There are currently 18 multifamily high-rises under construction totaling almost 7,000 units, and 14 of those projects are in Downtown Seattle. Prior to 2010, there were less than 14 total apartment high-rises in Seattle. Because high-rise development is much more expensive to build, much higher rents (average of over $3,000 per unit) have to be achieved to make those projects pencil. There are concerns over the depth of the high-rise market and if developers can get those high-end rents.
What do you think landlord incentives will be in Q1 and Q2 2018, and what might these indicate about the state of the market in 2018? What other metrics might be especially important in the year ahead?
Fourth quarter and first quarter typically have the largest amount of concessions, just due to the seasonality of our market. It's not unreasonable to see one-month free rent concessions on most new lease-ups throughout the year. However, right now we're seeing some communities offer 6 weeks free and in some cases 8 weeks free on larger more expensive apartments that are $3,000 and up. Most of these concessions are in the core markets where there's a large concentration of deliveries.
As we enter into second quarter, like every year this past cycle, those concessions should burn off for stabilized properties and go down to 2-4 weeks free for new lease-ups. Part of it is seasonality, part of it is the ebb and flow of Amazon's hiring. When Amazon's not bringing in people, like they didn't this past winter, the market feels it. However, in the past three months Amazon's announced nearly 1.4 million square feet of new office leases in Seattle, with approximately 650,000 square feet being in existing buildings that the company will start to occupy this year. Therefore, we expect the rental market to rebound in the spring and summer months.
One metric our team likes to look at is the delta between renting and home ownership costs. It's approximately 50 percent cheaper to rent in the Seattle MSA versus owning, when factoring in a 10 percent down payment, a 4 percent interest rate and real estate taxes for a home purchase. In core markets that spread is even larger.
Granted, we're comparing studio, one and two-bedroom units to larger homes. Nonetheless, in many markets nationally there really isn't that discrepancy. And compare that to six years ago in Seattle, that delta was 30 percent. As families grow there will obviously be a need to move out of an apartment and into a house. However, the longer and wider that delta exists, the better for the rental market despite the new supply.
Market surveys, reports and research are a big part of the multifamily team's operations. What do you think this research will reveal about the market in 2018?
Based on our 2017 research, job and population growth is moderately slowing. Employment growth went from 3.2 percent to 2.8 percent in 2017, and population growth declined from 1.7 percent to 1.5 percent. With that said, those numbers are still strong and twice that of the national average.
At the same time, the amount of new construction supply is increasing. This time last year there were roughly 21,000 units under construction in the Tri-Counties, and today it's approximately 25,000 units. In short, fundamentals are stabilizing (more so in the core) towards normal growth instead of the hyper growth we've seen over the past few years. In 2018, we'll see investors picking and choosing their spots rather than just going after anything and everything in the market.
Along with a new set of opportunities, 2018 will surely present some challenges to overcome. Do you have any concerns about the year ahead? Conversely, what most excites you and the multifamily team?
It's exciting to see the landscape of our market change. There are over 100 tech companies in Seattle today that have set up offices from out of state. That figure is double from what it was in 2014. We're hiring the brightest minds in tech, life sciences and aerospace.
Amazon gets all the headlines, but we're excited to see the continued expansion of out of state companies coming into our market such as Alibaba, Apple, Facebook, Google, SpaceX and Salesforce. But more importantly, it's inspiring existing local companies like Microsoft to expand and evolve. The software giant is at almost 50,000 employees locally, and their multibillion dollar expansion/renovation of their campus will lead to 8,000 new hires.
I don't think our team's concerns have really changed from the previous year. The issues the last couple of years have been: 1) When will the cycle end? 2) Developers are getting squeezed, with lack of available land, construction costs outpacing rent growth, tight credit to finance their projects, and affordable housing mandates that kill the economics of their projects. 3) Owners are seeing expense growth eat into their NOIs, with real estate taxes, utilities and payrolls being the biggest culprits. Since 2010, apartment expenses have gone up 50 percent in our region. 4) Lack of available inventory. Sales and volume declined in 2017, and we may see more of the same in 2018.
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