HEALTHY OUTLOOK, LOW INTEREST RATES SPUR BIDDING ACTIVITY

Below-trend completions helped balance apartment supply and demand in the Portland metro, despite a slow-moving job recovery. With private-sector employers no longer shedding jobs, the local economic outlook has improved, giving households who doubled up during the recession the confidence to lease individual apartments.

Existing complexes will continue to field these returning renters, as building activity remains low. As a result, vacancies will improve further through year end, and absorption levels, which turned positive in each submarket this year, will continue to strengthen.

Locations near downtown currently account for the bulk of leasing activity, a trend expected to intensify in 2011 as employers ramp up hiring. Luxury condos recast as rentals may present some top-tier supply exposure in the city, but the overall impact of such stock will be minimal, as the bulk of this supply has been absorbed through steep rental discounts.

As rehired professionals rent more affordable mid-tier units, downtown rent rolls will show stronger improvements next year, pulling the vacancy rate in the Northwest/Downtown submarket closer to historical averages. Challenges will persist, nonetheless, as leasing in outlying blue-collar areas will remain light until broader job growth occurs in mid-2011.

As recovering property operations boost buyer confidence and interest rates remain low, investment activity will increase. With interest rates low and buyers recognizing a wave of REO listings will not likely materialize, more investors are making offers on well-located assets.

Properties near downtown Portland continue to capture the most attention, with cap rates for best-in-class assets averaging in the low-6 percent range. Prolonged marketing times in 2009 and early this year encouraged sellers marketwide to lower price points to divest ahead of possible capital tax gains increases, though price cuts were largely mild. Owners of complexes farther from downtown amenities, particularly where renter turnover is most pronounced, have decreased prices sharply to compete with the greater availability of listings; initial yields for these assets currently average between 7.5 percent and 8.0 percent.

2010 ANNUAL APARTMENT FORECAST

	Employment: Resumed private-sector hiring in the fourth quarter will expand marketwide employment by 2,000 positions this year, a 0.2 percent increase. In 2009, Portland staffing levels fell by 55,000 workers. After cutting jobs for two consecutive years, white-collar employers will account for a sizable share of gains in 2010, a trend that bodes well for renter demand downtown.
	Construction: Development activity will fall below historical norms this year, with builders on track to complete just 660 units, down from 2,034 units in 2009 and the smallest num- ber of apartments brought online since 2005. Over the past five years, deliveries averaged 1,200 units annually.
	Vacancy: The average vacancy rate will finish the year at 4.8 percent, representing a 210 basis point improvement from 2009, when weaker economic conditions caused vacancy to rise 170 basis points.
	Rents: During 2010, asking rents will increase 1.9 percent to $818 per month, and effective rents will rise 2.5 percent to $743 per month. Last year, asking rents slipped 2.7 percent, while effective rents dropped 5.1 percent.

ECONOMY

• The local job market recovery remains in flux, as the elimination of tem- porary census workers during the third quarter offset employment gains achieved in the first half. Year over year, Portland employers shed 8,500 positions for a 0.9 percent head count decrease, following the loss of 75,800 workers in the preceding 12-month period. Excluding government payroll reductions, metrowide employment levels flattened year to date.
• The government, financial activities and construction sectors lost a total of 4,600 jobs over the past year, outpacing gains recorded in the professional and business services and education and health services segments.
• Nike Inc. leased more than 190,000 square feet of space in two buildings in Beaverton. The company expects to hire 160 permanent positions to oc- cupy the new facilities. In addition, Intel Corp. plans to build a new plant in Hillsboro, which will create up to 1,000 permanent jobs and 6,000 to 8,000 constructions positions. The project is slated for delivery in 18 months.
• Outlook: Marketwide employment levels will expand by 2,000 positions this year, a 0.2 percent increase and a considerable improvement from 2009, when 55,000 workers were eliminated.

HOUSING AND DEMOGRAPHICS

• Over the past year, permits for 3,600 single-family housing units were is- sued, up from 2,780 units during the previous 12 months. Multifamily per- mit issuance fell 3 percent annually to 970 units.
• The median home price dipped 2 percent year over year to $236,500. Household income levels remained flat during that time at $55,900 per year, $1,400 less than the minimum required to qualify for purchasing a median-priced home.
• Renting will remain the most affordable option for most residents. Current- ly, the average Class A asking rent is $285 per month less than the typical mortgage obligation on a median-priced home, using conventional financ- ing criteria.
• Outlook: Along with the disparity between the monthly rent and mortgage payment, stricter lending criteria and a high unemployment rate will deter a sizable share of residents from leaping into ownership in the near term.

CONSTRUCTION

• Approximately 650 apartment units came online in the Portland metro over the past year, down considerably from the completion of 2,287 units in the prior 12-month stretch.
• The only complex delivered so far in 2010 was the 152-unit Broadstone Enso in the Northwest/Downtown submarket, added during the first quarter.
• All 550 apartment units under way in the metro will come online in the Northwest/Downtown submarket during the fourth quarter. The planning pipeline consists of 1,600 units, only 7 percent of which have established start dates.
• Outlook: Developers will complete 660 units this year, down from 2,034 units in 2009. Over the past five years, deliveries averaged 1,200 units annually.

VACANCY

• Since reaching a cyclical peak in the third quarter of last year, marketwide vacancy has fallen 210 basis points to 4.8 percent, supported by strong de- mand for Class A rentals.
• Top-tier vacancy averaged 4.9 percent in the third quarter, down 290 basis points from the same period last year. Operators of Class A complexes in the Northwest/Downtown submarket, where developments efforts were concentrated in recent years, posted the largest vacancy reduction over the past year, driven by generous concessions offered to fill newer units.
• In the Class B/C segment, vacancy improved 140 basis points year over year to 4.7 percent, a rate below the sector’s five-year average.
• Outlook: Vacancy will finish the year at 4.8 percent, down 210 basis points from 2009, when weaker economic conditions caused vacancy to rise 170 basis points.

RENTS

• Recent occupancy gains have allowed owners to raise rents. Thus far in 2010, asking rents have advanced 1 percent to $811 per month, and effective rents have risen 1.7 percent to $737 per month.
• Class A asking rents reached $940 per month in the third quarter, up 2.3 percent from one year earlier and nearly on par with the peak levels at- tained during the third quarter of 2008. Lower-tier asking rents advanced 1.6 percent year over year to $693 per month but remain 4 percent less than the sector’s cyclical high.
• Operational improvements have encouraged many owners to scale back in- centives. In the third quarter, concessions totaled 33 days of free rent, down three days from the start of 2010. Average revenues, meanwhile, have risen 3.9 percent so far this year.
• Outlook: Asking rents will increase 1.9 percent to $818 per month, and ef- fective rents will rise 2.5 percent to $743 per month.

SALES TRENDS**

• Investment activity in Portland has yet to recover, though the slowdown has eased considerably, with sales velocity dipping just 10 percent over the most recent 12-month stretch. In the prior year, deal flow fell 47 percent.
• Subdued trading has led to a 9 percent decrease in the median price over the past year to $63,300 per unit. During the last six months, assets sold at a median price of $65,600 per unit.
• Cap rates increased approximately 50 basis points in the past year to the high-6 percent to low-7 percent range, though lower-tier assets traded with initial yields closer to 8 percent.
• Outlook: Lower-tier listing availability remains greatest in the east, where Class C assets with deferred maintenance currently list at cap rates begin- ning in the low-8 percent range. The Gresham area, in particular, fared well through the downturn due to its affordability but weakened considerably late in the recession as residents took in roommates. With hiring yet to gain momentum, local residents in the area will remain slow to de-bundle.

CAPITAL MARKETS

• The yield on the 10-year U.S. Treasury held in the mid-2 percent range through October due to concerns regarding the durability of economic re- covery. The yield last peaked at 4 percent in early April of this year.
• Despite significant losses and ongoing troubles associated with Fannie Mae and Freddie Mac’s residential mortgage portfolios, their multifamily hold- ings continue to outperform, with delinquency rates holding well below 1 percent. The GSEs and commercial banks remain the dominant sources of financing for apartments, but life insurance companies have begun to com- pete more intensely for attractive deals that meet their criteria.
• Loan-to-values (LTVs) among portfolio lenders range from 55 percent to 75 percent depending on asset quality and location, as well the strength of the borrower. For best-of-class deals financed by agency lenders, LTVs can push closer to 80 percent. Lenders generally require debt-service coverage ratios of 1.25x to 1.30x, well above pre-crisis levels but relatively close to historical norms.
• All-in mortgage rates offered by portfolio lenders on smaller seven-year loans range from 4.80 percent to 5.75 percent, while agency loans typically price 55 basis points to 100 basis points lower, depending on the deal. Larger seven-year loans of $5 million or more price between 4.5 percent and 5.5 per- cent among portfolio lenders and 4.0 percent to 4.5 percent for the agencies.

SUBMARKET OVERVIEW

• Since peaking at 21.5 percent last year, the Class A vacancy rate in the Northwest/Downtown submarket has improved to 12 percent, despite supply additions during the first quarter. Late-2011 completions will inflate vacancy modestly, but the rise will be temporary, and resumed job growth will continue to drive up occupancies in the area.
• Vancouver received a $3 million grant to redevelop the Crescent industrial area. The gentrification effort could generate up to 750 jobs, boosting the city’s work force and bolstering rental absorption.
• Vestas Wind Systems will lease space in the Pearl District and transform the old Meier & Frank Warehouse into a 172,000-square foot headquarters. The move will create up to 200 permanent positions in the next few years, as well as 450 construction jobs, bolstering demand for local housing.

SUBMARKET VACANCY RANKING