Orlando apartment vacancy plunging, M&M report says

Sunday, December 5th, 2010



By: Marcus & Millichap

Operating conditions in the Orlando apartment market have started to stabilize. ORLANDO - The recession has ended and trends recorded through the first three quarters of 2010 confirm operating conditions in the Orlando apartment market have started to stabilize. The metrowide vacancy rate has fallen to less than 10% for the first time in three years, but aggressive rent increases will not occur until employment growth accelerates in mid- or late 2011.

Annualized job growth of 0.5% year-to-date was sufficient to help drive down vacancy in nine of 11 submarkets. In addition, the construction of new units represents only a minor issue as the recovery takes shape, with one of the lowest completion totals on record expected this year and extremely low permitting.

Despite improving absorption and limited construction, the lack of tenant turnover and household creation associated with a strong economy continue to impede efforts to raise rents, and the use of concessions remains common, especially in lower-tier properties. Over the past year, rent declines were most significant in northern submarkets with heavy concentrations of Class B/C stock.

Rents continue to fall, but concessions have begun to stabilize, rising only slightly in the past 12 months, after climbing in the preceding year. A few more quarters will pass before concessions burn off significantly, but many property owners acknowledge the use of leasing incentives is leveling off. As a result, buyers are starting to investigate opportunities to purchase Class B properties that can be repositioned and re-tenanted within the next 12 months as job growth and household formation gain momentum.

Cap rates for these assets typically range from 8.5% to 9.0% after reserves and deferred maintenance expenses. Several recent transactions, however, involved lender-owned assets purchased by large investors. In fact, sales of lender-owned properties accounted for 40% of all units sold in the past year. Prices for these assets often dip to less than $30,000 per unit and will continue to generate interest as lenders clean up balance sheets.

Economy

The delivery of more than 3,000 hotel rooms so far this year contributed to the creation of 5,500 leisure and hospitality jobs and during the first three quarters. Other sectors lost jobs, though, as a net 3,100 positions were added during this time. The increase in total employment nonetheless represents a stark turnaround from the first three quarters of 2009, when 48,300 jobs were shed.

The modest pace of job growth has only slightly reduced the unemployment rate, which stood at 11.6% at the end of the third quarter, compared with 11.7% at the close of 2009. The unemployment rate decreased in each of the four counties in the metro area, led by an 80 basis point decline in Osceola County to 11.9%.

Approximately 4,600 jobs were eliminated in the third quarter, as the conclusion of census-related work resulted in the termination of 1,900 government jobs. The financial services and professional and business services sectors also continued to pare payrolls during the period, as 2,200 total positions were cut.

Outlook: Total employment in Orlando will expand 0.9% in 2010 through the creation of 8,700 jobs. Last year, 50,100 jobs were lost.

Housing and demographics

Following a 6.7% drop last year, the median household income declined 1% in the first three quarters of 2010 to $46,900 per year. Still, single-family homes have become more affordable, as the current median household income is nearly twice the amount needed to cover the monthly mortgage payment on a median-priced residence in the metro area.

The expiration of the first-time homebuyers tax credit at mid-year drastically slowed housing starts. In the second half, construction will start on about 2,200 homes, down more than 20% from the first half.

The slow pace of the economic recovery continues to deter multifamily property developers. In the 12 months ending in the third quarter, multifamily permit issuance totaled 800 units, a decline of 33% from the preceding year.

Outlook: The improvement in single-family home affordability has not yet emerged as a competitive threat to multifamily rental owners but will likely become an issue in the next 12 months to 18 months.

Construction

Multifamily developers completed 1,753 units in the 12 months ending in the third quarter, expanding rental stock 1.5%. During the preceding year, 3,400 apartments were put into service.

With the delivery of the 425-unit District Universal Boulevard in late 2009 and 377 units at 55 West on Church Street, Class A stock in the South Central submarket increased 7.5% in the past year.

Approximately 7,700 units are planned in the market, an amount equal to a modest 6% of existing stock.

Outlook: All 1,328 apartment units due for completion in 2010 came online in the first half of the year.

Vacancy

A seasonal surge in demand underpinned a 120 basis point increase in the vacancy rate to 9.8% in the third quarter. Vacancy declined 140 basis points in the first nine months of 2010 due to the addition of jobs and debundling of combined rental households.

Demand for new units has been tepid, as properties delivered this year were about 53% vacant at the time of completion. In the two years prior to the recession, properties averaged approximately 30% vacancy at the time of completion.

Class B/C vacancy dipped 100 basis points in the third quarter to 11.7%. In the Class A segment, vacancy decreased 140 basis points to 7.6%, as many residents who became employed also became renters.

Outlook: Vacancy at new properties will remain elevated while an economic recovery gains traction, but relatively strong demand for units in existing complexes will persist over the rest of 2010. As a result, vacancy will decline 160 basis points this year, including a 20 basis point drop in the fourth quarter to 9.6%.

Rents

Asking rents rose for the second time in the past three quarters, advancing 0.3% in the third quarter to $839 per month; year to date, asking rents are down 0.4%. Also in the third quarter, effective rents increased 0.2% to $769 per month and have declined 0.6% since the start of the year.

Concessions remain in wide use, but the rate of increase has slowed. In the past 12 months, leasing incentives rose from 8.2% of asking rents to 8.4% of asking rents. During the preceding year, concessions surged 120 basis points.

In the third quarter, Class A asking rents rose 0.3% to $971 per month, while monthly Class B/C asking rents fell 0.1% to $723. Year to date, Class B/C asking rents have declined in nine of 11 submarkets.

Outlook: This year, asking rents will rise 0.7% to $845 per month, and effective rents will gain 0.8% to $775 per month.

Sales trends

Transaction velocity over the most recent 12-month stretch was virtually unchanged from the preceding one-year period. Properties of 200 or more units comprised more than half of the transactions in the past year.

Reflecting sales of lender-owned assets and short sales, the median price of properties sold in the last 12 months fell 40% to $30,600 per unit.

Cap rates for Class B/C assets range from 8.5% to 9.0%, down slightly from earlier in the year.

Outlook: Sales of large, lender-owned properties at deep discounts will continue to account for a considerable portion of activity in the market. A further stabilization in vacancy and resumption of rent growth next year will stimulate greater interest in smaller Class B/C assets.