NORTHEAST SNAPSHOT, OCTOBER/NOVEMBER 2010

BOSTON MULTIFAMILY MARKET

A broad-based recovery continues to take shape in Boston, with most private employment sectors projected to expand through the second half. Though a pullback of government hiring will ease the pace of overall growth, continued gains in the professional and business services, leisure and hospitality, and education and health services sectors will support household formation and demand for both Class A and Class B/C apartments. Consequently, the average vacancy rate will fall below 6 percent this year, a level last reached prior to the recession. Vacancy is highest among top-tier properties, exceeding 7 percent, though the segment posted the largest improvement in fundamentals during the first half. In the Central City/Back Bay/Beacon Hill submarket, both occupancy levels and rents rose measurably in that time as renters continued to seek housing near major employers. Class A properties in under-supplied suburban submarkets, including the North Shore/Merrimack River Valley, also remain in high demand. This strengthening in renter demand has enabled some owners to rein in concessions, though operators of lower-quality complexes or assets in most tertiary locations still report asking rent declines and leasing incentives averaging as much as 1 month of free rent.

Vacancy Improves, Rents Stabilize

Looking at Boston fundamentals, slowing supply growth and expanding payrolls supported a decline in vacancy and minimal reduction in rents. Metrowide vacancy improved to 6.2 percent in the past 6 months. Vacancy fell 10 basis points during the second half of last year. Steep rent cuts in the final 6 months of 2009 lured renters to top-tier units during the first half of this year, driving down the Class A vacancy rate 60 basis points in that time to 7.3 percent; the average rate dropped 30 basis points in the previous half year. By year’s end, employment-generated demand growth will underpin a 50 basis point decline in vacancy to 5.9 percent, following a 40 basis point rise last year.

Owners reduced asking rents by 1.7 percent year over year to $1,691 per month, while effective rents fell 1.8 percent to $1,597 per month. Asking and effective rents slid 0.3 percent and 1.3 percent, respectively, during the previous 12 months. Even as overall rents decline, some upward movement was recorded in the top tiers of the market. Improving Class A vacancy rates have permitted owners to raise rents in this segment 1.2 percent since the start of the year to $2,085 per month. Asking rents were trimmed by 3.8 percent in the preceding 6-month period. Lower-tier asking rent trends have been less extreme, though demand has been slower to recover. As of the second quarter, Class B/C asking rents of $1,407 per month were 0.4 percent higher than at the beginning of the year but down 1.8 percent from the second quarter of 2009. As 2010 comes to an end, asking rents are poised to rise 2.1 percent to $1,705 per month, while effective rents will appreciate 2.9 percent to $1,618 per month. Asking rents slipped 4.1 percent last year, and effective rents retreated 1.5 percent.

Limited deliveries of new apartments will limit further vacancy increases. Apartment construction output has fallen to 685 units since the end of 2009, compared to the delivery of 1,385 apartments during the prior 6 months. There are 450 units under way in Boston, with completions stretching into 2011. Additionally, 29 projects totaling 5,230 units are proposed, though few developers have announced start dates. Builders are most active in the North Shore/Merrimack River Valley submarket, where 510 units will come online this year and another 760 units are under consideration. After local apartment inventory increased by 3,540 units last year, supply growth will ease to 1,010 units in 2010. Since 2000, construction efforts have yielded an average of 2,740 apartments annually.

Investor Confidence Improves, But Sales Remain Slow

Even as GSE lenders have remained active and regional banks have competed for operationally sound assets, tighter lending criteria and revenue uncertainty have slowed multifamily transaction velocity 23 percent since the second quarter of last year. The number of sales decreased 34 percent in the prior 12 months. Apartment values have slipped alongside rents. In the past year, the median price declined 27 percent to $106,250 per unit, following an increase of 12 percent in the preceding 1-year span. Cap rates in deals closed this year averaged 8 percent, as buyers are more willing to acquire older assets or properties in secondary submarkets. Supply additions and tenant shuffling have hindered Class B/C operations in the North Shore/Merrimack River Valley submarket. As a result, already elevated cap rates continue to rise, attracting aggressive investors with sufficient capital and management experience to add value to struggling properties.

Top-tier sales velocity, however, will remain limited over the short term as owners resist selling amid depressed pricing. In the Class B/C segment, deal flow remains low, despite rising buyer confidence. Recent price declines have investors targeting smaller lower-tier properties, primarily assets containing 25 or fewer units in Boston’s core, while more aggressive buyers continue to look to Quincy, where initial yields generally start at 9 percent.

— Jim Linfield is a senior associate in the Western Massachusetts office of Marcus & Millichap Real Estate Investment Services.

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