Urban Core Continues to Draw Investor Attention While Buyer/Seller Disconnect Widens in Suburbs

High-quality jobs proliferate as corporate expansions boost employment growth. A talented labor pool is bringing many new companies to the Colorado Front Range and they are creating a number of well-paying positions. Cloud-based software firm Xero recently opened its new head-quarters in LoDo, while VF Corp., a worldwide apparel and footwear company, has plans to open its global headquarters in downtown Denver in 2020. The inflow of degreed positions is sparking demand for Class A and B units, pushing vacancy rates for these asset classes into the lower-5 and mid-4 percent bands, respectively. As the number of available apartments declines, developers will be adding more than 14,000 rentals to the market, many of which will be luxury units. The urban core will receive a sizable portion of the new supply, particularly the Five Points neighborhood where more than 1,000 units will be finalized in 2019. In addition, Capitol Hill will witness the completion of nearly 400 apartments as the area’s revitalization efforts progress. Demand for apartments will remain strong in 2019, and the average effective rent will rise by more than 3 percent.

Urban assets garner elevated interest. As value-add options in Capitol Hill continue to diminish, investors will likely increase their interest in the East Colfax corridor near the UCHealth University of Colorado Hospital. Here, cap rates in the upper-6 percent band are achievable, attracting many private buyers, particularly those targeting assets under $2 million. Neighborhoods closer to the urban core just south of City Park will lure investors with similar criteria, though cap rates in this area will be up to 50 basis points lower due to the proximity to the city center. Moreover, buyers are being more selective and focusing on assets near the core, also applying downward pressure on yields in and around Downtown Denver. The bidding for outer-ring suburban properties, meanwhile, remains relatively subdued, widening the bid/ask gap and potentially encouraging owners to lower pricing in correspondence to market conditions.

2019 Market Forecast

To Our Valued Clients…

The extended growth cycle, now approaching its 10th year, has offered apartment investors a truly unique range of opportunities. Record-breaking apartment construction that so many feared would overwhelm the market has barely kept up with demand. Average rents have climbed nearly 50 percent over the last decade, while average vacancy rates have tightened dramatically. Class C apartments have generated their greatest performance gains in recent history, while secondary and tertiary markets have enjoyed an extended growth cycle. As investors look ahead, it is with some caution. The question on the back of their minds is “How long can this fantastic momentum last?”

Last year, tax reform boosted the economy and confidence levels, sparking favorable apartment demand and supporting stellar apartment absorption, which had the second highest total in 25 years. Looking forward, labor force shortages will slow job creation but will also favor apartment housing as workforce participation edges higher. Millennial’s will be a driving force, as more of the 67 million young adults between 20 and 34 years old find work and have an opportunity to move out on their own. At the same time, rising home prices and mortgage rates have joined new tax rules that reduce the advantages of homeownership, jointly reducing first-time homebuying. This combination bodes well for apartment housing demand in 2019.

The positive dynamics of the housing market will likely sustain seller pricing expectations, while buyers eye the rising cost of capital. This will extend the expectation gap and potentially weigh on transaction activity. Cap rates have remained relatively stable over the last few years, but the yield spread over the 10-year Treasury has tightened, reducing investors’ ability to generate positive leverage. In their effort to capture higher yields, investors will continue to pursue assets in primary markets’ suburban locations and in secondary and tertiary markets, increasing the flow of capital into these areas.

Many unknowns assuredly await investors in the coming year as slowing international economies join financial market volatility and a tightened or possibly inverted yield curve to weigh on investor optimism. Still, the strength of the employment market and positive demographic drivers that reinforce apartment housing demand will favor multifamily real estate. We hope this report provides useful insights to help you navigate the changing landscape. As you recalibrate your strategies, our investment professionals look forward to assisting you in meeting your goals.

JOHN SEBREE

First Vice President/National Director, National Multi Housing Group

JOHN CHANG

Senior Vice President, National Director Research Services