With a short supply of units and increased vitality in downtown areas, apartments are poised for stable growth through the rest of the year.

While the apartment rental market has experienced softening fundamentals – reduced unit demand, escalating vacancies and falling rents – over the past few years, investor demand for Connecticut multifamily properties remains intense. The combination of strong demand and a limited supply of for-sale properties has pushed pricing to record levels.

However, low interest rates are supporting current acquisitions at reduced capitalization rates and investors are banking on an economic turnaround to shore up rents and vacancies. Experts feel that limited new construction and improving national and local economies will promote positive absorption in 2004 and boost effective rents.

According to reports from MPF Research, a Texas-based multifamily market research house, “The Northeast region is the portion of the country to study for signs that U.S. apartment market fundamentals are getting back on track. Improved economic conditions should directly fuel an increase in apartment demand more so here than elsewhere, partly because a high premium to buy vs. rent housing – even in a low-interest-rate environment – means that the apartment sector is losing fewer residents to home purchase. Furthermore, since the region’s new construction volume is always comparatively limited, increased demand will push occupancy upward more quickly across the Northeast than in the areas that are adding significant new product.”

Steve Witten, senior director of Marcus & Millichap’s National Multi Housing Group, noted that the national economy is finally picking up steam. The Department of Commerce has reported the economy expanded at a 3.1 percent annual rate in the second quarter, marking an improvement from the 1.4 percent annual growth recorded in the previous two quarters.

“I’d say we’re staged for continued growth,” said Mike Stone, vice president of multifamily at CB Richard Ellis in Hartford. “Traditionally this is a very stable apartment market because there is no oversupply. There is just no threat of oversupply here. The investment risk parameters are reasonably low compared to bigger markets, so we’re getting national attention”

Since Hartford enjoys market equilibrium, new properties with higher rental rates tend to help the entire market rather than hurt it, said Stone.

“We have built-in stability just because there is no oversupply. When the major markets have growth they tend to grow faster than us, but when there is contraction they tend to contract faster. Hartford will go up and down with the cycles, but not to a large extent. You can bet that your property will remain at a relatively high occupancy rate as long as it’s well managed,” said Stone.

‘Sustained Growth’

Like most of Connecticut, the suburbs of Hartford have very high barriers for the construction of apartment complexes. That, in conjunction with rental rates that are only marginally high enough to make construction feasible, has kept the number of complexes down.

“You almost have a better chance of winning the lottery than you do of getting approval on an apartment complex,” said Stone.

The city itself is experiencing development as it tries to transition from a commuter city to one where people want to live. Two complexes have broken ground recently, with one at 55 Trumbull St. and one at 111 Pearl St. The former opened its doors to the first tenants this week, and the latter rapidly nears completion.

“Those are only two that have broken ground, but there are five or six other proposals downtown,” said Stone. “There is a lot going on behind the scenes from a financing perspective.”

Downtown Hartford hasn’t seen that sort of construction activity in about 15 years, so those developments coming online should be well received, he added. Stone also noted that the key to reasonable absorption and occupancy rates is creating vitality downtown.

“There needs to be a reason for people to live downtown, and the proposals on the table seem to identify with that issue and seem to be addressing it,” said Stone.

“Economists are predicting sustained growth through year-end and into 2004, which should finally promote job creation and put a dent in the unemployment rate,” said Witten.

In Connecticut, employment decreased by 20,800 jobs over the 12 months ending in July, largely the result of manufacturing job losses. The state’s unemployment rate rose to 5.2 percent, up from 4.4 percent in July 2002.

Witten said, “Even as the national economy picks up steam, Connecticut is expected to lag the recovery due to the state’s budgetary woes and slower job growth.”

Throughout the economic malaise, the strength of the housing market and consumer spending has kept the economy afloat. As reported by the Office of Federal Housing Enterprise Oversight, Connecticut housing prices for the 12-month period that ended on June 30, 2003, appreciated 6.84 percent over the previous year’s prices. To put that into context, U.S. prices increased 5.56 percent over the same period.

“Vacancy rates in many of Connecticut’s major markets, including Hartford and Stamford, have climbed to between 8 [percent] and 9 percent due to poor demand fundamentals, a product of job losses, net out-migration and renters exiting the apartment market in favor of homeownership,” said Witten.

Other markets that have not been as hard hit by job losses, such as New Haven, have fared better, with vacancies hovering in the 5 percent to 6 percent range.

Rental unit demand and rents, which are closely tied to household growth, employment and housing affordability, have felt the effects of the slow economy, low interest rates and increased home affordability.

Consequently, a number of properties are offering concessions such as a month’s free rent to entice tenants. In Fairfield County, for example, second-quarter 2003 asking rents averaged $1,600 and effective rents averaged $1,530, according to Reis Inc., a New York-based firm that compiles rent comparison information.

Despite the overall weak market fundamentals, upscale apartment projects continue to be the norm in Stamford and downtown New Haven. AvalonBay Communities has added Avalon on Stamford Harbor, a 323-unit luxury complex that includes a variety of floor plans, including a spacious 2,000-square-foot, three-bedroom model that rents for well over $3,000 a month.

As reported last week, in revitalized downtown New Haven, properties such as Residence on the Green and the Strouse-Adler building are attracting young professionals and aging baby boomers with an appetite for the urban lifestyle.

According to Witten, even though vacancy and rent fundamentals have weakened, there is no shortage of buyers for multifamily investment properties. Sales prices vary widely, depending on factors such as property location, size, age and condition. But in general, well-located, well-maintained “B” and “C” properties are generating per-unit pricing in the $38,000- to $60,000-per-unit range, with cap rates typically ranging between 8 percent and 10 percent.

The capitalization rate, or cap rate, is the ratio between a building’s net operating income and its present value.

“A”-quality properties are trading in a range of $78,000 to $250,000 per unit, with cap rates in the range of 7 percent to 8.5 percent.

Marcus & Millichap reports that so far in 2003, 2,006 apartment units have traded for a total value of $126.5 million and an average value of just over $63,000 per unit.

“It’s about an 8.5 percent increase in average per-unit sales values over 2002 and with deals under agreement, scheduled to close by year-end, we fully expect a record-setting year,” said Witten. “2002 saw a total of 2,937 units trade and with 2,006 units selling year-to-date, we should well surpass the previous year in total deal velocity. Sales for 2002 totaled $169 million, and we will well exceed that for 2003.”

There remains a sizeable stock of older apartment product in Connecticut that is well poised for healthy rental growth after modernization and repositioning. The condominium market is extremely active at the moment and investors are seeking opportunities to convert older buildings to condos. A study conducted by the National Association of Realtors lists condo resales in the Northeast at a median price of $177,600 in the second quarter of 2003, which represents a 21.6 percent jump from 12 months earlier.