APARTMENT DEMAND STEADFAST

[Pages:10]MULTIFAMILY MARKET REPORT: 1Q2014 33Q20133Q2012

APARTMENT DEMAND STEADFAST:

VACANCY REMAINS LOW & RENTS RESUME THEIR GROWTH DESPITE LOOMING SUPPLY WAVE

Prepared by:

Aim?e LaMontagne Baumiller Real Estate Market Research PNC Real Estate 249 Fifth Avenue Pittsburgh, PA 15222 412-762-9192 Aimee.Baumiller@ realestate

EMPLOYMENT: Job growth bounced back after a slow winter, with above average

gains in April. Payrolls are expected to improve further in 2014 as many drags on the recovery diminish. The unemployment rate moved down to 6.3 percent in April, a result of the labor force falling.

VACANCY: Vacancy was mostly flat in 1Q2014 at 4.9 percent, even as

construction levels increased. Given additional apartments set to deliver in 2014, we project apartment vacancy to rise as high as 5.6 percent by the end of 2014.

SUPPLY: Multifamily construction will be at high levels in 2014, which could

flatten rents and raise vacancy in some markets with insufficient demand. However, we do not view oversupply as a concern nationally. Existing apartment inventory remains in balance with demand, even as the level of monthly completions is now exceeding the 20-year average. As we had expected, 2013 witnessed rising levels of construction, but 2014 is set to experience even more deliveries. This increased construction will be a return to more normal levels, at least on a national basis. We continue to track markets and submarkets with the highest construction levels and inventory growth rates.

DEMAND: Net absorption of apartment units was robust in 1Q2014 despite rising

levels of new supply. In most markets, newly completed properties are leasing well. However, we expect that net absorption will fall behind completions in 2014. This positive, lower expectation is driven by healthy renter formation levels, but tempered by growing competition with both newly delivered rental apartments, as well as the for-sale housing market.

RENT GROWTH: The first quarter's rent growth exceeded expectations, with

annual effective rent growth for market rate apartments averaging 2.9 percent. Middle-market properties drove this acceleration, with most of the competition from new supply concentrated at the top end of the market. While rent growth showed some momentum in 1Q2014, we expect the larger trend is slower rent growth, with some markets even posting slight declines. We expect effective rents to grow at a more moderate annual pace of 2.0 to 3.0 percent in 2014.

CAP RATES: Apartment cap rates fell by six basis points in the fourth quarter, to

average 5.68 percent. Many investors continue to move to secondary and tertiary markets in search of higher yields. Given rising interest rates and historically low cap rates, investors are placing greater importance on leasing fundamentals as a key driver of apartment prices, and will likely avoid markets where rent growth and occupancy levels could be impacted by a growing construction pipeline.

PNC is a registered service mark of The PNC Financial Services Group, Inc. This document is for general informational purposes only and is not intended as specific advice or recommendations. The information contained herein is gathered from public sources believed by PNC to be accurate and reliable at time of publication, but neither PNC nor any of its affiliates is providing any guaranty or warranty as to the accuracy, completeness or reliability of that information or of the conclusions presented in this document. In addition, markets do change. Opinions expressed herein are subject to change without notice. The information set forth herein does not constitute legal, tax or accounting advice. You should obtain such advice from your own counsel or accountant. Any reliance upon the information provided herein is solely and exclusively at your own risk. ?2014. The PNC Financial Services Group, Inc. All rights reserved.

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ECONOMY The April employment report came in above market consensus with 288,000 payroll job gains (273,000 private/15,000 public), a 1.7 percent rise from a year ago. These stronger numbers suggest that the slower job growth in December 2013 and January 2014 was due to the weather rather than a result of any weakness in the economy. February 2014 and March 2014's job numbers were revised upward, resulting in an average payroll gain of 238,000 each month for the last three months. The top sectors leading job growth gains in April included professional and business services, transportation, trade, and utilities, and education and health services. The unemployment rate dropped sharply in April to 6.3 percent as a result of the labor force falling by more than the number of employed.

PNC's economists believe that job growth will grow by a modest annual rate of 1.7 percent for 2014, with an average monthly job growth of 200,000 throughout the year. They expect the unemployment rate to decline to 6.1 percent at the end of 2014. Economic growth is expected to be stronger in 2014 than in 2013 due to less drag from Federal fiscal policy and continued recovery in the housing market. Despite higher mortgage rates, continued job gains and pent up demand should propel the housing market forward, driving economic and job growth over the next year.

In addition to construction jobs created from the uptick in both rental and for-sale building, job growth and household growth are driving increased rental and for-sale demand. The chart above illustrates the overall unemployment rate compared to groups that tend to rent apartments the most: households aged 25 to 34 (more transient) and those with a Bachelor's degree (more able to afford higher market rate rents). The younger group's unemployment rate closely tracks the national average, and in April 2014 (6.7 percent), it was well below unemployment rates of 10.0 percent and higher seen in much of 2009 and the first half of 2010. Households with Bachelor's degrees or higher tend to have unemployment rates about half the overall rate (3.3 percent compared to 6.3 percent).

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APARTMENT MARKET TRENDS Vacancy Vacancy rates were again mostly flat in the first quarter, remaining at decade lows. The subset of market rate apartment properties with 40 or more units (as reported by Reis) edged 10 bps lower to 4.0 percent vacant, far below the ten-year national average of 6.2 percent.

Looking at the larger picture, the Census' vacancy rate for all rental apartments with five or more units rose 70 basis points to 9.5 percent, though it is still below its ten-year average of 10.7 percent. Market rate apartments' vacancy remained at an average 4.8 percent in 1Q2014, the same as last quarter.

Tightening vacancy rates over the last few years have been a result of constrained supply and a declining homeownership rate. However, both of these conditions could reverse to some extent over the next few years and vacancy would rise, as construction ramps up and the for-sale market strengthens, attracting some buyers from the renter pool. For 2014, however, the likely rise in vacancy would be a consequence of rising construction rather than reduced demand.

Over the next few years, the impact of construction and a strengthening forsale housing market could be tempered by increasing condo conversions (which remove units from the rental inventory), as well as rising interest rates (which could deter renters from buying homes). Additionally, the apartment market should continue to benefit from demographic trends that should help keep vacancy close to 5.0 percent over the long term. Third party analysts project continued strength through 2014, with vacancy ranging from 4.2 to 6.0 percent.

APARTMENT VACANCY RATES- 1Q2014 (bp change from year ago)

Top Markets

Vacancy

Bottom Markets

Vacancy

Minneapolis

2.5% (-30) Indianapolis

8.7% (+40)

P o rtla nd

2.7% (-90) Tucson

8.4% (-50)

Mia mi

2.8% (-40) Memphis

8.1% (-80)

Oakland

2.9% (-50) Las Vegas

7.8% (-110)

San Jose

3.2% (-40) San Antonio

7.7% (+60)

Ventura

3.2% (-70) Birmingham

7.7% (+60)

New ark

3.3% (-20) El Paso

7.6% (-40)

Orange County

3.5% (-100) Greensboro

7.4% (-80)

San Diego

3.5% (-70) Atlanta

7.2% (-90)

Boston

3.6% (0) Jacksonville

7.1% (-120)

As shown on page 6, we expect Source: CBRE-EA; PNC Real Estate Market Research vacancy on a national basis to rise to 5.6 percent by the end of 2014, as a surge in apartment deliveries enter the market. We see vacancy rising slightly higher in 2015 to 5.7 percent.

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Supply On a national basis, multifamily completions continue to rise, but existing inventory remains balanced with demand. Overbuilding concerns are limited to a handful of markets experiencing more supply than demand. Completions in April 2014 (242,000 units) were 47.6 percent higher than they were one year ago, now exceeding the 20-year average of 239,850 units. This number is also above its January 2011 trough by 165.9 percent.

Based on the adjacent chart, it appears that the rising permits and starts should soon translate into higher levels of completions. In April 2014, permits and starts were up by 253.9 percent and 380.2 percent from their March 2010 troughs. As we had expected, 2013 welcomed increased construction back to normal levels. Construction is on track to rise further in 2014 before moderating in 2015. The slowdown in completions during 2015 is expected to coincide with stronger job growth, resulting in increased demand to absorb excess supply from 2014.

The multifamily data in the chart above includes conventional market rate apartment properties as well as student, senior, and affordable housing, and for-sale condominium units. Hence, while permits and starts are past the 300,000 level, this should not translate into as high a number of conventional rental apartment properties. While the majority of multifamily completions currently are rental, during the housing boom (2004-2006), rental apartments' share of multifamily starts was less than half of all new projects. As the housing market recovers currently, we expect the share of rental apartments to decline and condo share to increase, softening the impact of overbuilding concerns.

We continue to track markets and submarkets with the highest construction levels and inventory

growth rates. As highlighted in our previous quarters' reports, new construction is picking up to more

normal levels, reaching high levels in some submarkets, particularly those that were the first to recover

and/or have low barriers to entry. While we do not expect to see overbuilding on a national basis,

new apartment supply concentrated in a few submarkets could warrant concern over the next few

years.

The

adjacent table

lists the top 10

construction

markets

by

degree

of

Markets with the Largest Expansion of Existing Supply, as of 3/2014

Market

Vac. BP

Expansion

Job Growth Y/Y

Existing Vacancy Change, Units Under to Existing Units

Inventory Rate Last 12 Mo. Construction Supply Planned 1Q13a 1Q14a 1Q15f

1 Nashville

111,556

3.8%

- 140

7,795

7.0% 7,521 2.6% 2.6% 2.3%

2 Austin

191,004

4.6%

- 80

12,177

6.4% 14,871 4.6% 2.9% 3.9%

supply expansion. The following page details the top submarkets using this same measure.

3 Raleigh/Durham

134,251

5.4%

40

8,489

4 Charlotte

134,471

5.1%

0

8,402

5 Washington, DC

551,940

4.7%

0

32,636

6 Salt Lake City

88,304

4.3%

120

4,782

7 San Antonio

149,858

7.7%

60

7,981

8 Denver

278,571

4.1%

- 90

14,202

9 Miami

296,527

2.8%

- 40

11,712

10 Seattle

372,105

3.9%

- 40

13,299

Source: CBRE-EA; Moody's Analytics; PNC Real Estate Market Research

6.3% 6.2% 5.9% 5.4% 5.3% 5.1% 3.9% 3.6%

8,630 12,706 70,000

3,535 7,200 15,209 28,748 30,134

2.9% 2.5% 1.2% 4.1% 3.1% 3.7% 2.5% 2.8%

3.7% 2.2% - 0.1% 1.3% 1.8% 2.3% 2.5% 2.2%

3.0% 2.4% 1.6% 3.5% 3.5% 2.6% 2.6% 2.3%

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APARTMENT DEMAND STEADFAST

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Washington, DC and San Antonio account for nine of the top 25 submarkets, as shown in the table below. Washington, DC is a market to watch, given rising vacancy and job losses. As noted on page 8, this market is also experiencing rent declines. However, DC's long term average annual apartment absorption is fairly high, so after a few years, the market should recuperate from its supply expansion.

San Antonio is faring slightly better in the face of large amounts of construction activity, with vacancy rising in only one key construction submarket (Far North Central). However, job growth is slowing, which will likely impact demand for those newly delivered units.

While only one of its submarkets is in the top 25 for high supply, Indianapolis is another market to watch. The Carmel/Hamilton County submarket (#6 below) currently is 8.9 percent vacant and has 2,850 units underway, with another 2,423 units planned. This submarket is noted as one that is vulnerable to losing renters to home purchase home, given the relatively affluent renter base.

Submarkets with the Largest Expansion of Existing Supply, as of 3/2014

Market

Submarket

Existing Inventory

Vacancy Rate

Vac. BP Change, Units Under Last 12 Mo. Construction

Expansion to Existing

Supply

Job Growth Y/Y Units Planned 1Q13a 1Q14a 1Q15f

1 Houston

Spring/Tomball

5,652

4.6%

- 180

2,002

35.4%

814 4.1% 2.5% 3.2%

2 Charlotte

Uptown/South End

11,078

4.7%

- 70

3,290

29.7% 2,456 2.5% 2.2% 2.4%

3 Washington, DC Navy Yard/Capitol South

9,335

5.6%

390

2,122

22.7% 5,235 1.2% -0.1% 1.6%

4 San Antonio

Far Northwest San Antonio

8,504

6.2%

- 50

1,893

22.3%

828 3.1% 1.8% 3.5%

5 Nashville

Franklin/Williamson County

5,871

4.5%

- 220

1,260

21.5%

279 2.6% 2.6% 2.3%

6 Indianapolis

Carmel/Hamilton County

13,559

8.9%

140

2,850

21.0% 2,423 1.6% 1.8% 2.1%

7 Denver

Broomfield

7,671

3.7%

- 230

1,580

20.6% 2,670 3.7% 2.3% 2.6%

8 San Antonio

Far North Central San Antonio

5,227

7.0%

90

1,066

20.4%

0 3.1% 1.8% 3.5%

9 Dallas

Rockwall / Rowlett / Wylie

2,037

3.3%

- 140

392

19.2%

381 2.4% 2.8% 3.5%

10 Nashville

Central Nashville

12,973

4.2%

- 170

2,387

18.4% 4,629 2.6% 2.6% 2.3%

11 Washington, DC Woodbridge/Dale City

13,207

4.8%

190

2,283

17.3%

504 1.2% -0.1% 1.6%

12 Austin

South Austin

12,703

4.5%

- 300

2,130

16.8% 1,034 4.6% 2.9% 3.9%

13 Austin

Cedar Park

5,105

4.9%

40

842

16.5% 1,678 4.6% 2.9% 3.9%

14 San Franc isco SoMa

36,444

3.2%

- 320

5,991

16.4% 11,044 4.9% 1.7% 2.5%

15 Washington, DC Frederick

9,609

4.9%

10

1,553

16.2% 1,626 1.2% -0.1% 1.6%

16 Denver

Tech Center

9,631

4.7%

- 90

1,533

15.9%

891 3.7% 2.3% 2.6%

17 Dallas

Intown Dallas

25,754

4.7%

- 70

3,793

14.7% 2,229 2.4% 2.8% 3.5%

18 Kansas City

South Overland Park

11,234

4.1%

- 60

1,650

14.7%

0 0.3% 0.2% 1.6%

19 Washington, DC East Alexandria

13,666

5.0%

90

1,964

14.4% 3,343 1.2% -0.1% 1.6%

20 Salt Lake City West Valley City/Airport Area

9,440

3.9%

190

1,351

14.3%

507 4.1% 1.3% 3.5%

21 Washington, DC Rockville/North Bethesda

14,864

4.7%

- 70

2,088

14.0% 2,643 1.2% -0.1% 1.6%

22 Atlanta

Buc khead

18,877

4.0%

- 40

2,638

14.0% 2,352 1.8% 2.2% 3.1%

23 Raleigh/Durham Northeast Raleigh

7,618

5.4%

- 10

1,048

13.8%

545 2.9% 3.7% 3.0%

24 Washington, DC Crystal City/Pentagon City

8,321

5.6%

200

1,110

13.3%

890 1.2% -0.1% 1.6%

25 San Antonio

Central San Antonio

10,847

4.8%

- 160

1,432

13.2%

958 3.1% 1.8% 3.5%

*Job Growth reported is at the metro level. Sourc e: CBRE-EA (as of 3/2014); Moody's Analytic s; PNC Real Estate Market Research

While we had expected this additional construction to flatten rents, rent stagnation has not yet occurred nationally, as demand continues to be strong in many markets. The majority of submarkets (16 of 25) identified in the table above are still experiencing tightening vacancy rates. Areas with a shortage of inventory combined with strong population and job growth continue to offer opportunities for apartment development.

Furthermore, rising levels of permits and starts are evident of upcoming completions in the overall multifamily market. After gaining steam in 2013 with over 214,300 deliveries, completions will expand further in 2014 to an estimated 280,000 units.

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Demand

Net absorption in 1Q2014 was robust

at 41,881 units (Reis) to 59,965 units

(CBRE-EA). Reis' absorption number

(investment grade complexes with

40+ units) is well ahead of

completions, and 1Q2014 marked a

widening lead, as illustrated in the

adjacent chart.

CBRE-EA's

absorption number (all multifamily,

5+ units), nearly matched

completions (58,099 units).

Household growth is driving the absorption numbers, especially among single person households. This can be seen as a longer-term trend in the declining homeownership rate (which has moved from 67.9 percent to 64.8 percent over the last five years). The adjacent chart shows renter households' growth over time.

We are currently experiencing an above average growth rate in renter households, at 2.6 percent annually. While not all renters rent traditional apartments, this overall trend will help support the apartment market. This trend could be an indicator of a potential shift in consumer preference in favor of renting. While we do expect pent-up-demand for the single family housing market as it continues to recover, we do believe that the rental apartment market has strong demographic trends that will support demand over the long term.

Our absorption and vacancy projections are detailed in the adjacent table. Based on our expectations for employment growth, demand, and new supply, we expect 160,000 units of net absorption for 2014, falling short of new supply (280,000 units). In 2015, we estimate more demand and less supply, at 215,000 units of net absorption and 240,000 completions. Vacancy is expected to rise to 5.6 percent by the end of 2014, then to 5.7 percent in 2015.

VACANCY /ABSORPTION PROJECTIONS

United States

All Classes of Apartments, 5+ Units

New Supply Inventory Vacant Units Vacancy Net Absorption

YE 2009a 177,102 14,336,019 1,051,878

7.3%

102,189

YE 2010a

59,341 14,395,360

858,149

6.0%

253,070

YE 2011a

53,086 14,448,446

747,365

5.2%

163,870

YE 2012a 125,189 14,573,635

719,058

4.9%

153,496

YE 2013a 214,315 14,787,950

724,512

4.9%

208,861

Y E 2014f 280,000 15,067,950

844,512

5.6%

160,000

Y E 2015f 240,000 15,307,950

869,512

5.7%

215,000

1Q2013a 2Q2013a 3Q2013a 4Q2013a

41,264 52,358 59,900 60,793

14,614,899 14,667,257 14,727,157 14,787,950

741,947 674,647 676,910 724,512

5.1% 4.6% 4.6% 4.9%

18,375 119,658

57,637 13,191

1Q2014a

58,099 14,846,049

722,646

4.9%

2Q2014f

71,115 14,917,164

742,301

5.0%

3Q2014f

67,975 14,985,139

731,701

4.9%

4Q2014f

80,440 15,065,579

842,141

5.6%

No te: Our pro jections fo r absorptio n and vacancy use CB RE-EA 's actual numbers as a baseline.

So urce: CB RE-EA ; P NC Real Estate M arket Research

59,965 51,460 78,575 -30,000

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Concessions Concession data represents another indicator of the multifamily segment's firm recovery. As shown in the accompanying graph, concession levels have been on the decline since peaking at 7.3 percent in 4Q2009. The last couple of quarters have shown a bit of flattening, with concessions ticking down slightly, standing at 1.3 percent as of 1Q2014.

Concession participation, a metric

represented by the percentage of

apartment

owners

offering

concessions (lower graph), decreased

in 1Q2014 to 15.7 percent. While this

metric had been declining since the

beginning of the apartment recovery,

it now appears to be leveling off,

perhaps a response to some

weakening in the ability of landlords to

hold rents firm. The next few quarters

will indicate whether this is a reversal

of the trend.

This trend of flattening concessions is no surprise given the amount of new supply entering the market. Looking ahead, we expect concessions to remain somewhat constant or rise slightly in 2014, as new product is delivered to the market. More competition will impact landlords' ability to raise rents. Offering more concessions typically translates into flattening rents.

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Rent Growth

Multifamily rent growth surprised many analysts in the first quarter, with annual rent growth stronger than expected, at 2.9 percent. While 4Q2013 revealed slowing rent growth with flat to declining quarterly changes, 1Q2014 showed some unexpected rent momentum that is

Source Reis CBRE-EA Axiometrics Av erage:

APARTMENT RENT GROWTH: 1Q2014

Annual Percent Change Quarterly Percent Change

Asking Rent Effective Rent Asking Rent Effective Rent

3.1%

3.2%

0.5%

0.6%

n/a

2.5%

n/a

0.8%

2.3%

2.9%

0.4%

0.5%

2.7%

2.9%

0.5%

0.6%

unusual at this time of year. Rent growth was strongest on the West Coast, in Texas, and in some

Southeast markets. Annual effective

rent growth for the nation ranged from

2.5 to 3.2 percent.

Likely driving the rent growth acceleration this quarter is the middlemarket, Class B and C properties (comprising the largest proportion of the apartment inventory), which are almost completely full, with very little competition. Most of the new supply additions are priced at the upperrange, leaving the middle-priced properties in a strong position to raise rents. In contrast to the high-quality Class A assets, which likely have already reached peak rents, Class B and C properties have more room for rent growth, as residents living in this stock generally cannot afford to rent the brand new Class A properties or purchase a home.

While 1Q2014 showed strong rent growth numbers, we believe that longer term, rent growth will flatten. In addition to rising construction levels pressuring rents at the high end of the rent spectrum, incomes aren't growing fast enough to keep pace with rent growth. In previous reports, we had warned of the increasing price sensitivity of renters, which would put pressure on rent growth.

Reis, CBRE-EA, and Axiometrics expect annual rent growth to range from 2.3 to 3.3 percent through 2015. Our outlook includes completions surging

APARTMENT EFFECTIVE RENT GROWTH RATES- 1Q2014

Leading Markets

Rate

Lagging Markets

Rate

Oakland

2.2% Washington, DC

-0.2%

San Jose

2.1% El Paso

-0.1%

in 2014, then easing in 2015. With expected stronger job growth balancing our concerns about new

San Francisco De nve r Portland Se a ttle

2.0% 1.9% 1.7% 1.5%

Gre e ns b o ro Hartford Pittsburgh P ro vid e nce

0.0% 0.0% 0.0% 0.1%

supply and price sensitivity, we see rent growth continuing to slow in 2014, with annual rates between 2.0 and 3.0 percent, unchanged from last quarter. We suspect that some markets with

Miami

1.4% Albuquerque

0.2%

Houston

1.2% Tucson

0.3%

San Diego

1.1% Norfolk

0.3%

Austin

1.1% Richmond

0.3%

Note: Rent growth rates reflect quarter-over-quarter change in same store effective rents. Source: CBRE-EA; PNC Real Estate Market Research

serious supply concerns could experience zero to negative rent growth.

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