D.C.'s Multifamily Absorption Rate Is Starting To Slow, But Construction Isn't
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For years, D.C. apartment developers have built thousands of apartments, and they have leased them up quickly, satiating a seemingly endless desire for new rentals in the urban marketplace. But the tide is starting to turn.
Vacancy in D.C.-area apartments in the second quarter rose from 2.7% in 2017 to 3.6%, according to Delta Associates' latest report. Coinciding with another quarter of modest rent growth, indicators are pointing to a cooling-off period for rental leasing. While thousands of units are still being leased up each quarter — still above the area's historical average — that is largely a result of the continued local influx of supply.
"We had projected for the past year or two that absorption would steadily start to decrease, and that is steadily starting to happen," Delta Associates President William Rich said. "We think that rent growth metro-wide will remain below average — there will be some areas that will do better than others. Overall, we’d say the metro-wide average would be below what the region had been accustomed to earlier in the decade."
While absorption has begun to slow, construction has not. Over the next three years, more than 29,000 apartments are expected to deliver in the region, up from just under 28,000 from 2017.
D.C. developers appear to be more confident in the market's multifamily fundamentals than their counterparts around the country. So far in 2018, the region's construction starts are up 22% year over year, with the third-most project starts in the U.S.
"I would say that the city is continuing to be a beacon for multifamily tenants who are looking for new product," Rich said. "D.C. offers a unique environment for the renter. Areas of the city are evolving to offer more amenities and services, and the wealth is spreading to more parts of the city."
While other high-growth markets like Houston and Dallas might be hitting the pause button in anticipation of a possible recession by 2020 — right when the projects that just started construction would be set to come online — D.C. developers can have more confidence in their projects if they know their history.
"Washington historically has been a recession-resistant marketplace," Rich said. "If we were to go into a recession over the next 18-24 months, the rest of the country might have a more pronounced slowdown. That may not be the case as much in Washington. Even though there are now more private sector jobs in the Washington area, our main employer in town is still the federal government."
While the absorption trend is one to keep an eye on, landlords can take comfort that rents are on the rise, albeit modestly. The average apartment rent in June 2017 was $1,803 a month, according to Delta's report, which ticked up to $1,842 this year.
While small, the growth is still a shift from 2017, when District apartment rents dropped 3.9% from the previous year. Rich attributed that dip to a huge increase in supply as landlords tried to evaluate the market. That was most pronounced in Northwest D.C., as the hottest areas for construction — along the Waterfront and around NoMa and H Street — performed well in 2017. Rents rose in all D.C. submarkets in the second quarter of 2018, Rich said.
That is not the case in Suburban Maryland and Northern Virginia, which continue to lag behind the District in rent growth, absorption and construction. Class-B rents rose in the second quarter, but absorption in the lower-quality properties in some areas was negative, according to Delta's report.
There is one sector of the multifamily market that is steadily gaining momentum: condominiums. Development pace is up in the condo market, and builders are increasingly going after larger projects, like the Westlight building and the two condo buildings at The Wharf.
Deliveries in 2018 are expected to double 2017's figures, and prices for new buildings and condo resales are up 1.1% and 3.8%, respectively. As apartment absorption continues to decline, more developers could look to building for-sale units to mitigate risk.
"I think it’s possible that the condo market will pick up a bit in activity, based on the premise that apartment absorption may slow down slightly, but I don’t think it’s going to be a paradigm shift from apartment to condo developments for most of the multifamily development in the city," Rich said. "It’s still going to be a primarily rental-oriented marketplace. But the share of condo construction will likely go up a bit over the next couple of years."
One thing that could stem the tide: continuing interest rate increases. The Fed plans to institute more raises as the year goes on, assuming the economy doesn't go south. It remains to be seen what the impact will be of President Donald Trump's unusual criticism of the rate increases.