Builders Get Back in Game By Dawn Wotapka The Wall Street Journal 03-03-2010

Builders Get Back in Game
Construction of Multifamily Units Expected to Soar in 2010
By Dawn Wotapka
The Wall Street Journal
March 3, 2010

In St. Petersburg, Fla., close by Tropicana Field, an unusual structure is emerging from a construction site: a rental apartment building.

The work in progress on the Fusion 1560, a 325-unit upscale project in one of the states hit hardest by the housing crisis, is a sign that developers of multifamily housing are tiptoeing back into the business. This year, real-estate investment trusts, or REITs, are expected to start close to $1 billion in new multifamily projects, according to real-estate research firm Green Street Advisors. While that still is less than average, it is a significant increase over the $100 million of development starts in 2009.

Analysts caution that the increase in construction doesn't mean there has been an improvement in the business. Apartment vacancy is at a record and unemployment, essential to the sector's health, remains elevated.

But operators are betting that limited new supply, combined with an improving economy, will lead to ideal market conditions nationwide starting in 2011 or 2012. From then until 2015, "apartment REITs may generate the best property net operating income growth that they've seen in a very long time, maybe ever," said Haendel St. Juste, a REIT analyst with Keefe, Bruyette & Woods Inc.

To be sure, there are risks. Given the multiyear construction window, companies have to start now to be ready in time. If the economy weakens further and recovery is delayed, landlords may be forced to keep rents low or offer free rent to get leases signed.

"There's an element of risk," said Andrew McCulloch, an analyst with Green Street. "But if you were to go back a year, the outlook is much more clear today. Their confidence level in that eventual recovery is much higher."

Owners said the rent declines appear to have bottomed out in some areas and concessions are moderating. In New York, Equity Residential said it has stopped paying broker fees for certain unit types. In better times tenants pay that fee, typically one month's rent.

The gap between new and renewal leases has narrowed from about 10% nine months ago to about 5% today, a sign of confidence as landlords have to give up less to sign new tenants, Mr. St. Juste said.

Landlords also are excited about demand. The 20-to-34 age group, prime renting age, is expected to increase by five million in the next decade, according to Hessam Nadji, managing director of Marcus & Millichap, a real-state-investment brokerage firm. People who moved home or who bunked with roommates during the downturn also might ink leases as the economy improves.

Moreover, construction costs "have fallen rapidly in the last two years," said Tom Toomey, chief executive of apartment owner UDR Inc. A unit that would have cost $300,000 to build two years ago could now be built for as little as $220,000, Mr. Toomey said.

Lumber prices have been cut 15%, while concrete prices are down 10%, he said. Labor costs have fallen as much as 15%. Starting development now "is starting to become an easier decision," Mr. Toomey said.

The sector's optimism was apparent in January's housing starts. Construction of multifamily dwellings rose 9.2%, the Commerce Department said.

At Humphreys & Partners Architects LP in Dallas, which designs apartments, inquires and job counts have more than doubled from a year earlier, said Chief Executive Mark Humphreys. "This time last year the financial world had come to an end," Mr. Humphreys said. "Everybody was frozen in time; they were just stunned. The phone was not ringing. Well, the phone is ringing now."

Developers said they are avoiding Las Vegas and Phoenix, which were overbuilt during the housing frenzy, in favor of more stable markets, including Washington, Boston and San Francisco.

In 2011, AvalonBay Communities Inc. plans to complete six projects with more than 2,100 units in locations including Walnut Creek, Calif., New York and West Long Branch, N.J. The rents will average more than $2,000 a month, according to securities filings.

Equity Residential, meanwhile, plans to deliver 111 units in New York's Chelsea neighborhood in late 2011.

Developers also are using conservative projections when planning projects. Zaremba Group, which is building Fusion 1560, is targeting rents between $925 and $2,300 a month in 2011, when it hopes to be fully leased. Mr. Zaremba said that matches the current market.

"We're not banking on [rent increases]," he said.