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Sule Aygoren CarranzaSule Aygoren Carranza is managing editor of Real Estate Forum.

WASHINGTON, DC-The metro area’s class A apartment market continues to be a top performer, but the amount of new developments planned and under way could pose a challenge going forward. Always considered a solid market for multifamily, Greater Washington, DC has increasingly exhibited signs of stress since the end of 2006. And according to Delta Associates, things didn’t look much better as this year kicked off, thanks to a growing shadow rental market, condominium reversions, a growing pipeline of supply and weaker job growth.

The region’s year-end stabilized vacancy rate of 3.7% was much lower than the national rate of 5.8%, but represented an 80-basis-point increase over the prior year. As a result, landlords weren’t able to push rents up as aggressively as they have in the past–growth during 2007 was 1.8%. That’s a drastic decline from the long-term annual average rent growth of 4.4%. Owners of class A assets were only able to grow rents by 1.3% last year, compared to 4% the prior year.

On top of that, high-end landlords offered more concessions in ’07–4.8% of face rent versus 2.4% in 2006. For projects in leaseup, the rate is higher, at 9%. That’s a hike from 5.9% of face rents at year-end 2006 and 3.7% in 2005. These levels are higher in response to the higher number of projects currently in lease-up–41 versus 20 in year-end 2006.

That could be due to lagging absorption. Though overall absorption of class A and B units was strong last year at 3,264 (5,042 for class A alone–coming in first for absorption in the nation), take-up in new projects remained steady at 17 units a month. “This,” note Delta researchers, “is particularly noteworthy as the number of projects marketing doubled since last year.”

Indeed, the 36-month pipeline has exploded, mainly due to reversions. After hitting 18,000 units in 2005–a critically low figure–it has more than doubled to 36,951 units at year’s end. Much of the stock is a result of reversions.

None of this has deterred investors, who picked up $1.7 billion worth of class A apartments, as well as another $537 million of land on which to build new apartments or condos. The latter total towers over the volume of land sales in 2006, at $200 million. Still, Delta analysts believe that at least in the short term, the slowing condominium sector, combined with the shadow space being put on the market, will negatively impact absorption rates of metro area apartments. One saving grace, though, is the tightening mortgage market. That should help to keep households in the rental pool, especially given the high home prices of the region.

Over the long term, the firm stresses that the large pipeline of must be closely watched. As the condo market slowed, the supply of apartments went up as developers switched their development plans. Over the past two years, almost 21,000 units were reverted and added to the class A pipeline. Though this is a small figure compared to the 500,000-unit inventory in the region, the effects of these reversions are impacting projections for several years ahead.

As a result, the vacancy rate in the region–including the District, Northern Virginia and Suburban Maryland–are expected to surpass 5% over the next few years, and supply should outpace demand at the metro level through 2010. The class A vacancy should hit 5.3% over the next three years, a level unseen since the early 1990s. Nonetheless, landlords should be able to tick up rents, although below the long-term average of 4.4% per year.

And while the DC region has been at the top of investors’ lists for years, other metro areas are beginning to surpass it, notes Delta. “In this phase of the cycle,” the firm says, “the successful investor/developer will invest in repositioning existing under-performing assets and developing new projects with superior design features at premier sites within submarkets that maintain a supply/demand balance.” Among these are mixed-use and niche products in areas with good access to transit and a vibrant environment.

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