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WASHINGTON, DC-Landlords in the Washington, DC metro area will feel some pressure in the next few years, but that pain will lead to an upswing in pricing power as market fundamentals return to the region’s historic norms. The groundwork is currently being laid for stronger conditions in 2011 and 2012, according to Delta Associates, and a product shortage will emerge shortly after.

The region is still considered one of the best apartment markets in the country due to its relatively strong job market, particularly with high-wage earners; transient workforce, which results in a large concentration of renters by choice; and a slow housing market that’s forcing many households to remain in the renter pool.

Despite its fundamental strengths, the Greater DC stabilized vacancy rate for class A and B product rose to 4.3% at midyear, a 70-basis-point uptick over the prior 12 months. Comparatively, however, that figure remains far below the national average vacancy rate of 6.6%. Class A rates barely moved, coming in at 4% compared to 3.9% last year.

Renters are continuing to lease up more class A properties; at 8,294 units, the DC area absorbed the most product among any other market in the nation so far this year. That, however, was to the detriment of the class B market, which saw more units become available. Altogether, absorption of class A and B product came in at 5,210 units for the first half of the year. On average, 15 units per month were leased up, thanks to an increase in concessions at new projects. Still, say Delta researchers, “this rate is remarkable, as the number of projects in lease-up now totals 47.”

Landlords at class A properties are becoming more aggressive to lure tenants, as the rate of concessions in that market rise to 6.3% of face rent, with the most pronounced increase found in the District proper. At midyear 2008, that figure was 4.1% of face rent. Concessions for all class A properties are at their highest level since 2003, and those at unstabilized projects–currently in lease-up–are the highest level Delta has ever recorded.

There are currently 17 low-rise projects with over 5,200 units in the lease-up phase. As a result of all of this, rents for all investment-grade product fell by 1.4% from June 2008 to June 2009. The class A market had a decline of 1.8%, after seeing rents grow by the same amount last year. High-rise class A product inside the Beltway, saw a 1% drop, while rents at class A garden apartments fell by 2.2%.

The good news is the pipeline of product under construction is declining, although it isn’t quite at the historically low level of 18,000 units, which it hit in 2005. The 20,771 units under way as of midyear 2009 are a marked improvement over the market’s peak of 36,951 units at year-end 2007, which was primarily due to the great number of failed condominium projects. Delta researchers believe the difficulty of obtaining credit will lead to further decreases in the number of projects under construction.

In the short term, the firm expects rent growth to hover in the negative territory until at least mid-2010 as deliveries of new projects continue. As construction completions slow toward the end of next year, landlords will once again have pricing power. Vacancy rates among stabilized projects will probably peak in the first half of 2011 before dipping again, particularly in the first half of 2012. “To take advantage of the market ‘sweet spot’,” say Delta analysts, “position now for delivery in early 2012, or even earlier in 2011 in select submarkets.”

Meanwhile, on the investment sales front, 2009 continued the slowdown in transactions that emerged in 2008. Just one class A property, a $109.5-million high-rise, changed hands in the first half, along with $6 million worth of land sales–which itself is an indicator of the reduced construction expected in coming years. Last year, only a dozen class A assets were flipped, totaling $884.7 million in overall sales volume.

On average, garden properties traded for $192,000 per unit in 2008, a 22% drop over 2007, and high-rise prices fell 11% over the same period to $359,000 per unit. This trend, says Delta, indicates that cap rates are rising from their low point in 2007. “Most observers believe price increases will now be earned the old fashioned way–by performance enhancement,” they state. “The apartment segment is a winner in the turmoil that follows this credit crunch, with homeownership rates edging down from their cyclical high of 70%. If that’s the case, demand for this product type should remain strong. So also should demand for this asset class among investors.”

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