Earlier this month a group of land developers proposing projects in Tysons met for the Biznow real estate conference to discuss the future of the growing region. After this meeting the Washington Post ran an article questioning whether the rental market could support the new inventory coming into Tysons, and if a lack of demand will slow development. This poses two questions in my mind: is there still a demand for more apartments in the Metro Region as a whole and is Tysons competitively priced given the current marketability of the area.
DC Metro Region Market As a Whole
On the first front, based on a Marcus Millichap analysis performed at the end of 2013, the region saw vacancy rates in apartments tick up slightly to 5%. The cause of this uptick was noted as being caused by significant new inventory coming on the market (over 16,000 since 2012). This increase in supply, for those of you who don’t believe in the idea of addressing affordable housing by increasing viability of new projects by density, also caused a drop in rental rates for Class A apartments (typically associated with new construction) of 5%. The average for all rental properties also slowed to only 1.3 percent growth, a historically minimal increase.
Whether this is good news or bad news is a bit of a trickier question. On one hand the cost of living in the DC metro region is astronomical, one of the highest in the country, and any slowing or decrease in housing price (the prime factor in cost of living) helps to provide new opportunities and attract new businesses. However, these same dynamics may lead to fewer new projects being perceived as viable for financing and lead to a slow down in supply, which in turn will cause pricing to go higher. Which way the pendulum will end up really depends on the flexibility of developers to prove financial viability even with lower rental rates.
With an average of 8,000 units per year being delivered is the market really being met?
Since 2000 the area has grown on average 70,000 residents per year. The current percentage of single person households or cohabitants is approximately 35%, so it can be assumed that conservatively 24,000 new prospective single renters move to this area each year. Also note that since 2000 the average age of this area has come down nearly 2 years, showing that the population is trending younger and therefore more single than in prior decades.
With 24,000 new prospective renters, and an average of 8,000 new units being constructed (conservatively lets assume they are 2 bedroom units), it would imply that we continue to have a shortage of 4,000 units per year. At a minimum, so long as current employment rates remain strong in the area, there is no extreme glut of apartments and the market should be able to sustain continued growth.
Although financing has been slowed from investors, the real test will be the absorption of the current 5% vacancy rate. Ultimately, if this new flurry of apartments is able to lease at a profitable rate, we will see renewed interest. At this time, it is very much wait and see.
Tysons Market
In Tysons specifically questions have surrounded rental rates that developers are planning to charge for new apartments. Many crowed that because of increased taxes and the requirements being levied on them per the 2010 comprehensive plan that the rental rates would need to remain high to attain financing. This is not unexpected of course, it is a smart tactic by the land developers to persuade some leniency, but is it the reality?
In March of 2012 Greystar and JPMorgan agreed to financing for the Ascent project in Tysons at a rumored price tag of $80 million. The project delivers 404 units which, per the Ascent website, range from studios in the $1900s to 2brs in the $3800s and an approximate average of $3000. At that price tag Greystar can anticipate revenue of $14.5 million per year at full occupancy. Assuming costs of $1.5 million per year in taxes, $1 million in management operation, and $2 million in utilities and maintenance the project will still garner $10 million per year at full occupancy with an ROI of ~8 years.
Of course, you can’t anticipate full occupancy at all times, especially early on, but this shows that the price point has plenty of flexibility especially when considering a reduction in price will cause a reflexive decrease in vacancy. For instance, at an average price point of $2500 per unit, Greystar could anticipate $7.6 million per year in profit with an ROI of ~10 years (still not that bad).
The idea that rental rates must be this high is really a matter of wanting to charge the highest amount that a market can bear and increase profits, not necessarily charging the minimum amount to make a project green lit for construction.
So is the Tysons market being priced correctly? Many noted during the Bisnow Real Estate event that Tysons will need to compete on price against Arlington (and perhaps even Reston) in order to navigate the early years of the areas transformation.
Based on a quick search of local listings one finds comparable apartments (Class A within 1/2 mile of metro):
| Sub-Market | PSF |
| Ballston | $ 32.50 |
| Courthouse | $ 34.90 |
| Rosslyn | $ 39.00 |
| Reston* | $ 24.00 |
| Golden Triangle D.C. | $ 43.00 |
| U Street D.C. | $ 44.40 |
*No metro currently
For the Greystar Ascent project the average price per square foot annually is $37.30, putting it above the cost per square foot of not only Reston, but also Ballston and Courthouse. An argument could be made that the price should be higher than Reston, due to proximity to Metro, jobs, and overall being closer to the city. However, the same can not be said about the Ballston and Courthouse sub-markets, both of which have established walk-able neighborhoods with ground floor retail and local amenities, as well as being closer to the city and arguable as close to the main job centers of the region.
In order to compete with these more attractive sub-markets, projects like Greystar must lower prices or wait until vacancy rates in Arlington essentially approach 0% in order to get spillover renters. The latter would mean years of high vacancy rates which will have a greater impact on financing ROI than the lowering of the prices. Therefore it’s likely, after testing the waters early on, that we could see a reduction in pricing closer to the $28 to $30 psf range.
Will that be too low to make future projects feasible?
At $28 psf and approximately 350,000 square feet of residential rental space Greystar would see revenue of $9.8 million and profit of approximately $5.3 million per year. That would mean an approximate 15 year ROI if that condition remained for the entire term, but this early lowering of price to address the reality of other markets could be short term as the area would mature. With each year Greystar could likely increase rents to average closer to the Ballston corridor pricing within the first decade. And while a 15 year ROI is longer than the currently projected 8 year ROI, it is also more realistic and likely to succeed.
If Greystar were able to achieve strong occupancy with anything in the $30 per square foot range early on, it will likely be a signal for strength in the sub-market and continued investment and financing interest.