Strong opportunities for Tucson Class A apartments

By Eric Lamb, Wells Fargo


April 15, 2011

It is generally accepted that there are four major types of commercial real estate: office, industrial, retail and multifamily (apartments). The demand for commercial real estate peaked in 2007 and has decreased dramatically since then due to the financial crisis and Great Recession.

Increased vacancy rates occurred across all major property types during the ensuing time period, which forced property owners to lower their rental rates to either maintain existing tenants or attract new ones.

These worsening operating conditions caused investors to move their capital to investments perceived to have less risk and provide more liquidity, such as stocks, bonds and money market accounts. As a result, the values of commercial real estate investments decreased significantly.

The good news today is that the fallout to date from this crisis has not been as bad as feared and market conditions are stabilizing, and in some cases improving. Regarding office, industrial and retail properties, the discussion stops here.

The multifamily market, however, is considered to be in full recovery and warrants further comment.

The general consensus is that the changing dynamic of home ownership is the root cause of the multifamily recovery. According to the U.S. Department of Commerce, home ownership peaked in 2005 at 69 percent and has decreased to 66.5 percent in 2010. Additionally, with the more cautious underwriting of residential mortgages, this phenomenon is not expected to reverse course anytime soon.

A concurrent cause also has been the availability of attractive financing from government-sponsored entities. The high loan-to-value, low interest rate loans these entities provide for multifamily properties are not available for the other major property types.

According to Apartment Insights statistics/trends summary for the fourth quarter 2010, there are 63,640 multifamily units in Tucson. When differentiating the inventory based on class (A, B, C) with Class A being newer properties with the best amenities and location, and Class C being the oldest with inferior amenities and location, approximately 12 percent of the units are Class A, 74 percent are Class B and 14 percent are Class C.

Additionally, over 81 percent were constructed prior to 1991, with an overall average age of 28 years. Consequently, as of year-end 2010, Tucson ranks 27th of 28 major western cities in terms of average apartment rent per unit, according to RealFacts.

Apartment Insights reports the average monthly rent per unit in Tucson is $631 and the average occupancy is 90 percent. In comparison, the average monthly rent per unit for Class A properties is $858 and the average occupancy is 94 percent.
The maxim is that capital will flow to the opportunity providing the greatest perceived return with the least amount of perceived risk. Given the strong operating metrics and the availability of favorable financing, recent sales of Class A properties in Tucson have occurred at prices near the 2007 peak.

Therefore, real estate developers as well as their investors and lenders, are allocating capital to the development of new Class A multifamily projects. Local banks are providing variable interest rate construction financing with upwards of 80 percent loan-to-cost, and loan terms covering construction and lease-up, for well-capitalized and experienced developers who provide personal loan guarantees.

Lenders representing the government sponsored entities are providing nonrecourse, fixed interest rate financing as low as 5.5 percent, with upwards of 80 percent loan-to-value, 10-year terms and 30-year amortizations for good-quality properties with stabilized operating histories.

The 96-unit Tanque Verde Valley Casitas opened in 2010 and has reportedly achieved stabilized occupancy. Construction is ongoing at the 304-unit Riverside Crossing, at River Road and La Cholla Boulevard, and the 168-unit Legacy at Dove Mountain in Marana. Several projects are in the planning stages for northwest and northeast Tucson.

One experienced multifamily professional recently stated he believes Tucson could absorb 2,000 new units per year into the foreseeable future. Interestingly enough, one of the main reasons there isn’t more multifamily development ongoing is the lack of appropriately entitled land within the metropolitan area, a process that takes several months with the local planning and development agencies.

Contact Eric Lamb, vice president and relationship manager for Wells Fargo Middle Market Real Estate, at [email protected] or (520) 577-5682. Lamb has been responsible for originating and managing a commercial investment real estate loan portfolio since 2006.

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