Will Hartford s Booming CBD Apartment Market Continue to Thrive? The Hartford Central Business District apartment market is booming; expanding in a way not seen in generations. Fueled by a mix of low interest rates, low capitalization rates, favorable real estate tax agreements and state-sponsored funding, the market has grown 795% since 2002 when there were only two projects. Moreover, with another 565 units in the planning/construction stages, the current 1,585 unit market could increase by another third in the next 24+/- months (1,115% from the 2002 figure.) With such dramatic recent and projected growth, now is a good time to take stock of what this means for the CBD apartment market itself for rental rates, occupancy, absorption, unit mixes and other factors and consider how these forces might impact the larger local economy. Background As noted in the table below, the CBD housed only two apartment projects totaling 177 units before the building boom. Starting in 2003, 55 On the Park and in 2004, Trumbull on the Park together more than doubled the number of units in the market. The success of the first two apartment projects spawned many others. By 2007, the market had quintupled, and has further accelerated in the last decade to now total 1,585 units, inclusive of the 2 original properties, Bushnell on the Park and Union Place Apartments. There are 7 additional projects in the pipeline which have the potential to add 565 units to the CBD market over the next few years. Public economic development agencies have been a fundamental driver of growth in this market, as their direct investment and lending support have underwritten much of the unprecedented growth and have bridged the gap between actual construction costs and property values based upon achievable market rents. 2017 VALBRIDGE PROPERTY ADVISORS Italia & Lemp, Inc. 1
The growth of apartments has had several ancillary effects. First, Class B office vacancy which had hovered in the 40%-45% range has come down as these older, substantially vacant office buildings were converted to new apartments. Secondly, as apartments started filling, the Hartford CBD vibe began changing as apartment residents brought life to the CBD streets, frequenting bars and restaurants. The new apartments have brought a mixture of empty nesters and young professionals into the city and pumped life into an area that traditionally had seen the streets roll up at five o clock. Developers identified an untapped market a population with a desire for an urban living experience in which they can walk to both work and after work recreational activities. The new projects which have been and continue to be developed are packed with amenities that meet the needs of the new urban dweller. Amenities such as concierge services that allow for package deliveries are critical to those who have moved to primarily on-line shopping. On-site fitness facilities are filled with the latest equipment. Lounge areas with wi-fi allow for a communal work environment. Attractive architectural details are found in many of the converted former office buildings. Pet-related amenities such as pet walking areas, pet spas and pet cleaning areas are provided. All these and many more attractive features have contributed to the successful leasing of the apartment properties. The focus of the remainder of this article will compare and analyze apartment projects developed since 2014 to the present with pre-2007 housing stock, as well as discuss the potential for success of future projects. Rental Rates The apartment rental rates have exceeded expectations in the new projects built from 2014 to the present. While concessions were seen early on during lease up, these have largely disappeared. For the apartment stock built pre-2007, rental rates declined as the newer projects came on line. The newer projects were designed to meet the demands that the market exhibited (i.e. smaller less expensive units with more amenities). The good news is that pre-2007 apartment stock rental rates have now (1 st Qtr. 2017) rebounded as the entire market has stabilized. 2017 VALBRIDGE PROPERTY ADVISORS Italia & Lemp, Inc. 2
The following information was obtained from historical data of CoStar and Valbridge Property Advisors. Data has been adjusted for utilities based on the CT Department of Housing Utility Allowance figures and assumes the tenant incurs costs of an electric heat pump (heat/ac), hot water, general electric, and cooking. The following chart compares average one-bedroom rental rates of pre-2007 housing with post-2014 housing. Prior to 2014, average rental rates stayed in the $1.55/SF to $1.65/SF range. Once new product appeared, rates for older units decreased to $1.57/SF, but have since rebounded to average $1.67/SF in first quarter 2017. As expected, post-2014 developments have generated superior rental rates in comparison to older properties, but all expectations were surpassed at rates higher than $2.00/SF as the red line illustrates above. This chart illustrates the high and the average onebedroom square foot rates for each housing category. The current high end for pre-2007 units is equal to the average for post- 2014 units. The Grand on Ann development opened first in late 2014 with one-bedroom rents averaging $2.15/SF. Once other post-2014 projects opened, the average of new units dropped to $2.03/SF in 2015 and $2.07/SF in 2016. First quarter 2017 data indicates a 1% increase to $2.09/SF. This slowing rate of rental rate growth suggests that the market may have peaked at current rates. In contrast, pre-2007 units had a 4% increase as of early 2017; however, rent levels are only back to rates achieved in 2014. 2017 VALBRIDGE PROPERTY ADVISORS Italia & Lemp, Inc. 3
Most rental rates in first quarter 2017, shown below, fall in the range of $1.55/SF to $2.18/SF with a straight average of $1.87/SF. Most knowledgeable parties expect nominal rent growth over the next few years in anticipation of additional housing stock. Furthermore, it is unlikely that rents for pre-2007 apartments will experience significant growth given the superior competition from the more current apartment stock and the probable addition of newer projects. Occupancy The occupancy level for Hartford CBD apartments remained flat in the 95%+ range for several years prior to 2013. Since that time, occupancy levels remained strong with a high in 2014 of 98%. As new units came online in late 2014 and 2015, occupancy levels dipped to an average of 81%, but quickly rebounded in 2016 to an average of 93% as the new developments were leased and improved still further in first quarter 2017 to 95%. 2017 VALBRIDGE PROPERTY ADVISORS Italia & Lemp, Inc. 4
Current occupancy rates are strong for all properties in the Hartford CBD with a range of 86% to 100% with 4 projects reporting 100% occupancy. In total, the 15 projects have an average occupancy of 94%. Absorption The absorption levels have surpassed most everyone s reasonable expectations. Since December 2014, a total of 7 new apartment developments have come online (697 units). Most projects were redevelopments of existing Class B office structures. The first new development, the Grand on Ann, came online in late 2014 with 26 units, which leased in roughly 12+/- months. Four additional projects came online throughout 2015 totaling 659 additional units, followed by a pause with only 12 additional units coming online in 2016. Although rental rates dipped slightly as this new product was leased and concessions were offered, all new inventory was absorbed. Clearly, the apartments were built and they came! Information provided directly from developers and online articles (including The Hartford Courant and Hartford Business Journal), result in the following estimated absorption figures during December 2014 to September 2016, or approximately 22 months. 2017 VALBRIDGE PROPERTY ADVISORS Italia & Lemp, Inc. 5
During these 22 months, the market absorbed on average, 26 units per month with a highwater mark being 50 units per month. Unit Mixes The typical unit mix seen in the Hartford CBD has historically consisted of 90% one- and two-bedroom units. The post-2014 projects were designed to meet new demand for more one-bedroom units. While demand continues to be strong for this unit type, developers anticipate a greater need for studio units in the future. Of the 565 potential pipeline units, 55% or 314 units, are studios. The developers learned the strong preference of the Hartford apartment dwellers to live alone as economically as possible. Thus, developers have adapted to meet market demands. The graphs that follow show the potential upcoming unit mix change. 2017 VALBRIDGE PROPERTY ADVISORS Italia & Lemp, Inc. 6
Pipeline Projects Several new projects are in various stages of construction or are still coordinating financing. The Radisson Hotel at 50 Morgan Street is converting Floors 10-18 into 96 apartment units and is expected to open in late summer 2017. Additional inventory likely to come online soon includes 53 market-rate units at Front Street Phase IV (81 Arch Street). The largest potential apartment project includes two vacant office buildings at 101 & 111 Pearl Street, in which the owners are seeking financing to redevelop into 258 new units. -96 units at 50 Morgan Street -8 units at 1279 Main St -53 units at 81 Arch St -258 units at 101 & 111 Pearl St -60 units at 370 Asylum St -66 units at 103-109 Allyn St -24 units at 105-107 Wyllys St Total: 565 units Assuming these projects come to fruition, the total number of apartments in the Hartford CBD could reach 2,150 units by 2019. 2017 VALBRIDGE PROPERTY ADVISORS Italia & Lemp, Inc. 7
Development Realities Financial challenges continue to make apartment development economically infeasible without assistance from favorable government financing and tax agreements with the City of Hartford. Simply put, the achievable rental rates do not support the development costs. The construction costs are similar to other first tier urban areas such as Boston, yet the achievable rental rates, while improving, are in many instances a third to a half. All new apartment projects developed in the Hartford CBD since Trumbull on the Park in the early 2000 s (except for 55 on the Park) are partially funded by the Capital Region Development Authority (CRDA) and benefit from the residential tax assessment ratio, currently 32.21% for the 2015 Grand List, instead of the typical ratio applied to apartments of 70%. This benefit/subsidy remains in place into perpetuity. It should be noted that the Front Street Lofts are fully tax exempt from real estate taxes due to a long-term land lease with the State of Connecticut. Early projects, such as Trumbull on the Park, are approaching expiration of the original tax agreements. If these agreements are not extended or favorably renegotiated, property values would be significantly impaired. Potential extension or a new agreement is possible for these projects; however, it is not guaranteed. There is precedent for extension as evidenced by The Lofts at Main & Temple agreement, which expired in 2012 but was extended to 2021. Stay tuned. According to Mr. Michael Freimuth, the Executive Director of CRDA, roughly $65,000 per unit has been invested in existing projects with a similar amount pledged to projects now under construction or in the pipeline. Whether this funding will be available for future projects is questionable given the State s dire economic condition. This will most likely determine whether or not future projects move forward. Summary The Hartford apartment market has proven several times over that demand exists. The old adage --- build it and they will come --- has proven to be true. However, developers must continue to evolve projects to meet the demands of its tenants. Given the high cost of urban construction, government subsidies will continue to be required to allow future projects to come to fruition, whether it be in the form of below market government financing and/or favorable real estate tax agreements. Overall, the market should be watched closely. Ideally, new development will be slowly constructed over time. Rental rate growth is not anticipated to increase significantly in the near term as new product is added. It does however appear that there is sufficient demand to enable absorption of new apartments which are under construction or in the pipeline, provided the projects are thoughtfully phased in. Patrick A. Lemp, MAI plemp@valbridge.com Josephine C.A. Aberle, MAI jaberle@valbridge.com Caroline Hafey chafey@valbridge.com Valbridge Property Advisors is a national commercial real estate valuation and advisory firm with 68 offices. The above article was produced by the Connecticut office based in Hartford. The Connecticut office services the entire State of Connecticut, Western Massachusetts and Rhode Island. Please visit our website at: https://www.valbridge.com/state/8/connecticut 2017 VALBRIDGE PROPERTY ADVISORS Italia & Lemp, Inc. 8