Phoenix Apartment Sector Starting to Revive

Phoenix, one of the nation's most-battered apartment markets, is showing signs of life.

Brokers report that bidding wars have started to break out for recent-vintage apartments. A case in point: the 512-unit Biscayne Bay complex in suburban Phoenix attracted more than 30 bids last month. The seller, a California State Teachers partnership, is likely to get its $43.1 million asking price, which would translate into a 6.3% capitalization rate - a level unachievable only a few months ago.

Meanwhile, special servicer LNR Partners is seeking $52.9 million, or $84,000/unit, for a foreclosed luxury apartment complex in Phoenix. That would provide the buyer with an initial annual return of just 5.1%, based on $2.7 million of net operating income last year. While some market players think that price is too aggressive, the fact that LNR and its broker, CB Richard Ellis, are shooting that high reflects the newfound strength in the market.

To be sure, no one is suggesting that Phoenix is anywhere near as vibrant as Boston, New York or Washington - markets that never collapsed during the downturn and are now commanding relatively lofty prices, especially for stabilized apartment properties. But Phoenix, one of the first areas to plunge into the abyss, seems to be starting to revive. That is giving it a leg up on Las Vegas and parts of Florida and California - which also were crushed by the housing implosion, but remain in the doldrums.

Fund sponsors and apartment operators are clamoring for listings of both stable and distressed complexes. The demand indicates that investors think prices in the Phoenix area are at or near the bottom, market pros said. That, in turn, should encourage lenders to step up the liquidation of foreclosed properties, they added.

The firming up of the market has come faster than some market pros expected. Phoenix was virtually untouchable for apartment investors for much of 2008 and 2009. Prices plunged as high foreclosure rates and the failures of dozens of condominium projects led to an oversupply of rental units. Investors assigned negative values to land zoned for condominium and multi-family development.

Several high-profile owners of Phoenix-area apartments, including Bethany Group of Irvine, Calif., and Archstone of Denver, took big hits. Other institutional players, like AIMCO of Denver, scaled back Phoenix offerings amid sagging prices.

It was a dramatic comedown for Phoenix, once one of the nation's hottest apartment markets. In 2006, $2.9 billion of large apartment properties traded hands in the metropolitan area. Volume plummeted to $367 million in 2008 and $192 million in 2009, according to Real Estate Alert's Deal Database, which tracks transactions of at least $25 million. Values dropped by at least 40% from the market peak, and investors often demanded cap rates of 9% or higher.

But now Phoenix appears to be stabilizing. Lenders largely avoided dumping distressed properties during the downturn, which kept supply tight. What's more, construction slowed significantly. About 1,800 apartments are expected to come on line in the Phoenix area this year, down from an average of 4,100 the past five years, according to Marcus & Millichap.

Economic conditions are also improving. Some 11,000 new jobs are forecasted for 2010, versus a net 112,600 decline last year. Also, the rise in vacancy rates appears to be slowing. Last year, the vacancy rate soared by 120 bp, to 12.3%. This year, Marcus & Millichap projects an increase of only 30 bp.

Brokers are touting Phoenix's traditional selling points: comparatively cheap prices and consistent household growth, particularly from retirees and other transplants from more-expensive states.

LNR's offering could be a test of how much prices have firmed up. LNR foreclosed in November on the 629-unit property, at 19920 North 23rd Avenue, after falling occupancy dragged income below the amount needed to service a $63 million securitized mortgage.

Seattle-based S-J Management bought the 45-building property in May 2006, a year after its construction, for $80.8 million, or $128,000/unit. When the housing market turned down, the occupancy level started to decline. S-J Management began to offer rent concessions, causing expenses to soar. For example, the company offered new tenants free cable television, only to see cable rates jump dramatically. By the time LNR foreclosed on the property, called Canyons, the occupancy rate had dipped to 78%, and income covered only two-thirds of mortgage payments.

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