Getting Ahead of an Apartment Crunch

Kristin Davie misses her freedom. The 22-year-old has been living with her parents in Colonia, N.J., since graduating from Marist College in May. She and two friends set a deadline of September to find jobs and a New York City apartment they could afford to share. September's long gone, and she's still at home. Davie left her first job, where she was unhappy; now she has a new one. "I'm hoping we'll be in the city by the end of April," she says.

The managers of AvalonBay Communities are hoping right along with her. While most apartment construction is on hold, AvalonBay (AVB), a real estate investment trust based in Alexandria, Va., plans to start $400 million worth of new rental units this year, mainly in the Northeast.

With the unemployment rate at 9.7% and the apartment vacancy rate at 8%—the highest ever, according to research firm Reis (REIS)—this might seem like the worst possible time to start building. Rents plunged last year, yet AvalonBay CEO Bryce Blair says it won't be long before the job market recovers and people in their twenties, such as Davie, move away from home or out of their shared apartments and into rentals of their own. The units AvalonBay plans to start this year won't be ready for occupancy until 2012, and by then Blair expects demand to be strong. "If we're able to build and deliver new product into a period that is really absent of supply," he says, "we'll have a competitive advantage."

With $300 million in cash and a $1 billion credit line, AvalonBay, the second-largest publicly traded apartment owner in the U.S., can afford to be contrarian. Construction financing for private developers—a category that includes most of AvalonBay's rivals—dried up as banks were swamped by bad loans. U.S. builders started 92,000 units in 2009, a 58% decline from 2008 and the fewest since the government began collecting the data in 1974. AvalonBay built nothing for the first nine months of last year, then started two projects.

"It is as difficult to finance a new development today as in any time in my 30 years in the real estate business," says Charles R. Brindell Jr., president and CEO of closely held Trammell Crow Residential, which has developed more than 225,000 multifamily units across the U.S. For the first time in its 33-year history, Trammell Crow didn't start a single development last year, when it failed to line up financing for four planned projects in the Northeast.

The largest publicly traded apartment owner, Equity Residential (EQR), the real estate investment trust founded by billionaire Sam Zell, is emphasizing acquisitions over construction. It does, though, plan to build 111 units on a property in the Chelsea neighborhood of Manhattan that it acquired in 2009.


Will AvalonBay's bet pay off? Ron Witten, founder of Witten Advisors in Dallas, is a believer. "We will have fewer apartments than the market will have need for," he says, "which will drive rents higher." Witten says rents may increase by about 6.5% and the vacancy rate drop below 5% by 2012. Others think any shortage won't last long. "When financing gets better," says Victor Calanog, director of research at Reis, "building is going to be quick."

Certainly, some areas will rebound faster than others, and Kristin Davie may want to find a place soon. According to forecasts by research firm Axiometrics, New York City rents could climb 6.7% next year and 8.6% in 2012.

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