Construction progresses at the site of the Modera West Wash Park Mill Creek Residential building near the corner of Logan St. and Speer Blvd. in Denver on Feb. 6, 2019.
Despite warning signs that some tight twists and turns are on the road ahead, metro Denver’s apartment developers aren’t applying the brakes. If anything, they remain firmly on the accelerator.
As more forecasts call for an economic slowdown, if not a full-blown recession, later this year or next, apartment construction continues to drive forward at full throttle, leaving onlookers like Cary Bruteig, owner of Apartment Insights in Denver, concerned.
“We will continue to start projects with 10,000 to 12,000 units a year until it is crystal clear things are headed down,” said Bruteig. “When we have a recession, it will definitely hurt.”
Developers had 26,916 apartments under construction across metro Denver at the end of last year, according to his counts. Beyond those, another 25,686 are in the planning stages.
The region added 12,324 new apartments last year and 13,348 the year before, according to the Denver Metro Apartment Association. To put that in perspective, over the past three decades, the number of new units added in metro Denver has averaged 4,534 a year.
If there is a downturn, developers might come out the other side hands sweating, hearts pounding and mostly unharmed. But the sheer volume of new apartments underway, and the difficulty in changing course, suggests many projects may go over the edge of the cliff.
So far, tenants have snapped up the huge surge in new supply, confounding predictions of a saturated market. Companies continue to add jobs here, and young adults continue to move to the Front Range to fill those jobs. Plus, a lot of native millennials still live with family, leaving another pent-up base of demand.
Last year, metro Denver tenants absorbed 13,707 units, more than the number constructed, according to the Denver Metro Apartment Association. Bruteig acknowledges that some developers who pulled back in 2016 are kicking themselves for getting out too early. But a correction will come at some point, he adds.
Crying wolf, or warnings to heed?
Some developers have heard so many warnings of a slowdown that they have stopped listening, and there are plenty of forecasts out there that paint a positive picture.
“Demand for apartments remains strong in metro Denver, and effective rents will rise 3 percent,” predicts John Chang, an analyst with Marcus & Millichap, in an update on the local apartment market.
Yardi Matrix, another research firm, is looking for both occupancy rates and rent gains to hold steady over the next two years.
“There is no recession built into the model, and we do not believe that supply, although robust, or market saturation is currently an issue,” said Doug Ressler, director of business intelligence at the Phoenix firm.
[RELATED: Is metro Denver’s hot streak in home prices at risk? Analysts disagree.]
Others argue their projects are so well located or have just the right amenities that tenants will flock to them. Put another way, they know how to handle curves in the road.
And some developers say they are looking to hold on for the long haul. Recession or no recession, Denver’s popularity will remain intact. A downturn is a bump in the road, not the end of the ride.
“It’s difficult to predict the future but we take the information we have today and make our best projections,” said Brian Wynne, senior managing director with Mill Creek Residential, which has six communities at various stages in Denver.
That said, Mill Creek has gotten more cautious in forecasting the amount of income that its new developments will generate.
“Our investors are still excited about the market but are being selective in their investments. The location has to have an inherent demand for additional residential homes versus what is there today,” Wynne said.
An argument could be made Mill Creek has that. It has two projects in the trendy River North neighborhood with 541 units between them that are currently leasing. Modera Cap Hill at 1200 Grant St. has 197 units that will pre-lease this spring.
Modera West Wash Park, 400 N. Grant, expects to put 241 apartments on the market in early 2020 and Modera LoHi, which should have some great views of Lower Downtown at 2555 16th St., is expected to add another 132 apartments on the market in the fall of 2020.
A rendering of the Modera River North apartment building.
Wynne said that if the company exercises enough caution on the front end, then it should have confidence that three, six, or 10 years out “there will be demand for high-quality residential property in a good location.”
Across the board, lenders are requiring larger down payments to protect against defaults, and the equity investors putting up those down payments have become more selective in what they will back.
Teo Nicolais, an instructor at Harvard Extension School who specializes in residential real estate, notes that financing is taking longer and getting harder to put together. More friction has emerged in the multifamily market.
Despite that, a record number of apartments are still coming down the pipeline. Developers tell Apartment Insights they plan to complete around 17,000 apartments this year, which would be off the charts for metro Denver.
But wishing isn’t delivering. Nicolais estimates the 125 projects now underway will deliver something closer to 13,500, given the limits on new construction.
Still, that represents a high volume for metro Denver. In 2010, at the bottom of the housing bust, only 498 new apartments were delivered. Now that many are hitting the market every 15 days in metro Denver, he said.
Delays in permitting and shortages in construction labor have repeatedly frustrated expectations. It typically takes two years to plan and permit a project and another two years to complete it once construction gets underway.
For example, plans for Modera LoHi first became public in February 2017. Ground broke this month, nearly two years later. And once construction starts, it is nearly impossible to stop, Nicolais said.
The apartments now hitting the market were conceived in the optimism of 2015 and 2016. In that regard, apartment developers are similar to farmers. They plant the seeds, wait for them to grow and hope a market is still there come harvest time.
Commodity prices might signal farmers to plant corn, not wheat. But if they all do it at the same time, which they are prone to do, prices will plunge and any returns will evaporate.
The problems with recessions, or at last the least two, is that apartment absorption goes to zero, said Bruteig. Landlords are now much better at adjusting rents in real time to reflect demand. But that only means they will realize they are in trouble much sooner once they go into a skid.
“If you are seven stories up on a 14-story building, you don’t have the option of stopping. You have to finish it,” Nicolais said. “Developers may well know we are headed toward a recession. They may see rents are dropping. They can’t stop building.”
Push 12,000 or 13,000 new apartments into a market with zero absorption and that is the very definition of a crash.
A rendering of the Modera LoHi apartment building, currently under construction.
Avoiding a crash
Why not let builders build away? An apartment glut will push down rents and boost concessions, like those flat screen television some landlords are offering to get leases signed. If surplus replaces scarcity, life gets easier for tenants and the market might finally restore some of the affordability it lost this decade.
Apartment rents have softened and are running a little bit above the rate of inflation. Vacancy rates are rising slightly, but nothing to cause alarm.
Nicolais said he understands that optimism is in the DNA of developers and those who back them. He also acknowledges that being aggressive in metro Denver has paid off for the last several years.
But he also argues crashes should be avoided if at all possible. When the home construction boom turned to bust last decade, it wiped out a majority of builders, derailed the careers of construction workers and sent several community banks into receivership.
New home construction hasn’t fully recovered a dozen years later. Too little supply has caused home prices to spike in metro Denver, squeezing households and limiting the options for those who want to own. When more apartments and homes were needed to accommodate all the people moving in, the workers just weren’t there.
And it isn’t just developers who are exposed. Investors bought up a lot of metro Denver’s older apartment buildings. They could find themselves struggling to make loan payments if rents drop too much or units stay empty.
Even buildings that filled up in the last few years could also get into trouble. Construction loans normally have short-time frames, within 10 years, before they must be rolled over into a mortgage. If metro Denver’s apartment market gets too soft, landlords could find themselves in a bind when it comes time to refinance.
That represents a darker scenario, and not everyone agrees. While the rate of job growth and the unemployment rate in Colorado are moving closer in alignment to the U.S. average, the state still has an advantage, said Paula Munger, director of research with the National Apartment Association, in a visit to Denver last month.
After a long period of stagnation, wage gains in metro Denver are starting to kick in. They rose 6.9 percent last October, much faster than the U.S. average.
“Denver is above trend. It is a growing area,” Munger said. That is true now, and it should remain true as the country works its way through the next economic cycle.
The NAA predicts the country will need 4.6 million additional apartments through 2030, and that is with two recession built into that time frame, a mild one in 2020 and a severe once late in the next decade, Munger said.
The apartment industry is optimistic about 2019, especially when it comes to markets like Denver, Munger said.