By Jack Stubbs
“In the last cycle in Seattle, there was obviously a huge wave of multifamily being introduced into the market and a dearth of condominium product,” said Alex Henderson, vice president of Grosvenor Americas’ Puget Sound co-investment team. “But [now], if people were given the choice and more condo product was available, then I think you would see a pent-up demand within the market.” Henderson foresees renewed interest in condominium development in Seattle in the coming cycle given the potential oversupply of rental product and the simultaneous lack of for-sale product.
In an industry report by Polaris Pacific, a San Francisco-based research and marketing firm that operates throughout the western United States, the data points to a similar conclusion. Across the board for all condo types, the price per square foot for condos has increased dramatically year-over-year, a trajectory that demonstrates a combination of increased demand and short supply of condominiums in the Puget Sound region. As of November 2017, the price per square foot of low-rise buildings (4 stories or less) was $663, an annual change increase of 16.5 percent. The price per square foot for mid-rise buildings (5-12 stories) was $709, representing a 23.6 percent increase from the previous year. Finally, the price per square foot for high-rise buildings (13 stories or more) was $788, up 17.5 percent from the previous year. Longitudinally, from November 2016 to November 2017, the median price increased 40.7 percent to $550,000, which is also up considerably from the median price of $400,000 posted in 2008.
Geographically, by district in Seattle, the annual median per square foot price has increased as well, suggesting that the demand for condo products is a widespread trend. All of the districts in Seattle (downtown, West Seattle, Capitol Hill, Lake Union, Queen Anne, Fremont/Ballard, Northwest Seattle and Northeast Seattle) experienced an increase in median per square foot price, according to the Polaris report. The most notable year-over-year median per square foot increase occurred in Northeast Seattle, which experienced a 42 percent increase.
The condo market is currently experiencing the after-effects of the last cycle, according to Henderson, with a couple of factors in particular contributing to the relative lack of condo development—micro- and macro-trends both play a role. The Washington Condo Act and the financial crash in 2008 are two factors contributing to developers’ wariness about developing condos, given the risks and challenges associated with getting adequate financing. “Much of that has been driven by the big financial crisis of the last cycle. Part of it [also] stems from developers’ concern over the Washington Condominium Act and the litigious nature of the state of Washington from a construction and warranty perspective,” Henderson said.
In addition, the market forces since the recession have driven a lot of developers to consider apartment rentals also because they offered a higher yield on their investment, while at the same time lending constraints have made buying an option for fewer people. As a result, there are currently 795 new condos under construction in Seattle (481 of these downtown), with an additional 614 condos (including 287 in Capitol Hill and 130 downtown) that are entitled and could begin construction in the near future, according to Polaris Pacific. Conversely, there are 7,027 apartment units currently under construction (including 2,976 downtown, 969 in Capitol Hill and 639 in Lake Union), with an additional 5,336 units approved for construction.
Looking at the demand for condos more generally, one of the key metrics by which it is measured is MRI (months of remaining inventory), which indicates how many months it would take for the current supply on the market to be absorbed: six months is considered a balanced market, according to Polaris, while nine months or more is considered an oversupplied market. As the report indicates, the MRI has decreased from 3.5 in 2014 to 1 in August 2017, a trajectory that is indicative of strong demand and currently very little supply on the market.
Henderson believes that rising rental rates in the Seattle market mean that people moving to this city might eventually view buying as a preferable alternative to renting. “In the last few years, rents have been rising so rapidly in the market driven by rampant demand. it’s taken awhile for the market to catch up and build enough product,” he said. “I think traditionally the cheaper option [has been] to rent. But in such a rapidly-escalating rental environment, I think the gap between buying and renting is narrowing.”
This may be true for certain properties and neighborhoods, however, according to a fourth quarter of 2017 report by Zumper, the median rents in Seattle for one-bedroom units have been flat year-over-year, while rent for two-bedroom units has decreased since 2016.
However, there is also another, perhaps less tangible, more ingrained factor at play as well, according to Henderson. “There comes a stage when, if you’re in your late 20s or early 30s, you can see the benefits of owning a home and paying some of the monthly mortgage versus paying rent to a landlord. I think there’s a different psychology associated with that type of home ownership,” he said.
Henderson believes that over the course of one’s lifetime, especially for those looking to settle in a dynamic city like Seattle, greater consideration is given to the bigger picture—and the city will evolve as a result. “Psychologically, from a home-owners perspective, the ability to build up some home equity would be a preferential option to being a lifelong renter…it is an important stage in [one’s] life progression, and it will be particularly important for the city.”
In the longer term, condos offer more stability than shorter-term rental options for some. But this all-important sense of stability is further complicated by generational differences, with an intense in-migration of millennials into Seattle a key recognized factor, according to Henderson. “They’ve typically been moving there for the short-term for work. And as they’ve become more embedded within the city—with the increasing number of tech jobs becoming available—what may have been a transient move becomes more permanent,” he said.
However, unfortunately for millennials and their younger successors, the Gen Zers, hoping to relocate to Seattle, the current gap of condo inventory in the market means that this stability-through-home-ownership will be difficult to achieve. “There are just no condos available at an affordable level for people to climb the housing market ladder,” Henderson said, “and there’s no sign on the horizon of that changing anytime soon.”
Even though affordable new condo inventory is scarce in the market, three current developments highlighted in Polaris Pacific’s report—Nexus, developed by Burrard Group; Insignia, developed by Bosa; and Luma, developed by Lowe Enterprises—demonstrate that there is demand at some levels of the market. Nexus is a 40-story, 374-unit project located in the Denny Triangle submarket in downtown Seattle. The project has an average monthly absorption of 19 units, with unit prices ranging from $688 per square foot for a studio to $1,146 per square foot for a three-bedroom unit. Insignia is the newest luxury condo development in Seattle (comprised of 203 one-bedroom units, 502 two-bedroom units and two three bedroom-units) that has a monthly absorption rate of 16.6 percent and is located at the intersection of South Lake Union, Downtown and Belltown. The Luma development is located between First Hill and Capitol Hill, comprising 168 units that range from $527 per square foot to $903 per square foot.
There are some structural issues within the buying and rental markets that have contributed to the lack of further condo development. Risks associated with condo development mean that developers in Seattle will likely opt to pursue apartment projects instead, according to Henderson. “From the conversations that I’ve been having with developers in the market, there’s an assumption that if you build a condo project, you’re going to end up in a lawsuit at some point down the line. There’s a long tale of potential litigation for condo projects from a developer’s perspective,” he said.
Condo projects are also difficult to finance in Washington State, where there is no required binding pre-sale agreement in place, meaning that developers can’t get preferential financing for condos—and banks are subsequently less willing to finance condo projects, according to Henderson.
For millennials looking to buy in the currently-inflated market, Henderson believes that they might not be able to move quickly enough and could miss the boat. “My concern is that millennials will miss the opportunity to get onto the housing ladder when house prices are rising so quickly. It’s difficult to make the step from a standing start into a single-family home,” he said.
Ultimately, though, even when considering the financing issues and various litigation risks associated with condos, the onus will be on the Seattle developers to make the first move. “My view is that there will come a point in the market where that gap is going to widen, and the pent up demand will become so strong that some developer will have to make the first step and be brave,” he said. Even though for the meantime, local developers appear unwilling to take that risk, increasing demand in the market for condo developments dictate that they may soon not have a choice, according to Henderson. “Economic fundamentals dictate that that will eventually be the case.”