Marcus & Millichap: apartment market kick into high gear.

The Manhattan apartment market has kicked into a higher gear.

Boosted by a robust local economy, vacancy continues to fall to low levels not seen in years, and rents are climbing at an exhilarating rate.

Four of the borough's six submarkets have recorded year-over-year vacancy decreases plus sizable effective rent gains, and the vacancy rate is virtually unchanged in the remaining two submarkets. Stock reductions for condo conversion account for some of the decline in vacancy and, with the for-sale housing market cooling down, it is unlikely that stock reductions will offset new supply to the extent recently recorded.

Nonetheless, it is important to note that recently delivered projects have not adversely affected market fundamentals, confirming the underlying vigor of demand generators in the market. Concessions, meanwhile, are burning off and now account for a scant 2.8% of asking rents, compared with 5.5% of asking rents eight quarters ago.

As fundamentals strengthen, investors' appetite for local properties remains substantially undiminished.

Transaction activity is currently a bit slower than one year ago, but remains up substantially when measured over a longer time period. Values are rising and cap rates continue to contract, and it is fair to question how much farther they will go before transaction volume starts to slow significantly.

The slowdown has yet to occur, but some potential investors have probably moved to the sidelines as cap rates have dropped to extremely low levels. These investors, however, are likely to jump back in on the upswing, motivated by the desire to acquire properties with long-term appreciation potential and growing current income.

Employment: In the borough of Manhattan, employers will add 33,000 jobs this year, a 1.4% increase. Citywide, 50,000 new positions are projected, a 1.4% gain and up from 39,000 jobs in 2005.

Construction: Builders are on track to deliver 1,800 rental units in Manhattan this year, down from 3,285 units in 2005.

Vacancy: With robust demand expected to persist in the near term, the vacancy rate in Manhattan is projected to fall 20 basis points this year to 2.8%, the lowest level since 2000.

Asking Rents: Owners will continue to aggressively raise rents this year, resulting in a 7.5% hike in asking rents and a 7.8% jump in effective rents to $3,412 per month and $3,323 per month, respectively.

Economy: In the 12-month period ending in June 2006, 58,000 positions were added in the five boroughs of the city, a 1.6% gain, compared with 32,000 jobs in the preceding 12-month period.

In Manhattan, employment growth this year is being driven by office-using sectors. Approximately 20,000 office-using jobs are forecast to be created in the borough this year, a 2.3% gain and an increase from 18,000 new jobs in 2005.

Employment gains continue to be posted in Manhattan's important securities industry, albeit at a slower pace than one year ago. Through June, 4,500 jobs had been added, compared with 7,800 jobs in the first six months of 2005.

The outlook for the borough of Manhattan, is that employers will add 33,000 jobs this year, a 1.4% percent increase. Citywide, 50,000 new positions are projected, a 1.4% gain and up from 39,000 jobs in 2005.

Housing & Demographics 

Multi-family permit issuance in Manhattan is forecast to reach 5,800 units this year, bringing the total number of units permitted in 2005 and 2006 to 10,300.

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All of the units permitted, however, may not be built for any of several reasons, and those units that are built may be delivered over several years.

The median price for a Manhattan condo or co-op in the second quarter was $880,000, a 14% increase from the year-earlier period. Sales velocity was slowing in all segments of the market, but especially in entry-level units, as higher interest rates were deterring many first-time buyers.

The gap between the monthly payment on the median-priced condo or co-op and average monthly rent rose from nearly $1,500 in the second quarter last year to approximately $2,200 in the second quarter of 2006.

Outlook: Higher interest rates will keep would-be buyers in rentals a bit longer, providing a boost to already strong apartment fundamentals. Moreover, Manhattan will always remain a renter's market, as 71 percent of households occupy rental residences.

Construction

Rental inventory increased 1.5%, or by 1,300 units, in the 12 months ending in the second quarter this year, as completions totaling 3,352 units were partially offset by units removed for conversion to condos.

Approximately 700 units were completed in the first half of 2006, and 5,000 units are currently under construction. Of the units under construction, 2,700 rentals are due for completion in 2007. The planning pipeline, meanwhile, contains 6,000 units.

Among the 3,352 units completed in the past four quarters, 2,500 units are in the West Village/ Downtown submarket. These new units have increased rental stock in the submarket by 12 percent.

Outlook: Builders are on track to deliver 1,800 rental units in Manhattan this year, down from 3,285 units in 2005.

Vacancy: Vacancy of 2.7% in the second quarter was 50 basis points less than the rate in the year-earlier period, and 30 basis points less than the vacancy rate at year-end 2005. The vacancy rate in the third quarter, usually a high demand period, is expected to fall to 2.6%.

Despite a large number of new units coming online, the vacancy rate in the West Village/Downtown submarket declined 50 basis points during the past 12 months to 3.2%.

Vacancy in the Midtown West submarket improved by 170 basis points to 1.9% over the past 12 months. Since the second quarter of 2005, rental stock in the submarket has been reduced by 5 percent due to condo conversions.

Vacancy in the submarket has fallen 20 basis points this year without any stock reductions.

Outlook: With robust demand expected to persist in the near term, the vacancy rate in Manhattan is projected to fall 20 basis points this year to 2.8%, the lowest level since 2000.

Rents: Second quarter asking rents of $3,272 per month were 7.2% more than the year-earlier period, while effective rents of $3,181 per month were 7.7% more. Effective rents are on pace to finish the third quarter at $3,268 per month.

Rents are climbing at a faster pace. In the second quarter of 2005, asking rents and effective rents registered increases of 5.2% and 6.7%, respectively, from the corresponding period one year earlier.

Stout rent growth and occupancy gains have produced an 8.2% gain in property revenue in the 12 months ending in the second quarter. With occupancy at a high level, a greater portion of future revenue growth will come from rent increases.

Outlook: Owners will continue to aggressively raise rents this year, resulting in a 7.5% hike in asking rents and a 7.8% jump in effective rents to $3,412 per month and $3,323 per month, respectively.

Sales trends: After a steep rise in activity in the preceding period, sales velocity has tapered off some during the past 12 months. On a trailing 12-month basis, velocity has declined 6%, but remains at an elevated level. Sales velocity for properties selling for $10 million and more has soared 54% during the most recent 12-month period, but the median price has slipped 10% so far this year to $350,000 per unit. The median price for all transactions, though, has climbed 19% this year to $200,000 per unit.

Assets are currently pricing at cap rates ranging from 4.5% to 5.8%, with the best-quality assets in superior locations pricing at the lower end of the range or less. Last year, cap rates ranged from 4.8% to 6.0%.

Outlook: Despite recent price appreciation and cap rate compression, local assets are still likely priced less than replacement cost.

Cap rates, though, may edge up in the near term, but prices will continue to climb.

BY MITCHEL R. LABAR SENIOR VICE PRESIDENT & MANAGING DIRECTOR, MARCUS & MILLICHAP MANHATTAN OFFICE