Ed: This is the third in Michael Luis’s series on Seattle’s high housing prices.
The first two articles are here, and here. Editor’s Note: The story was posted without the author’s concluding paragraphs. They are now appended to the end of the story. Apologies to readers.
In an urban area, the great majority of low-cost housing consists of apartments in older buildings in less fashionable neighborhoods with few amenities and upgrades. Think of a typical walk-up building with surface parking, no elevators or corridors, laminate countertops, basic appliances, vinyl and cheap carpet on the floor, and maybe even a popcorn ceiling.
Not a very attractive thought for those who can afford better, but bear in mind that the region is home to tens of thousands of residents of modest means who cannot get access to the limited supply of subsidized housing and will want to live in such places. Despite all the efforts to produce more subsidized housing, the great majority of “affordable” housing will be found in older apartments that started out middle market and have been allowed to filter down. The problem is that we have stopped producing the kinds of buildings that will, over time, add to that stock of inexpensive apartments. Meanwhile, fewer of the existing candidates can be counted on to become affordable.
Apartments are a commodity, and on one level, rents should be a simple function of supply and demand, as mediated by vacancy rates. When vacancy rates are high, renters have the upper hand, and when such rates are low, building owners have the upper hand. But, of course, it isn’t that simple.
In this article, third of our housing-cost series, we look at factors that have been keeping apartment prices high in the Seattle area.
Factor I: Lags between demand and supply changes
Developing an apartment building is an act of faith that enough new renters will be coming into the market when the building opens. It takes a minimum of several years to get a building designed, permitted, and built, and a lot can happen in a local economy during that time to affect demand.
No one could have anticipated the massive hiring by technology firms starting in 2020. Vacancy rates plunged from about 5.5 percent pre-pandemic to 3.6 percent by September 2021. Rents shot up accordingly, increasing 17 percent from pre-pandemic to their peak in 2022. Projects that were under construction opened in this timeframe, but it was impossible to get more apartments on the market in response to the big jump in demand..
In economic terms, the supply of apartments is far less elastic than the demand for them, so quick increases in demand result in large price increases. Unfortunately for renters, this process does not always work in reverse.
Factor II: What goes up does not always come down
Apartment rents tend to exhibit a strong ratchet effect: they go up as demand outstrips supply, but they don’t always come down right away when supply outstrips demand. Landlords just hate to lower rents if they can possibly help it.
In a stable building, most apartments are occupied by people with leases that lock in their rent. Imagine that you signed a lease for $1,800 per month, and a few months later, your neighbor gets a lease for $1,500. You would not be very happy, and you will press the landlord for lower rent now, or certainly when your lease is up. So will everyone else in the building, resulting in chaos with each lease renewal. This is a situation that landlords would really like to avoid.
The preferred method of filling apartments during a glut is to offer “incentives.” This might be a month or two of free rent, a break on parking fees, or a free toaster. That means the lease itself will be signed with something close to the rent being paid by existing tenants. The new tenant will get an effective rent break for the first year and existing tenants will be less peeved. The cost of incentives, or even longer vacancies, can be much lower than the cost of renegotiating rents throughout a building or seeing angry tenants move out.
In the Seattle market, vacancy rates bottomed out at 3.6 percent in September 2021 and have climbed steadily since then, reaching over 6 percent in March 2023. Rents kept climbing, however, and did not peak until August 2022. Since then rents have fallen only about 7 percent.
But those are averages, and how the rent and incentive game is played in individual buildings depends on the objectives and constraints of the building owner.
Factor III: Differing investor objectives
Consider that there are different types of investors that own apartment buildings, each with different objectives that will determine their strategy for managing rents and vacancies.
Stability owners. A small building might be owned by a retiree who has owned it for decades, holding little or no debt, and relying on a stable group of tenants for regular rental income. These owners might keep rents especially low to preserve stability, and they can afford to do so since their costs are low. A smaller building might also be owned by a wealthier local investor looking for diversity in their portfolio, and thinking not just of income but also of property appreciation. This investor may also trade lower rents for stability.
Investment owners. Larger complexes tend to be owned by institutional investors who need to park cash in places with good long term prospects. Real Estate Investment Trusts (REITs) are investment vehicles that bundle portfolios of properties. Pension funds gather massive amounts of cash and need to generate income over long time horizons. University endowments need diverse portfolios. Because these investors usually operate nationwide or globally, and have long time horizons, they may be less concerned with downturns in individual markets and consequently willing to hold the line on rents and accept higher vacancies.
The Puget Sound area market, with its strong underlying economy, has been a hot one for institutional investors for years. This means that developers can find buyers for their new buildings, and, thereby, find investors and lenders for construction. Developers will have less worry about the state of the market the moment they finish with construction.
At the same time, national investors will also be attracted to older complexes, knowing that they can renovate them and get a good long term payback. Local investors are getting frozen out. Mid-market buildings, which might otherwise filter down in the market, maintain high rents. Institutional investors with deep pockets can keep older buildings from ever becoming affordable.
And, as mid-market buildings get absorbed into national portfolios, we are not building these kinds of complexes any more.
Editor’s Note: The following story on apartment costs was posted without the author’s concluding paragraphs. They are now appended to the end of the story. Apologies to readers.
Factor IV: The action is in urban centers, and they are expensive
A drive on the arterials running through Seattle’s suburbs will reveal thousands of apartments in large, walk-up complexes with surface parking, built in the 1970s and 1980s, and aimed at the middle market. Land was inexpensive and walk-up construction is among the least expensive forms of housing. All that changed starting with plans developed under the state Growth Management Act (GMA).
GMA planning emphasized the development of urban centers that would be less auto dependent and have a greater integration of residential and commercial uses. The old two- and three-story walk-up style buildings, with their large footprints and surface parking, don’t fit this urban-center model. Developers gradually moved away from them and into urban-center buildings. For example, Woodland Commons opened in 1978 in Bellevue with 302 units on 15 acres, and the Blu in Olde Bellevue, opened in 2019 with 135 units on two thirds of an acre, a tenfold increase in density.
The problem is that urban center housing is expensive to build. Most urban center buildings are five stories of wood frame over a concrete podium, with underground parking. Structured parking alone can cost more than $50,000 per space, and even with wood frame, other costs are higher. These apartment buildings have corridors, fire exits, elevators, lobbies, and other non-revenue generating features that walk-ups don’t have. Other cost factors: urban center land is expensive and construction in a tight setting is complicated. Also, take all the costs of five-over-one construction and blow them up for concrete high-rise.
In the 1990s, urban-center-style apartments were viable only in Seattle and some parts of the Eastside. But they have spread throughout the region and are being built in most of the designated urban centers.
Factor V: The pipeline of affordability has been shut off
The region has been on an apartment-building tear. Between 2010 and 2022, King County added 124,000 apartment units, 80,000 of which were in Seattle. But the overwhelming majority of these units were aimed at the influx of young adults who have moved to the region to work in technology industries, where high wages can support high rents.
The shift from locally owned, walk-up-tyle apartments to institutionally owned urban-center buildings has effectively shut off the pipeline of future affordability. Expensive midrise and high-rise buildings owned by deep-pocketed investors will never filter down to the affordable level, and some of the remaining walk-ups will be renovated or replaced, preventing them from filtering down. Meanwhile, the population in need of affordable housing keeps growing. Government subsidies will never come close to filling the gap. “Affordable” units built by non-profits come in at $400,000 or more per unit and take years to build.
The remedy for this is not obvious. We might start by admitting that large numbers of low and moderate income people would happily live in a less central area, park in a carport, and walk up some stairs in the rain in exchange for rent they can afford.