Jansen Multifamily Team Blog

We’ve all been exposed to the fable Chicken Little in one form or another.  Whether through books as a child or DVDs as a parent, the basic premise of the story is that, through misinterpretation of a specific event, or series of events, Chicken Little incites mass hysteria throughout his kingdom on the mistaken belief that a cataclysm of Biblical proportions was imminent.  The moral of the story, as we have interpreted it, is that one shouldn’t believe everything one hears.   However, what happens to the moral of the story if Chicken Little had been right?  What if his prognostications of doom were proven accurate and nobody listened to him?  Fiscally conservative economist Peter Schiff was considered a “Chicken Little” by most financial experts and political pundits; Schiff came under fire and became the subject of widespread ridicule in 2006 for comparing the American economy to the Titanic and himself to a lifeboat, trying to convince people to leave the “sinking ship.”  Well, this time “Chicken Little” got it right.  The subprime mortgage market did melt down.  The housing bubble did burst.  The United States’ economy did implode.  The blue-sky outlook of the anti-Schiff pundits paralleled that of many apartment professionals, be they investors, managers, brokers or lenders; from 2004-2008, historical value trends in the Puget Sound Apartment market were broadly ignored, resulting in an “Appreciation Anomaly” and, eventually, a “falling sky.” 

According to data published in the August 2009 Apartment Advisor, published by Dupre & Scott Apartment Advisors, Puget Sound apartment price per unit rose an average of 6.49% compounded annually between 1980 and 2003.  The Jansen Multifamily Team has dubbed these twenty-four discount periods “pre-Anomaly.”   In 1980, the average price per unit for a 20+ unit apartment building in the Puget Sound Region was approximately $25,000.  This figure grew to $65,000 per unit by year-end 2003.  Rents during the pre-Anomaly years grew in-line with price per unit appreciation, from $300 to $800, or roughly 7% compounded annually.  This makes sense from a value investing standpoint, as a property would have to generate more income to justify a higher price per unit.  

The Appreciation Anomaly first reared its head in 2004, with the Tri-County (Pierce, King, and Snohomish) average price per unit jumping 12% from 2003 to $75,000, while rents remained relatively flat.  In fact, from 2004 to 2008, the average annual Tri-County price per unit appreciation rate was approximately 12% (price peaked in 2008 at $120,000, a $55,000 per unit increase since year-end 2003), while rents grew at an average annual pace of 4% (an increase of $150 from year-end 2003 to just $950 per month).  This cavernous spread between rent growth and price per unit appreciation should have been a red flag to apartment investors that prices were inflated and the “sky would soon fall.”  The Puget Sound apartment market was simply too optimistic to realize that it was on the same sinking ship as the rest of the economy.

Continuing the trend line established by the aforementioned pre-Anomaly price per unit annual appreciation data into the Appreciation Anomaly years tells us that Puget Sound apartments were overvalued by 34.84% as of year-end 2008.  As stated above, prices had risen to $120,000 per door by 2008, while the pre-Anomaly appreciation rate dictates that the average price per unit should have been $88,994.  It is not until 2013 that the pre-Anomaly price per unit appreciation rate reaches apartment values $120,000 per door.

The rapid decline of national and local apartment values, however, should not incite mass hysteria; rather, market movement of any kind should be viewed as an opportunity to make money.  True, values may not reach their 2008 peak for another three years.  That being said, the average 2009 Tri-County price per unit is approximately $105,000, which is only 10.8% higher than the 2009 value indicated by the pre-Anomaly trend line.  Another price decrease of only 4.05% will cause actual price per unit to fall in line with the pre-Anomaly trends by year end 2010.  If Peter Schiff followed the Puget Sound apartment market, we like to think that his message would be one of cautious optimism:

Opportunity is presenting itself; the market is near bottom and now is the time to buy or sell and reset your investment basis.  Government spending is out of control and inflation is imminent.  What better to own than an apartment building during years of hyper inflation?  After a couple of flat years, hold onto your hats…