Capitol Hill Area Multi-Family Market Q1 2019

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H St/NoMa Submarket Overview

For a submarket that delivered more than 6,700 units and quadrupled its inventory this cycle, fundamentals are extremely resilient. Demand continues to keep up with new deliveries, thanks to the flood of renters moving to H Street and NoMa. This has kept vacancies in check, and even when vacancies do spike, strong demand results in only a handful of quarters of elevated vacancies. Another 800-plus units are expected in 2019, but based on recent trends, current performance is likely to continue.

Year-over-year rent growth last year surpassed the recent peak in 2015 and was closer to the peaks last seen in the first year of the cycle. Rents should continue to grow as the initial shock of brand new luxury apartments continues to wane. Because almost all of the inventory is new, most rent gains and investor interest comes from the first wave of supply back in the midyears of the cycle. Sales volume cleared $200 million in those years, as early investors took a chance on this emerging submarket, but was quiet the past two years.

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Capitol Hill Submarket Overview

The identity of this iconic Washington, D.C. neighborhood is slowly changing. Developers added a significant number of high-end, luxury units to the streets of Capitol Hill this cycle, expanding the apartment inventory by 25%. Developers like Foulger-Pratt and Donatelli Development are transforming entire blocks with the additional supply underway.

Demand for apartments is untested because this type of inventory has never historically been available. Most renters opt for an English basement, which helps explain why developers never built here. With the popularity of H Street to the north and Navy Yard to the south, Capitol Hill is becoming a viable option for development. But it is taking time for these recently delivered projects to stabilize. The vacancy expansion in 2017 was notable, and the two properties that delivered that year averaged just seven to eight units leased per month.

Strong fundamentals led to significant rent gains in the early years of the cycle, but recent weakness slowed that growth. The high-end market was particularly soft, as 4 & 5 Star properties underperformed relative to 3 Star properties. But that could likely be explained by the significant gap between 3 Star rents and 4 & 5 Star rents. Owners in older properties have more room to push rents, while the influx of competition in 4 & 5 Star rents hamstrings owners.

Sales volume is typically low because of the limited inventory. When properties do trade, like the handful of deals last year, pricing is reflective of the smaller apartment complexes. Institutional players being priced out of H Street, Downtown, and Southwest/Navy Yard were able to find a few opportunities earlier this cycle. And with even more projects delivering in the coming years, Capitol Hill might remain in their focus.

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Southwest/Navy Yard Submarket Overview

Vacancies were down considerably last year, as strong absorption and a lull in supply allowed new deliveries to fill. Over the cycle, vacancies haven’t completely unraveled, remarkable for a submarket that added more than 6,000 high-end units in nine years. Occupancies were even above the three-year average at the end of 2018 thanks to record net absorption. Landlords continue to benefit from a growing base of young, wealthy renters willing to pay higher rents for better access to neighborhood amenities.

Another substantial wave of projects should deliver in the coming years, again raising questions of over-supply. But based on this submarket’s recent past, new supply has done little to slow rent gains and the sale of the Onyx early last year is the first trade in more than three years, signifying optimism not just for developers, but also for other investors.

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