Paragon

Prior Market Studies

APARTMENT INVESTMENT RETURNS

The following is an article gleaned from information included in the June 2004 Dupre + Scott Apartment Advisor. It describes expectations and results for apartment investors in the Seattle tri-county (King, Pierce, and Snohomish) area since 1991. The total return to an investor is derived from three sources: cash flow, mortgage amortization, and price appreciation.

Cash Flow

Buyers of apartments generally expect to make a 7% cash flow return on their initial equity in the first year of ownership. Below is a table showing anticipated and actual cash flow yield in year one of ownership for the tri-county area.

Year	Anticipated	Actual
1991	7.4%	4.6%
1992	9.6%	7.6%
1993	10.3%	9.1%
1994	8.4%	7.6%
1995	11.0%	8.4%
1996	8.7%	6.5%
1997	8.8%	6.2%
1998	9.5%	6.2%
1999	8.4%	5.7%
2000	8.2%	5.0%
2001	11.0%	7.1%
2002	12.0%	8.2%
2003	10.8%	8.8%
2004	9.7%	6.9%
Average	9.6%	7.0%

Price Appreciation

Investors believe real estate goes up in value over the long term. Many buyers project a three percent or higher annual price increase. This is based on expectations for inflation or rent increases less expense increases. Dupre + Scott's data shows that investors got a median 3.8 % compound annual increase over an average holding period of 8.9 years. Needless to say investor experience varies and this is a measure of past performance only. Their data shows that fourteen percent of sellers sold properties for less than they paid, even in some cases after holding periods or ten or more years. At the other end of the spectrum one-quarter of the sellers experienced gains of at least 6.8% compounded annually. Appreciation has been above the fourteen year trend line since 1999 with the highest value increases in the 1999 to 2001 period. Price increases were lowest in 1994 and 1995 (a period of rapidly increasing interest rates) but were still positive by an average 3.3 % and 3.4 % and a median 2.1 % and 1.5 % respectively.

Mortgage Amortization

Mortgage amortization depends on the specific loan structure. An average of around 2 % is typical. This increases over the life of a fixed rate loan. Variable rate loans have variable amortization.

Total Return

As stated initially the total return is the sum of the three sources. Over time average initial cash flow yield was 7%, median appreciation was 3.8% and mortgage amortization was 2 %. This sums to 12.8%. This compares favorably to conservative stock and bond investments.

Where To Go From Here?

Over the last few years we have experienced 40 year low interest rates, rapid rent growth in the internet bubble followed by lowered rents in its aftermath and a declining economy followed by the current trough. Economists predict an improving economy for the Puget Sound region due to a number of factors and long term due to a critical mass of "creative people". It all feels like a slow return to normal for the factors affecting apartment ownership-interest rates, job growth, and new supply.

The recent low interest rates are a mixed blessing for investors. The benefit of lower mortgage payments has been largely offset by lower rent levels caused by renters turning into home or condominium owners. Most people anticipate that interest rates will rise over the next few years thereby reducing the outflow from renter to owner. This can also trend capitalization rates higher.

In conclusion nobody has a crystal ball, but trends seem to be normalizing, interest rates will be higher, but probably not dramatically. Occupancy will improve as jobs are created. Barriers to new development will continue. Rental rates should climb moderately as vacancies decline. The total return to the apartment investor should also be in the normal range.