Liberal pundits and city managers have been concerned over the cost of growth. They rightfully claim that urban growth places heavy demands on urban infrastructure and they have trouble financing that growth through the existing tax base. This is especially true in the current environment of tax limitations and lowered tax receipts caused by the current recession. Therefore, they have instituted a series of Systems Development Charges (SDCs) to ease their pain and have used this as an additional source of tax revenues to fund projects for their growing cities.

System development charges include:

1. Roads
2. Water
3. Sewer
4. Storm water
5. Fire protection
6. Libraries
7. Parks and recreation facilities
8. Schools

Those of you who have played the Sim City game will realize that cities cannot grow without any of the above items, and that they cost money to develop.

The challenge for developers is to find a piece of land that is inexpensive enough that, once an apartment building hits the market, it can be priced at a rent that tenants can afford. As the costs of construction, land, and the SDCs continue to rise, the rents will need to increase in order for a developer to make a profit.

Due to the current recession, we may see taxes increase at the city, county, state, and federal level. In order to deliver a new product to the market, developers are forced to increase rents to make the properties cash flow. (If projects don’t cash flow, banks will not finance them.) Therein lies the challenge to our future.

In many market places you can purchase older apartment properties in great locations and spend $5,000 to $10,000 a unit to renovate them. Lets assume you buy a 50-unit property for $40,000 per unit and spend $10,000 per unit renovating them to a like-new condition, which leaves you with a cost of $50,000 a unit. If new construction costs over $65,000 per unit to build, and the cost of land and the SDCs keep escalating—as is true in Oregon—then you have a great investment because the rents keep moving up. The keys to success in doing this are finding the right location and understanding the local building codes for your community. With some buildings, no matter how much money you spend to renovate, either you will never get it to be earthquake proof, or the asbestos removal could cost you more than the renovation. This means that it is important to do a thorough job of due diligence before closing the deal.

You also need to keep rental rates in mind and have a target rent. Those that rent apartments are often on a fixed income or have just started in the work force. According to the United States Census Department, roughly 30% of Americans live in multifamily housing of one kind or another: apartments, student housing, senior housing, etc. As our population keeps growing, there will be a continual need for apartment housing. There will also be a need for condominiums, and some developers will be able to take an apartment off line and convert it to a condominium project to make even more of a profit per unit.

In the Portland, Oregon marketplace we have seen a decrease in apartment construction because job growth is down (unemployment here is the highest in the nation at 8%) and demand for units is down. Vacancy rates hover between six and 10 percent depending on the sub-market. Market concessions are rampant. But this is a short-term market adjustment, and once the economy rebounds, the rents will stabilize. With the low interest rates it makes sense to buy a property to renovate.

Newly constructed units will force the rent levels even higher than they are today, which means there is a niche in the market for a developer to renovate a building to “almost new” condition.

Apartment dwellers typically cannot afford to buy a house and earn less than $13.00 per hour. A quick check of entry-level jobs on the Oregon Employment department web site reveals that the average employee earns from $9.00 to $12.000 per hour. This means that most can afford monthly rent between $500 and $700.

The increase in population will increase demand for housing over the next few years, but developers will struggle to respond to the need because of the low wages, the high price of development, and the high cost of land. As wages continue to inch up, it will be easier to make new construction pencil out. This means that in the short term, renovation is the name of the game for apartment developers.