What do you call it when building permits for multi-family units rise almost 22% in a year when absorption for unsubsidized rental units slows by 21%? When the vacancy rate for apartments edges from 5.5% to 5.9%, but the loan-to-value ratio for mortgages on apartment complexes shifts from 66% to 71%? When pension funds again raise their stake in the multi-family sector by buying Class A properties at cap rates of 9% or less, driving REITs toward older, smaller properties, second-tier markets, or new development in search of yields? We call these clear signs of a peaking property type.

While 1995 housing construction figures will show only modest aggregate change, the statistical totals will mask the sharp acceleration of multi-family activity. Construction of apartment complexes comprised of five or more units is estimated at 272,300 units for 1995, up 21.6% from 1994. The Commerce Department's Value of New Construction Put in Place indicates an increase of 24% in the inflation-adjusted dollar amount of multi-family development activity. Some will argue, defensively, that such figures - and any building volumes reasonably forecast for the remainder of the '90s - are less than 50% of the '80s cycle. True, but irrelevant. The disastrous, tax-motivated boom of the last decade is no benchmark of market needs. Present volume is too high for many markets and, if sustained, will limit this sector's investment returns between 1996 and 2000.

Occupancy trends bear out this seemingly harsh judgment. The sample of 60 MSAs in Landauer's apartment Market Quality Ratings rose 0.4% in total vacancy in the past 12 months. The Census Bureau's national rental vacancy survey also shows a year-over-year vacancy increase from 7.4% to 7.7%, a bit higher than Landauer's investment-grade property sample. Census Bureau figures for the Second Quarter 1995 indicate only 67% of units brought to market were absorbed in 90 days, compared with 82% in 1994.

Nevertheless, there seems to be no lack of investors. Lured by double-digit total returns in 1994 and 1995 pension funds added 34 apartment investments, or $700 million as measured by appraised value, to the NCREIF property sample. Anecdotal evidence suggests that some markets were watch-listed by pension funds in the Third Quarter, after a pullback in total return of 131 basis points in the NCREIF Apartment Index.

REITs executed 84 apartment deals in the first half of 1995, involving approximately 40,000 units. The 69 transactions where price was reported exceeded $1.2 billion in cited consideration. Tellingly, 25% of the acquisitions were development deals, bespeaking a higher-risk, higher-yield strategy going forward. It's a gambler's move, prompted by declining share prices and the shrinkage of investment spreads. As of the end of the Third Quarter 1995, the 39 residential REITs that make up 23% of this industry, had generated a meager 7.8% annual return.

Apartments are popular with small investors and mortgage conditions are supporting more transactions by individuals and limited partnerships. The life companies committed nearly $1.3 billion in loans in the Second Quarter 1995, bringing the four quarter total to $3.4 billion. Terms were reasonably disciplined: 8.1% interest, 1.46 times debt service coverage, on a typical ten year loan with 71% loan-to-value ratio. Financing should pose no problem this year.

In previous Forecasts, we predicted improving rental apartment occupancies (1990), the return of investment capital (1992), and a sharp rise in investor return (1993). Last year, though, we noted the timeliness of realizing capital gains through sale or refinancing. This is still a good strategy for 1996. Upward pressure on values will ease in the next two to three years, as more product is delivered-and vacancies increase. Residential assets are in good shape now, but for most markets we expect fundamentals to soften.

Landauer's Apartment Consolidated Indicators Scale (ACIS) combines, on a scale of zero to 100, the performance of multi-family markets as measured by occupancy, rents, affordability, renter demand and new construction. We present our ACIS rankings for 35 key markets, while showing our Market Quality Ratings for the complete set of MSAs in the accompanying map.

A gain this year, the top markets in the nation A are disproportionately in the West. The beginning of California's economic recovery has seen a resumption of job growth and has stanched the outflow of population. In the Bay Area, especially, there has been a notable tightening in occupancy to about 97% in San Francisco, Oakland and San Jose. All three achieve very good MQR 2 ratings. These are among the most expensive rental markets in the nation, and rents are advancing 3% or more per year.

Southern California is a different story, although apartment markets are more than holding their own. Los Angeles, San Diego and Riverside/San Bernardino have suffered substantial declines in single-family home prices. But multi-family developments have stepped into the breach, accommodating displaced demand. Comparable unit rents reportedly rose nearly 7% in the LA area since 1994. Apartment construction is at a standstill, indicating firmness in occupancy this year.

Las Vegas, the nation's #1 apartment market in our rankings a year ago, slipped to 10th place on this year's list, though its quality rating is still a good MQR3. Vacancy has edged upward, and may rise further as multi-family permit activity for the first half of 1995 was a vigorous 3,944 units. It remains to be seen whether the frenetic growth pace of the early '90s can be sustained, but given the lack of local economic diversification, we think a more conservative outlook is now justified.

Likewise, Salt Lake City falls a step to MQR4.This market experienced double-digit rental increases in 1995, but it will be hard to match this performance now that vacancies are trending above 5%. Over 4,700 apartment units were permitted in the first half of 1995, in a market where the total rental stock is only 104,200 units. Salt Lake City is still a promising investment venue, but high performance yields will be harder to achieve.

A construction boom has returned to the Valley of the Sun. The Phoenix metropolitan area permitted 5,300 multi-family units in the first six months of 1995, double the same period a year ago. Rents shot up 9% over the year, but further growth could be compromised by a softening in occupancy. We find this market at a less-than-desirable MQR5, recognizing its considerable volatility, very affordable single-family housing stock, and the prospects for sustained growth in Arizona's chief competitors, California and Texas.

Portland and Seattle are also among the most active apartment development markets in the nation, but their multi-family production is more in line with long-term demand. Each of these markets should add 27,000 renter households in the coming five years. Current development volumes match this demand growth quite well, and these MSAs should sustain good market quality barring the return of excessively speculative building.

The fast growing demography of Florida has not translated into favorable ACIS rankings. Single-family subdivisions have exploded. Infrastructure issues are critical, though, with overcrowding on the highways, in the schools and on supermarket checkout lines beginning to generate negative comment. Miami ranked fourth in the nation in multi-family building permits through June 1995, at a very appropriate volume of 4,546 units for the MSA. Apartment vacancies fell 1.8% in Dade County, in contrast to reduced occupancy levels in Ft. Lauderdale and West Palm Beach. Tampa has seen a multi-family development surge drop occupancy 92%. Rents grew about 3.5% last year, but are high by north Florida standards and must compete with a median single-family home price of $77,300.

Texas finds its apartment markets promising. Dallas/Fort Worth led the nation in multi-family building in 1995, yet both sides of the Metroplex saw occupancy rates rise and rents increase. In 1996 we may see a temporary softening as building volumes are digested. The Dallas economy is enjoying more steady growth in the late '90s than has been the case in the past 15 years, and apartment investments are benefiting.

Houston still has a steep climb back. A substantial employment gain of 50,000 jobs in 1995 didn't produce anything in the way of improved apartment occupancy or higher rents, while vacancies still stand at 8%. We termed Houston a "wild card" last year, and find its rating upgraded to MQR4 this year, based upon a forecasted growth in renter households.

Atlanta also earns an MQR4 rating, and is a particular target for REITs. There is an interesting set of housing trends visible in this metro market. High-end gated communities are very popular. But affordable housing, both in the ownership and rental categories, is part of the attraction for major corporations moving to Atlanta. We are looking for residential infill to be Atlanta's next major story.

Apartment conditions still appear solid in Chicago, Minneapolis/ St. Paul and Indianapolis. Construction activity is constrained compared with the Sunbelt and the Pacific Northwest. Rents are rising in many markets, though they remain low from an investment perspective in St. Louis and Kansas City. The likelihood of a decelerating Midwest economy, which has enjoyed an excellent rebound from the early '90s, accounts for the region's midrange MQRs of 4 and 5.

The Atlantic Seaboard is finally looking up. Modest supply additions, and a post-recession stabilization of the Northeast are producing vacancy declines from Boston through Washington, D.C. In New York, an extended lull has ended and luxury builders are again eying the high-rise market. The nation's capital, with its dynamic employment market, occupancy over 96%, and the addition of about 3,000 units in the coming year, is a favorite of institutions. Only Philadelphia, with vacancies at 11% and rising, is currently shut out of the apartment sector gains.

All in all, then, we can repeat our diagnosis of a year ago. Investors who moved into the multi-family sector five years ago should be extremely pleased with their foresight. There is now a window of market stability to reap the gains. One of the characteristics of a peak, though, is the downslope which ensues. Don't wait too long before executing those exit strategies.