Despite pandemic disruptions, optimism prevails in the multi-family market | Allen Matkins

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[co-author: Kitty Wallace]

Despite the move to the suburbs and falling rents, panellists in the California Commercial Real Estate Survey by Allen Matkins / UCLA Anderson Forecast are optimistic about the next three years in the apartment building sector. Rental rates are expected to rise faster than inflation across the board and vacancy rates are expected to decline through 2024. This optimism is caused both by the reopening of municipal facilities, attracting people back to city apartments, and by the return to the office at the beginning of the year.

Apartment building leaders Kitty Wallace of Colliers International and John Condas of Allen Matkins discuss what lies ahead for this sector of California’s commercial real estate market.

1. DESPITE A SECTION OF THE POPULATION MOVING INTO SUBDIVISION COMMUNITIES, A REDUCED RENTAL PRICE AND HIGH BUILDING COSTS, MULTI-FAMILY DEVELOPERS AND INVESTORS ARE STILL AT LEAST THREE YEARS IN THIS SECTOR. WHY THIS?

Wallace: Historically, California has been a top 10 market and although we have experienced unfortunate circumstances due to the pandemic, people remain hopeful. Investors, tenants and landlords alike think and plan strategically ahead, based on the historical market and the expected trends and future returns. At some point the COVID restrictions will be lifted. It is imperative that multi-family developers and investors take calculated steps today.

Several factors play a significant role in the development of this sector – many of which are high barriers to entry, diverse employment relationships, entertainment, weather, and a tenant base that has a high tolerance for rising rents. With this in mind, people are ready to invest and are predicting outperformance in value based on California’s track record. While most of California is forecast to have flat net growth within the next year or two, they are optimistic about the historic market increases from rent increases over the coming years. What we will see after the economy is fully reopened is a compelling place to “park money and profit.” With the diversity that we have in our sectors of employment, our population will experience a significant boom. Not only does this provide a nice opportunity for investors and developers to jump in, but it also highlights several trends that we are observing. The wood prices have risen. Labor costs are also rising. If you are looking to build real estate it makes sense to build in areas where you can get the best rents for your fixed costs, which increases the need to invest those development funds in high-end markets now.

Condas: Much expert data supports the claim that despite these factors above, California is still far behind in terms of residential unit production. Our customers agree with this point of view; job creation has far outstripped the production of new housing units. We have seen a flurry of new activity, which appears to be partly driven by the California reopening on June 15th. Our customers believe that the worst effects of COVID are behind us and as we return to a more normal situation the previous catching up to do, pre-COVID, will return.

2. WHAT ADDITIONAL OR NEW OFFERS ARE DEVELOPERS FOR YOUR PROPERTIES OR OTHER COVID-RELATIVE, IF A SIGNIFICANT MAJORITY OF SURVEILLANCE IN THE NEXT YEARS, PARTICULARLY IN SOUTHERN CALIFORNIA?

Wallace: We see a continuation and further development of common trends such as automation and the installation of various types of technology. From Nest thermostats to keyless entry to expanding Amazon lockers, developers are taking giant strides to ensure that their tenants are living in state-of-the-art housing units. There are now beneficial additions like Stockwell, a popular smart store that offers a full range of services, including lunch on the go or everyday retail needs. Improved Wi-Fi options are now mandatory. The inclusion of such surcharges not only offers the tenant an advantage, but also brings the landlord additional income.

Yoga studios and fitness studios have expanded dramatically and are sometimes relocated outside. We recognize the value of good health and have learned from the COVID pandemic that in many cases, outdoor exercise in California is not only doable, but preferable. Often we are limited in space. In some cases, developers are reinventing approaches by looking for other health and wellness options, including pickleball courts and lap pools. The use of outdoor areas has increased sharply, especially because these areas are difficult to get in the main metropolitan areas. In addition to fitness centers with play areas with bocce ball or cornhole and cozy gardens with herbs and fruit trees, tenants want user-friendly offers. COVID-19 encourages developers to work with a greater focus on the tenant and their wellbeing. On the manufacturing front, new elevators include COVID filtering options to keep our communities safer, with developers also trying to improve airflow in corridors and public areas.

Condas: Our customers are integrating amenities and changes to existing amenities to address COVID-related concerns. These amenities include more outdoor spaces that use Zoom to hold virtual cocktail tastings or cooking classes, reservable meditation rooms, and detached exercise equipment. You will implement cleaning and disinfection practices in on-site fitness centers and co-working spaces. Lounges, clubhouses and other areas are now being repurposed for homeschooling and remote work. Our customers are investing in more moveable furniture that allows them to place seating, dining, and study / work areas six or more meters apart. Partition walls are installed in co-working spaces so that tenants feel safe. Multi-bedroom units are now being advertised as one-bedroom apartments with home offices or distance learning rooms, rather than traditional marketing for 2-bedroom or 3-bedroom apartments. One bedroom apartments offer a creative space / work area where residents can comfortably earn a living from home, as a significant proportion of people now work from home.

3. WHERE ARE THE NEXT “HOT SPOTS” FOR MULTI-FAMILY DEVELOPMENT, IF NOT IN THE LARGE MARKETS THAT ARE ALREADY SATISFIED WITH HIGH-RISES? WILL PEOPLE CONTINUE LOOKING FOR LESS DENSITY LOCATIONS?

Wallace: While the hotspots will continue to be the regions with high barriers to entry, the Inland Empire will flourish due to the port and logistics market as well as increasing warehouse development. Institutional customers are now investing their capital in this striking development concept. There is tremendous population growth in the Inland Empire due to the constant growth of pensions. Over the past 11 years they have seen steady rental growth of 3%. In the past, only hundreds of new units were launched in this market. It is now expected that we will have almost 2,000 units built in the coming year. Though many rental markets in the state have been hit by the pandemic, San Diego was another hotspot, closely followed by Orange County and Sacramento markets, as those markets were more lenient with mask requirements, school openings and return to business.

Some renters and investors are flocking to areas outside of the state such as Montana, Idaho, Colorado, Arizona, or even Utah. Some because of the cost of housing, but many because of the restrictions in the state of California. Since some have left, many return because there are better options here; the prospects for growth are better. It is certainly a changing of the guard now with our tenant and investor demographics, but we will see investors tap their capital based on the upside potential. Our stores have a steady vacancy rate of 5%, which means that our rents are increasing. It is set to skyrocket over the next three years. Many rental markets are tense at the moment, so we’re seeing an unrelenting interest in these bags.

Condas: Our clients are particularly optimistic when it comes to developing multi-family projects in less densely populated suburbs like the Inland Empire. One reason the Inland Empire is so appealing to our customers is because of the tremendous job growth that has taken place there, driven by the number of warehouses and logistics facilities that have been developed. Land prices are also lower there than in more urbanized areas. These projects are being developed at a lower density than in urban areas, which allows more cost-effective construction methods to be used. We have also seen a lot of new development activity in Orange County outside of the coastal areas. Our customers also understand that the regulatory pendulum has swung towards a greater focus on housing due to the adoption of SB 330 by California legislators and the extremely high Regional Housing Requirement Allocations (RHNA) assigned to local governments by various government associations. State law requires cities and counties to demonstrate that these local governments have sufficient land with adequate density to meet their RHNA obligations. These high RHNA commitments will force local governments to zoning or reallocating properties to meet their respective RHNA commitments, making the claims process safer and slightly less risky.


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