Multifamily Experts Weigh in on California Market Dynamics and Investment Strategies

In a lively discussion among multifamily industry leaders at the latest GlobeSt multifamily conference, a range of topics were covered—from the current state of the California market to emerging operational trends and investment preferences across the multifamily sector.

Key Topics

• Proposition 33 and its potential impact on the market.
• The use of technology, such as AI and automation, to improve operational efficiency and reduce costs.
• Opportunities for converting assets, such as office or hotel properties, into multifamily units or updating units for additional revenue.
• The latest trends and developments in the multifamily market, particularly in California and other key markets.

Economic Overview

Top economists continue to forecast a soft landing for the economy, with GDP expected to show modest growth in 2025. While the pace of job growth is slowing, the labor market is still adding new jobs, although preliminary Bureau of Labor Statistics revisions indicate 818,000 fewer jobs than previously reported, with updates extending into 2025. The labor shortage is easing, and while wage growth remains elevated, it is trending lower. The Fed views this easing as a positive development, as a cooling labor market poses some risks but supports the possibility of a soft landing.

Inflation is also trending lower, with the Core PCE holding 50 basis points above the Fed’s 2% target. The unexpected 50 bps cut in September surprised the media, although treasury markets had already priced this in. A 77.3% likelihood exists for an additional 50 bps cut by year-end. Following the Fed meeting, treasury yields dropped significantly, with 5-year and 10-year rates down about 100 basis points from their peak. Projections from the Fed Dot Plot, Wall Street, and the SOFR curve indicate that long-run interest rates could normalize near 3.25% by the end of 2025.

The Mortgage Bankers Association predicts a rise in lending in the second half of 2024, particularly for multifamily loans, as the spread between 10-year treasury yields and multifamily cap rates widens, potentially facilitating increased deal flow.

One panelist at the conference noted that the United States is seen as a haven for capital and discusses the flow of capital to the county, outside of California, New York, and Boston, particularly in multifamily, industrial, and data centers.

Population migration has hit a 50-year low, driven by high interest rates and a cooling job market, resulting in fewer Americans relocating to new homes or cities. Texas and Florida have seen declines as top destination states, with the Carolinas and Tennessee rising in popularity. Additionally, the pace of move-outs from major cities like San Francisco, Los Angeles, and New York has slowed significantly, as many who wanted to relocate have already done so over the past four years.

Multifamily Market Dynamics

With the economic overview covered, panelists entered discussions surrounding national multifamily trends. The U.S. multifamily market is experiencing a robust rebound, with 152,000 units absorbed in Q3 2024, bringing year-to-date demand to 450,000 units—the highest since 2021. This demand surge is fueled by stable economic growth and a slowdown in renter households transitioning to homeownership. Although supply additions have outpaced demand for 11 quarters, the gap has narrowed significantly, holding vacancies steady at 7.8% for the first time in nearly three years.

Projections indicate 611,000 completions for the year, the highest since the mid-1980s, but supply is expected to decline towards the end of the year. The construction market is currently experiencing modern lows for total units in the pipeline; however, Q3 and Q4 2024 are expected to break records regarding units delivered, particularly in markets that were hottest in 2022, like DFW and Jacksonville. If absorption rates maintain their current strength, the market may balance by year-end, potentially leading to stabilization and rent growth approaching 2.0%.

With current construction levels at a low, deliveries will significantly decrease in 2025. “The challenge today with development is the math doesn’t work anymore. Two to three years ago, you could build a project for $80 million because you built it at a 6% cap rate and sold at a 3% to 4% cap rate. Now what’s happened is costs have skyrocketed,” said a panelist.

Not only the cost to develop, but also insurance and operational costs have increased dramatically. For example, property insurance has risen sharply, particularly in Gulf markets like Tampa and Houston, where per-unit insurance prices have doubled since 2022. As the 2024 hurricane season proves more impactful, Florida landlords are expected to face further challenges, with insurance costs rising from 4% to 8% of operating expenses in just five years. One panelist stated that insurance was previously 35 cents per square foot, and it’s increased to 85 centers per square foot, with higher capital expenses for older buildings.

Rent growth has stabilized, with overall increases remaining in the 1.0% range but beginning to climb to 1.3% in Q3. High-end properties see the weakest rent growth at 0.3%, while Class B and C properties outperform with growth rates of 1.7% and 2.2%, respectively. Regional variations are notable, with the Midwest and Northeast showing favorable rent growth due to moderate supply additions, while the Sunbelt struggles with negative year-over-year growth.

Transaction volume is down across the county. According to David Harrington, “If you look at the investment activity from across the county, it is uniform in that that focus is on the stabilized, newer construction assets, where you don’t have that risk of the value-add with some of the unknowns that exist today.”

A panelist said that “it’s one of the most amazing times to buy apartments today, given the lack of new supply, tight markets, and the fact that cap rates have gone up. You can buy deals at big discounts to replacement cost.”

Harrington also noted that “if you go back to last year, we were somewhere around 70% down from an already down year last year. Now, transaction volumes have come back, and we are up… I expect that to further accelerate as we end up this year through the fourth quarter.”

This optimism underscores the factors influencing buyer interest, even amid pressures on cost of capital following the Fed’s rate cut. Overall, the multifamily sector is navigating complex dynamics shaped by economic conditions and shifting investor preferences.

Proposition 33: Impacts and Challenges Facing California’s Housing Market

As California grapples with a housing crisis, Proposition 33 has emerged as a focal point of contention among investors, developers, and policymakers. The proposition aims to repeal certain rent control measures, which proponents argue will invigorate the housing market for renters, while critics warn it could exacerbate existing challenges in an already fragile environment.

The panelists highlight a cautious atmosphere among institutional investors, who remain hesitant due to the uncertainty around it passing. “We’ve faced this twice already, and it’s the uncertainty that causes hesitations in investors interested in deals,” noted Harrington. Many are contemplating whether to make offers contingent upon the passage of Proposition 33, illustrating the deep concern about its potential implications on multifamily in Los Angeles.

Conversely, smaller investors appear more confident, believing Proposition 33 is unlikely to pass, which could open up increased investment opportunities. This sentiment reflects a broader belief that once the proposition fails, property values may experience an overnight increase.

Development Challenges

The conversation around Proposition 33 also spotlighted the challenges of new development in California. Experts emphasized the necessity for special incentives and tax credits to make projects financially viable. One speaker pointed out that the supply dwindling, properties become obsolete, ultimately leading to a decline in the quality of life for residents. “With no development and no market-driven pressure, rent control doesn’t work for the better; it often makes the situation worse,” they argued.

California’s housing crisis is compounded by a high cost of living, alongside additional hurdles such as the recently implemented measure ULA and mansion tax in Los Angeles, which further discourages new development. This reality creates a cycle where high costs deter construction, leading to insufficient supply and ultimately driving rents higher.

From a developer’s standpoint, Proposition 33 raises significant concerns. A panelist highlighted how similar initiatives in other states, like New York, with the 421A Tax Exemption initiative, have facilitated the introduction of affordable housing. “We’re bringing 830 units to market, 30% of which are affordable, despite a challenging economic environment. We need interventions that focus on creating new housing rather than exacerbating legacy problems,” they explained.

Furthermore, transitioning outdated office buildings into new residential or mixed-use properties underscores the necessity for incentives to facilitate these conversions. Developers content that tax credits and other supports are essential to making such projects financially feasible.

Broader Market Implications

One panelist expressed a cautious optimism about California’s market conditions. While they noted factors such as a low new supply and attractive cap rates, they also raised alarms about Proposition 33’s potential impact. “Investments could drop by 15% to 20% statewide and even up to 40% in Los Angeles,” they warned, pointing to analogous situations in cities like St. Paul and Santa Ana, where similar policies have negatively affected the multifamily market.

Conclusion on Prop 33

As proposition 33 looms on the horizon, the proposition could either pave the way for investments or deepen the existing crisis. With challenges mounting and the need for innovative solutions, the future of California’s housing market hands in the balance.

Trends in the Marketplace: Operational Efficiencies and Technology Adoption

In the face of the challenges mentioned above, the panel discussion ends on what’s next for multifamily. How are owners/operators maximizing operations?

A panelist points out that artificial intelligence (AI) and innovative tech solutions are key to improving operations, particularly in energy-efficient building designs. Institutional investors are increasingly seeking green-certified properties, recognizing the long-term value and reduced operating costs associated with sustainable practices.

The integration of technology extends to property management as well. With the rise of self-property management platforms, landlords can streamline processes such as rent collection, service requests, and vendor management. One panelist highlighted the importance of customer service in tenant relationships, stressing that tech solutions can enhance communication and efficiency for smaller property owners.

Future Directions

Looking ahead, there are three significant changes posed to reshape the real estate market:

1. Virtual Tours: The adoption of virtual tours allows potential tenants to view properties remotely, improving accessibility and efficiency in the leasing process.
2. Conversion of Living Spaces: The trend of transforming living rooms into functional bedrooms continues to grow, reflecting shifting preferences in how residents utilize their living spaces.
3. Explosion of ADUs: In California, the demand for ADUs is surging, providing flexible housing options and helping to alleviate some of the housing supply issues.
4. Off-Site Modular Construction: This type of construction is set to revolutionize the housing market by enabling faster, more cost-effective building processes, while also allowing for greater design flexibility and sustainability in space utilization.
5. Innovative Energy Solutions: The focus on low-carbon emissions and alternative energy sources is gaining traction, with opportunities for retrofitting existing properties to incorporate these technologies.

Conclusion

The current trends in operational efficiencies and technology adoption reflect a significant shift in the real estate marketplace. As property owners navigate rising costs and changing tenant preferences, integrating innovative solutions will be essential for staying competitive. Embracing these trends not only helps in maximizing operational efficiencies but also prepares stakeholders for the challenges that lie ahead in a rapidly evolving landscape.