Steady San Diego

Gaining jobs across most sectors and rapidly adding residents, the city continues to be a strong and stable multifamily market.

Gaining jobs across most sectors and rapidly adding residents, San Diego continues to be a strong and stable multifamily market. At 96.8 percent, the metro’s occupancy rate is one of the highest in the country, underlining the city’s housing shortage and justifying the growing construction pipeline. Rents were up 4.8 percent in the year ending in March, continuing to outperform the national average.

Anchored by international trade, biotechnology, military operations and tourism, San Diego’s economy is a mixed basket benefiting from a deep talent pool as the city’s network of universities and research facilities offers startups solid ground and a cheaper alternative to Silicon Valley. With the $2 billion trolley expansion underway, San Diego continues to draw large-scale projects. Manchester Pacific Gateway, a $1.3 billion mixed-use development, will house the new U.S. Navy headquarters. Greystar’s Ballpark Village, the mega-project slated to bring 713 rental units to downtown, is also in the works. The list also includes the $1.2 billion Seaport project and FS Investors’ proposal for the Qualcomm Stadium site.

Offering acquisition yields akin to those of Los Angeles and San Francisco, the metro remains a fairly predictable and hot secondary market, with roughly $3.5 billion in assets having traded over the past two years. And as supply is slowly catching up with demand, Yardi Matrix expects rent growth to remain at sustainable levels, reaching 4.5 percent in 2017.

Read the full Yardi Matrix report.



The Next Wave in Multifamily: Middle-Market Assets

With multifamily development hitting the brakes in major cities and shy rent growth on the horizon, investors are setting their sights on middle-market assets owned by Baby Boomers. Industry leaders predict that, as this $10 trillion market changes ownership, the largest transfer of properties in the history of real estate will occur.

Multifamily is holding on to its title as the most durable and attractive asset type in the industry, though construction and rent growth are expected to dampen even further. Jay Rollins, managing principal & co-founder of JCR Capital, talked to Multi-Housing News about the next stage in the cycle: the winners, the losers and the most attractive investment opportunities.

MHN: Could you give us some details on a particular market where this theory could apply?

Rollins: Many markets are overbuilt—such as Denver, L.A. and Tampa—and rents will fall, but lenders have been conservative in their underwriting, and they will be fine. It will be equity and mezzanine lenders who will be disappointed.

MHN: What can you tell us about multifamily financing? It seems that only high-quality assets have access to capital. Should we expect this to continue going forward?

Rollins: Not true—all multifamily assets have access to capital. It’s one of the most durable asset classes there is. Furthermore, the federal government subsidizes the market, which compresses cap rates in multifamily by 100-200 basis points. As long as there are people, it’s a great asset. While the market has been extremely robust for years, lenders have generally stayed conservative and are not out over their skis the way they were in 2007. Going forward, investors simply need to pick their spots more carefully. It’s all about basis.

MHN: What are your predictions in connection to the multifamily market’s future? What is the next stage of this cycle going to look like?

Rollins: Not very different, except you will not see much more new construction of Class A multifamily in urban markets for a while. Absent that, it’s a strong market.

MHN: What should investments strategies focus on next, since the multifamily market is slowing down? What is the next big thing on the real estate investment agenda?

Rollins: The next big thing is the largest transfer of assets in the history of real estate. Specifically, middle-market assets (valued under $50 million) owned by aging Baby Boomers. The vast majority of the assets within this $10 trillion market will change ownership in the next 5-15 years. Every time that happens, it creates a financing opportunity.



Western Markets Dominate Rent Growth

From Seattle to San Diego, many tech-driven, Millennial-attracting markets have experienced continuous rent growth above previous averages.

For months, western markets have led the nation in year-over-year rent growth, according to Yardi Matrix’s monthly rent survey. From Seattle to San Diego, many tech-driven, Millennial-attracting markets have experienced continuous rent growth above previous averages.

Sacramento, in particular, has led the way, as growing demand is met with limited existing stock and low supply growth, forcing annual rent growth above 10 percent in recent months. Overall rent growth in the California capital fell back into the single digits in February for the first time since June 2016, and sits at 9.4 percent on a year-over-year basis in March. Strong gains in education and health services employment (4.2 percent) and professional and business services employment (4.3 percent) support the outsized rent gains. Affordability issues in nearby San Francisco and Oakland are also helping the Sacramento market as some residents are choosing cheaper rents, despite the significant commute to the Bay Area.

While Sacramento’s rent growth has far outpaced the rest of the country for several months, development remains light, as only 1,481 units are currently under construction. In 2017, completions are expected to add a little more than 1,000 units, representing a meager 0.6 percent of total stock. With a relatively quiet development pipeline, expect rent growth in Sacramento to remain among the strongest in the country.

Other Californian markets leading the nation in rent growth include the Inland Empire (6.5 percent), Los Angeles (5.5 percent) and San Diego (5.0 percent), as their diverse economies, quality of life and steady real estate fundamentals provide a strong foundation for rent gains.

Los Angeles remains an attractive gateway city, with a diverse population of Southern California natives, domestic transplants and immigrants. It has long been the global capital of the film and entertainment industry, but a burgeoning tech scene along with the most active port on the West Coast and a significant professional and business services industry make L.A. one of the most diverse economies in the nation. Construction activity has responded to the strong rent growth, and 2017 completions are expected to represent 3.7 percent of the existing apartment stock.

Just to the east of L.A., the Inland Empire offers a more affordable alternative to pricey urban apartments. As more residents move eastward, however, rent growth in the Inland Empire has picked up and remained well above the national average. With close proximity to the Port of Long Beach, the Inland Empire serves as a major distribution hub for much of the West Coast and Southwest United States. Trade, transportation and utilities make up roughly one quarter of the employment force in the metro. Continued international and domestic trade, as well as overall migration from L.A. County, should continue to drive rent growth in the Inland Empire. However, potential trade policy changes bear mentioning, as isolationist tactics could negatively impact the trade, transportation and utilities industry in the Inland Empire.

Seattle also found itself in the top five rent growth markets in March, as rents increased 5.4 percent. Strong job growth across the board, especially in the information, leisure and hospitality, and trade, transportation and utilities sectors, fueled growth in the Emerald City. Diverse job growth and steady in-migration has allowed the metro to absorb the significant new supply that has come online. While rent growth has decelerated from the once heady levels near 10 percent seen in 2016 due to the glut of new units hitting the market, Seattle seems poised to continue to outpace the nation.

A closer look at smaller markets experiencing outsized rent growth shows a similar trend to the larger markets. Rents grew in Reno by 10.3 percent on a year-over-year basis in March, as the northern Nevada market continues to make significant strides in developing its employment base. Manufacturing employment is up 6.4 percent year-over-year as several firms have chosen Reno as their preferred location for factories. Tesla’s gigafactory employed 850 manufacturing workers at the end of 2016, and plans to add 1,000 additional workers in the first half of 2017. Overall employment growth in Reno was 3.4 percent, more than double the national average growth rate.

Other strong rent growth markets can be found near major cities that have recently experienced significant rent and population booms. Tacoma (8.8 percent) and Colorado Springs (8.5 percent) offer more affordable rental rates with relatively close proximity to Seattle and Denver, and the urban sprawl continues to bring these cities together. As a result, the economies of Tacoma and Colorado Springs have expanded and diversified. While both remain strongly tied to local military bases, tech firms and start-ups have also grown in the markets.

Supply growth in Tacoma and Colorado Springs remains limited compared to their larger neighboring cities, however both markets reside in relatively development friendly states, and continued demand for housing may spur increased construction. That being said, as affordability issues mount in Denver and Seattle, expect cost conscious renters to fuel faster rent growth in Tacoma and Seattle.

Long seen as the American frontier, the Western United States has recently become the strongest region for domestic migration, and offers a number of attractive gateway markets for immigrants. Americans from many generations are moving westward for jobs, quality of life, and more favorable taxes, which has driven rents and development in many western markets. The trend of westward expansion should continue, and we expect rent growth to remain strongest in many of the Pacific and Southwestern markets.


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2017 Americas Investor Intentions Survey

The prospects of better U.S. economic growth and less regulation have piqued investors’ interest in commercial real estate this year despite rising interest rates, according to the CBRE Americas Investor Intentions Survey 2017.

The survey reveals the sentiment of nearly 1,000 investors focused on the Americas in 2017. Download CBRE’s full report for exclusive insights on their investment strategies, risk appetite and property sector preferences.​


Confronting the Affordable Housing Gap

The solution will come from various sources working together.

The concern voiced so often today about housing affordability reflects a sobering truth: Rents are rising more quickly than wages—and most new houses and apartments are priced such that only the wealthiest people can afford to live in them.

“We have an affordable housing crisis. In the rental housing space, that crisis is very acute,” says David Brickman, executive vice president and head of the multifamily business for Freddie Mac.

The latest spike in housing prices is just the most recent indication that the shortage of affordable housing has been building for decades. Building more new homes will be part of the solution, but will require much more complicated negotiations over how and where those homes are built. Most developers no longer have easy access to greenfields in unincorporated areas where they can build. New construction now involves long conversations—over issues ranging from zoning and schools to gentrification—that add time and expense to the development process.

Land Shortage = Housing Shortage
Simple economics have pushed the cost of housing higher and higher. Over the past 10 years, as the U.S. has slowly recovered from the Great Recession, the total number of new houses and apartments has fallen short by hundreds of thousands of units every year.

“The general housing supply hasn’t kept pace with the demand from new household formation,” says Andrew Aurand, vice president for research for the National Low Income Housing Coalition (NLIHC).

And the price of a rental apartment has risen accordingly. In order to afford a modest, two-bedroom apartment in the U.S., renters need to earn a wage of $20.30 per hour. That’s nearly three times the federal minimum wage of $7.25. It’s also higher than the estimated average wage of $15.42 earned by renters nationwide, according to the latest Out of Reach report, put out every year by the NLIHC. Many workers make up the difference with multiple jobs, overcrowding, substandard housing, or a mix of all three.

“Clearly, more housing production is needed—if you increase supply, that would generally relieve pressure on the housing market,” says Aurand. “But that’s just one component.”

The affordable housing shortage has been going on much longer than the latest economic cycle: The NLIHC published its first Out of Reach report in 2005.

The growing shortage of affordable housing represents the end of an era. After decades of development, the areas around many job centers have filled with sprawling, low-density communities. “There is no cheap land left on the periphery, with few exceptions,” says Brickman. “The country is getting full up—we’ve reached the natural limits of some metro areas.”

During the housing boom, developers found some of the few remaining greenfields to build on the exurban fringe, often more than an hour’s drive from job centers. These distant houses were often all that potential home buyers could afford and still qualify for a mortgage, even with the lax lending standards of the boom years. In the years since the crash, the cost of developable land has recovered relatively quickly and continues its rise. “Land prices are fundamentally driving the supply equation,” says Brickman.

At the same time, wages have grown slowly, while banks are much less willing to lend to potential home buyers. “The home ownership rate has declined, and there’s been a huge growth in the demand for rental housing,” says Aurand.

The Rise of New Rental Development
Demand is strong for all types of rental housing, but, like home builders, apartment developers can no longer easily find cheap land and large sites to build relatively inexpensive, new, garden apartments. More-expensive land means developers need to look for sites where they will be able to both squeeze more apartments onto an acre and charge higher rents.

Young people often express a preference to live in bustling neighborhoods within walking distance of amenities like shopping or transit. The rise of the information economy has also concentrated many jobs back in the urban core, which increases the concentration of workers who need to live within commuting distance of those jobs, pushing even more density into new development.

Many top apartment developers now focus on building mid-rise, elevator buildings with four or more stories of apartments on top of a concrete podium for first-floor retail space. These are much more expensive to build than three-story, wood-frame, garden apartment buildings.

Regulation also adds cost. Developers once escaped local government oversight by choosing sites in unincorporated areas. As developers squeeze into smaller sites in existing neighborhoods, however, they have to deal with rules, regulations, and other obstacles ranging from local building codes to impact fees to zoning board meetings, where area resistance can slow or stop the development.

Despite these challenges, developers are starting construction on new apartments at a rate of well over 300,000 a year. “There’s more multifamily rental development [going on],” says Robert Dietz, chief economist for the National Association of Home Builders. “That’s basically going to remain elevated.” Yet, so far, these new apartments haven’t been enough to make up for the shortage of housing overall. “The supply of rental housing hasn’t kept pace [with demand],” says Dietz.

And because of the high cost of development, these new apartments typically charge very high rents that only high-earning households can afford. “People’s income levels aren’t in line with the cost of producing new housing,” says Brickman.

These new apartments are likely to become more affordable with age, however. New construction can also help relieve stress on a housing market.

“If you build new housing, higher-income people can move out of older and less-modern units, making those apartments available,” says Aurand. Even this has a downside, however: The development can also attract new residents to neighborhoods that have been less expensive, raising rents overall. “The downside is potential displacement,” he adds.

Housing advocates hope that communities that now resist development may, eventually, be convinced to allow new housing at greater density than their zoning currently permits, such as the development of single-family townhouses and mid-rise apartment communities in suburban areas. “The development opportunities are in the inner-ring suburbs,” says Dietz.

Government affordable housing programs are also a piece of the puzzle.

The lowest-income households have very few choices outside of housing that receives some kind of government subsidy. That’s because the private sector can’t produce or even maintain housing at a cost affordable enough for people with the lowest incomes. “There’s a price point at which a private landlord doesn’t find an incentive to maintain their housing,” says Aurand. If subsidized housing is unavailable, overcrowding and substandard housing may be the only viable solutions.

Developers will continue to find some greenfields to build on, particularly on the edges of younger cities, though these sites continue to become more elusive. But new technology like driverless cars may make more of these fringe sites work for new development.

“There isn’t a silver bullet that’s politically feasible,” says Brickman. “The solution has got to be a lot of little things added together.”



Banks Pull Back From Large Multifamily Loans

While banks are still the largest financier and loan originator in the apartment construction market, they’re unwilling to lend as much now as they have been in the past compared with the value of the property, according to National Real Estate Investor’s Bendix Anderson.

Banks that once made loans that covered up to 75% of the cost of a development may now only cover 65%, and interest rates have risen to 275 to 325 basis points (bps) over LIBOR, up from the low 200 bps point range earlier in the recovery.

New regulations, such as Bassel II and Dodd-Frank, account for some of this hesitation to lend, Anderson notes, given that banks are now required to keep cash in reserve to offset their investments.

Lenders of all types are also growing more cautious as more new apartments open and vacancy rates begin to climb in many markets. Many lenders already have construction loans that are not performing as well as expected.

“Absorption is more challenging,” says Mitchell Kiffe, senior managing director with CBRE Capital Markets. “Pro forma estimates are maybe not being achieved. Lenders are looking carefully at all their new loan applications.”

Alternative funding sources include life company lenders, private equity funds, and FHA programs.