BANKING ON SOUTHERN CALIFORNIA’S STRONG MARKET FUNDAMENTALS
“When the dust begins to clear post-election-day, investors will find themselves freed of the current uncertainty. With clarity restored, we fully expect 2019 investment volume to far exceed that of 2018.”
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We have seen the dynamic occur time and again in commercial real estate. There is a cloud of unknowing that tends to hover over the industry in the weeks, and sometimes even months, that precede an election. The approaching midterms are no different, especially with Proposition 10 on the ballot, the so-called Local Rent Control Initiative.
While certain investors might be cooling their heels in anticipation of November 6, others are taking advantage of the rich opportunities that exist in the multifamily sector throughout the Greater Los Angeles MSA. They recognize that, beyond the impact of any political environment, the strong fundamentals of the SoCal multifamily market shine through.
We need only look at the numbers to see that strength in action. The Greater Los Angeles MSA has a vacancy rate that ranges from a low of 3.6% (Inland Empire) to a high of 4.2% (Orange County). In terms of investment activity, L.A. alone boasts a staggering $2.5 billion. (For more Los Angeles area market stats, click here)
What makes the market so vibrant? There are a number of factors. First, Los Angeles is a gateway city, very appealing to capital. Combine that with our growth in population and employment, overall market stability, the durability of the income stream and the low construction-to-existing-stock ratio, and market watchers can begin to see why SoCal is not like other markets.
The region’s strength is being driven by investors and occupants alike. On the investment side, institutions are looking to reduce the average age of their portfolios, shedding older assets--eighties and nineties vintage--for newer product. When they do chase older deals, it is with an eye to value-add, especially in well-located markets that can almost guarantee an upside. Meanwhile, pension funds and advisers are looking for plays that are in general more safe and secure--but they are looking, with an eye to beefing up their urban-core and coastal-market holdings.
Private investors generally follow a similar path as the institutions, albeit on a smaller scale and with some important differences. This is true not only in the product they seek but also in their approach to these products. We see private investors becoming more sophisticated, such as in their growing awareness of the importance of IRR. They are catching up in terms of their appetite for both technology and professionalism, and in some ways, they can be quicker to adopt new innovations.
If there is a major differentiation between private and institutional players, it is in the privates’ focus on today’s yield plus appreciation benefits, while the institutions are most commonly focused on the durability and the security of their investment. Both target assets convenient to a strong job base, with good transportation options, and while institutions tend to favor the newer, core and urban opportunities, private investors are less concerned with age and more focused on immediate yield.
In fact, one of the unique aspects of SoCal investment is that we sometimes have private groups competing with institutions for the same product. In short, there is a lot of capital chasing multifamily deals of all sorts.
Which brings us to the occupant side of the equation. The job market in SoCal is a major driver of multifamily’s strength, since business growth begets residential growth. And employers are following where the next generation of talent is headed, meaning that job growth is spreading out well beyond the city core.
While many of these jobs are linked to traditional media and the studio industry for which Los Angeles is known, the market today is more diverse than ever. The MSA is a growing magnet for new media and healthcare operations as well as more traditional non-entertainment verticals such as finance and legal. These providers of jobs are not only populating the L.A. core, but going beyond, to such submarkets as Hollywood or Santa Monica.
The diversity of the L.A. market is underscored by the Inland Empire, which is blossoming as well, with a renewed vitality driven by industrial tenants. It stands to reason, then, that multifamily there is in the 97% occupancy range with rents that are still improving. In fact, year-over-year rent growth in the Inland Empire--roughly 4.5%--exceeds virtually every other market in the country.
It should be noted that, where prices are getting out of reach for younger generations, such as in Downtown Los Angeles and the Arts District, renters are finding solutions, such as micro-units and cohabitation, to ease the rental burden.
Nevertheless, there has been a certain amount of outward migration, especially of millennials looking for a different quality of life. But this vacuum is being filled by both young and more seasoned players alike who continue to fill positions within one of the above-mentioned diverse verticals. They are finding affordability outside the urban core, and yet easy access to downtown, by locating on a metro stop or along transportation corridors in such areas as Downey (off 605 Freeway), or San Gabriel and Santa Monica (Rte 10).
If there is a problem in the otherwise positive picture of SoCal multifamily, it comes in affordable housing. Unfortunately, we are not alone, and it is an issue that plagues virtually every city in the US. The essential problem is keeping up with demand. Happily, efforts are being made. These include Measure JJJ and local Density Bonus measures.
Such initiatives provide developers with incentives when as much as 20 percent of their projects are earmarked for affordable uses. But more certainly needs to be done, and the industry as a community needs to spend some time analyzing how to provide more affordable options to keep people here.
These initiatives are a terrific start, especially built as they are on the foundation of the inherently strong SoCal multifamily market. When the dust begins to clear post-election-day, investors will find themselves freed of the current uncertainty. With clarity restored, we fully expect 2019 investment volume to far exceed that of 2018.