Multi-family market optimism prevails despite pandemic disruptions – real estate and construction

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Despite moving to the suburbs and falling rents, Allen Matkins / UCLA Anderson Forecast California Commercial Real Estate Survey panelists are optimistic about the next three years in the multi-family housing sector. Rental rates are projected to rise faster than inflation across the board, and vacancy rates are expected to decline between now and 2024. This optimism is driven by both the reopening of city amenities that attract people back to city apartments, and the beginning of the return to the office.

Leaders in the multi-family housing industry, Kitty wallaceColliers International and John Condas Allen Matkins, discuss what this sector of the California commercial real estate market will face.

1. Despite the fact that part of the population is moving to housing estates, falling rents and high construction costs, multi-family developers and investors remain optimistic in this sector, looking at least three years ahead. Why?

Wallace: California has historically been one of the top 10 markets, and while we have faced adverse circumstances due to the pandemic, people remain hopeful. Investors, tenants and landlords alike think strategically and plan ahead based on the historical market and expected trends and future returns. At some point, 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 include high barriers to entry, diverse employment, entertainment, weather, and a tenant base that tolerates rent increases well. With this in mind, people are willing to invest and predict positively based on California’s experience of above market value. While much of California is projected to have stable net growth over the next year or two, they are optimistic about the historic market gains in rent increases in the coming years. When the economy is fully open, we will see a great place to “park money and profits.” With the diversity we have in our sectors of employment, our population will experience a significant boom. This not only provides a great opportunity for investors and developers, but also highlights several trends that we are seeing. Lumber prices have gone up. There is also an increase in labor costs. If you are going to build real estate, it makes sense to build in areas where you will receive the best rent at a fixed cost, further exacerbating the need to invest that money in development in more expensive markets.

Condas: Many expert data support the assertion that even with these aforementioned factors, California still lags far behind in the production of residential buildings. Our clients share this point of view; job creation has far outstripped new housing production. We are seeing a flood of new activity, which appears to be driven in part by the resumption of operations in California on June 15th. Our clients believe that the worst impacts of COVID are behind us, and as we return to a more normal situation, previous deferred demand before COVID will return.

2. Since the vast majority of survey participants are still making headway with multi-family projects over the next few years, especially in Southern California, what additional or new amenities are developers considering for their property, COVID-related or otherwise?


Wallace:
We are witnessing the continuation and strengthening of general trends such as automation and installation of various types of technologies. From Nest thermostats to keyless entry and Amazon locker expansion, the developers are working hard to keep their tenants in very comfortable apartments. There are now lucrative add-ons like Stockwell, a popular smart store that provides a full range of services, including dining on the go or everyday retail. Advanced Wi-Fi capabilities are now a must. The inclusion of these types of add-ons not only benefits the tenant but also provides additional income for the landlord.

Yoga studios and gyms have expanded significantly and are sometimes moved outside. We recognize the value of health and, thanks to the COVID pandemic, have learned that outdoor exercise is not only acceptable but also preferred in California in many cases. We are often limited in space. In some cases, developers are reinventing approaches, considering other health and wellness options, including pickleball courts and lane pools. The use of open space has increased dramatically, especially as these spaces are difficult to find in mainstream urban areas. Tenants want convenient options in addition to fitness centers with playgrounds with bocci or corn holes and home gardens with herbs and fruit trees. COVID-19 encourages developers to pay more attention to the tenant and their well-being. On the production side, the new elevators include COVID filtering options to help keep our communities safe, and the developers are also looking to improve airflow in corridors and public areas.

Condas: Our customers are incorporating amenities and making changes to existing amenities to address COVID-related issues. Such amenities include more outdoor areas, use of Zoom to host virtual cocktail tastings or cooking classes, backup meditation rooms, and remote training equipment. They are introducing cleaning and disinfection practices in fitness centers and coworking spaces on site. Lounges, clubs and other facilities are now being redesigned for home teaching and teleworking. Our clients are investing in more mobile furniture that allows them to position seating, dining and study / work spaces six feet or more apart. Partitions are installed in the coworking space to make tenants feel safe. Multi-bedroom apartments are now being advertised as one-bedroom apartments with home offices or remote classrooms, instead of the traditional marketing of two or three-bedroom apartments. One bedroom apartments showcase a creative space / work area where residents can make a living from the comfort of their own home as a significant number of people now work from home.

3. Where will the next hotspots for multi-apartment construction be, if not in large markets already saturated with multi-storey buildings? Will people keep looking for less dense places?


Wallace:
While hotspots will continue to be regions with high barriers to entry, the Inland Empire will thrive thanks to the port and logistics market and the development of warehouses. Institutional clients are now investing in this astounding development concept. The Inner Empire has seen significant population growth due to the constant rise in rents. Over the past 11 years, they have seen stable growth in rents of 3%. Historically, only hundreds of new devices have appeared in this market. We are expected to have around 2,000 units built next year. While many of the state’s rental markets have been hit by the pandemic, San Diego has emerged as another hot spot, followed by Orange County and Sacramento, as these markets have been more lenient with regard to mask requirements, school openings, and return to business.

Some tenants and investors flock to out-of-state areas in Montana, Idaho, Colorado, Arizona, or even Utah. Some are due to the cost of housing construction, but many are due to restrictions in the state of California. Since some have left, many are returning because there are improved opportunities here; growth prospects are better. There is certainly a changing of the guard going on now, given the demographics of our tenants and investors, but we will see how investors use their capital due to potential returns. In our markets, the vacancy rate is stable at 5%, which means an increase in rents. It is expected to rise sharply over the next three years. Many rental markets are limited right now, so we are seeing unrelenting interest in these pockets.

Condas: Our clients are particularly optimistic about the development of multi-family projects in suburban, less densely populated areas such as the Inner Empire. One of the reasons the Inland Empire attracts our clients is the huge job growth that has occurred there, thanks to the number of warehouses and logistics facilities built. Land prices are also lower there than in more urbanized areas. These projects are being developed at a lower density than in urban areas, allowing for cheaper types of construction. In addition, we have seen many new developments in Orange County outside of the coastal areas. Our clients also understand that the regulatory pendulum has swung in a more housing-friendly direction due to the California Legislature’s adoption of SB 330and Extremely High Regional Housing Requirements (RHNA), which are assigned by local governments by various government associations. State law requires cities and counties to demonstrate that these local governments have sufficient land, zoned at appropriate density, to meet their RHNA obligations. These high RHNA commitments will force local governments to divide or rezone properties to meet their respective RHNA commitments, making the granting process more secure and somewhat less risky.

The content of this article is intended to provide general guidance on the subject. You should seek professional advice regarding your specific circumstances.

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