Golden Opportunity

California's major multifamily markets have remained strong.

In defiance of other sectors in its economy, the Golden State’s major multifamily markets have weathered the financial crisis and are projected to resume growth in the coming years. In cities like Los Angeles, San Francisco and San Diego, apartments are in strong demand and vacancies continue to trend downward.

“Multifamily has fared well over the last year,” says David Rifkind, managing director and principal of George Smith Partners, a real estate investment banking firm headquartered in Los Angeles. “How well is product specific and certainly market specific, but looking at California as a whole and multifamily as an asset class, it’s doing well.”

Marcus & Millichap’s Q4 2011 research reports for the state’s major metro areas show growth in both employment and rent over the past three years and forecasts this will continue through 2012. Vacancies are currently falling sharply in Riverside-San Bernardino, Sacramento and San Jose.

Additionally, according to MPF Research, three California cities made the top 10 list for rental occupancies in Q4 2011. San Francisco, San Diego and San Jose all had occupancy rates above 96.3 percent during this time, while Los Angeles came in close with a rate of 96 percent. San Francisco also ranked as the nation’s top metro for rent growth in 2011—with a rate of 14.6 percent.

That’s a huge number,” says Greg Willett, vice president of research and analysis at MPF Research. “In Northern California, you’re back to where you were pre-recession, and it is completely full.” Willett further states that the region is likely to be the number one market for rent growth again in 2012.

Rifkind says that growth in multifamily will likely continue in the short-term based on strength in the state’s urban areas, while suburbs and rural areas may move slower. However, in order for overall growth to be sustained in the long-term, one factor trumps all others.

“Right now, fundamentals are strongly in favor of all apartment classes in active, dense markets,” says Rifkind. “The periphery is going to continue to struggle for some time as the affordability gap between renting and owning continues to stay narrow. The next driver, which is the traditional driver of rents and higher occupancies, is jobs—and jobs are not being created in the rural areas and periphery just yet.”

Two regions, two stories

Obviously, with such a large state come regional distinctions, even with a general trend of growth and expansion. Willett points out that while the state overall is faring well, the southern metro regions are not performing as strongly as the northern ones.

“It’s much slower for those metros—job gain was slow to kick back in that part of the country,” Willett says. “Orange County has done reasonably well during the past year and has had some recovery, and occupancy and rents are going up fairly meaningfully versus the rest of Southern California.”

Indeed, Marcus & Millichap’s most recent research reports indicate that while Los Angeles is likely to see employment growth of 1.1 percent this year, this is not even half of the 2.4 percent forecasted for San Francisco. Furthermore, the Riverside-San Bernardino area is forecasted to remain in the bottom half of the company’s National Apartment Index (NAI) for 2012.

With respect to this and specific markets that should be avoided by investors and developers, Willett says that the suburban regions of Los Angeles stand out in particular due to their heavy reliance on single-family and influences from unconventional markets.

“The really sluggish [market] in California is Inland Empire, and that reflects just how badly that one got beaten up in the housing bubble,” Willett says. “It is a metro that has traditionally been very dependent on the real estate sector, so there’s still a huge hole to fill there. At the same time, they’ve got all these shadow markets full of family rentals that do not necessarily compete directly with apartments but do have some influence.”

However, while rent growth in this metro is below average, Marcus & Millichap states that “access to financing and occupancy is improving” as low interest rates have elevated buyers’ confidence. Construction and rental prices are both expected to increase in 2012.

George Smith Partners’ Rifkind observes that while the area still has many woes, there are still opportunities available for those familiar with its nuances and willing to take some risks. “Inland Empire is interesting,” Rifkind says. “It’s a very neighborhood market, product-type-specific. You can do well there, but you have to know what you’re doing. High desert markets are very thin, and will continue to be slow to recover.”

Different classes, different results

In addition to geographical distinctions, performance variations exist with respect to the various types of apartments. Different levels of income bring about demand for different classes of product, and which apartment class dominates is a strong indicator of which industries and income brackets have the highest levels of employment.

Rifkind indicates which apartment class he feels is outperforming the others across the state. “Class A in core coastal markets and major cities are doing the best,” Rifkind says. “The older product is doing less well but recovering in core markets, and the level of recovery starts to look weaker as you go further out into the periphery.”

Indeed, the San Francisco Bay Area is poised to see an active year of investment in top-tier assets, as both foreign and domestic investors take advantage of strong rent growth and job creation in the computer and information technology sectors. San Diego is expected to see a similar trend in its downtown area as professional and tech-related jobs will cause greater absorption of Class A properties, this according to Marcus & Millichap.

MPF Research’s Willett observes that while Class A is doing well, underlying regional distinctions make it difficult to generalize what’s happening across the state, with Southern California seeing different types of demand than Northern California.

“They’re moving, but in exception to the national pattern,” Willett says. “In Southern California, it’s the bottom part of the market that has done best. I think that’s just reflective of their affordability, and that’s an opposite pattern from what you see in most markets across the country where it’s the top tier that has led the recovery.”

This view is reinforced by MPF Research’s 2011 California market overview, which states that “middle-market product is positioned to play a much bigger role fueling overall growth than was the case in 2010-2011.” The report elaborates on this dynamic by stating that Class B and C products are due to become more popular “as some households get priced out of the most desirable stock.”