Western Multifamily Outlook: “With Uncertainty Comes Opportunity”

Apartment pros that embrace the challenge are most likely to find opportunity in this new, demanding economic cycle.

The considerable and abrupt increase in cost of money is having an impact on the still-strong multifamily sector. According to Kidder Mathews SVP Austin Kelley of Tacoma, WA, that means lower investment volumes, but also more would-be homebuyers remaining renters. Kelley and other brokers at Kidder Mathews, the largest independent commercial real estate firm on the West Coast, note that a complex dynamic is manifesting in similar forms up and down the region.

Investment Showing Strains

Scott Rosenberg, Kidder Mathews SVP in Los Angeles, calls the investment sector “a tale of two segments.” The mostly private investors who still need to complete 1031 exchanges are being forced to make deals with sellers “that are less than compassionate to the changes in borrowing costs.” This segment has been largely responsible for supporting recent valuations, although asset supply outweighs demand. Meanwhile, institutional, and local syndicates with under-allocated cash are finding it difficult to achieve required returns that have not kept up with the newer valuations.

“In essence, their exit cap rate expectations are higher, and that is taking a big bite out of the ‘value-added equity’ assumptions that drive a huge piece of the returns investors require,” Rosenberg said. “This is effectively pricing them out of the market, at least for now.”

Jordan Carter, Kidder Mathews EVP in Portland, OR, reports that institutional investors are having to adjust return expectations while getting used to the new reality of having to put more money down to offset higher lending rates. Robin Ossenbeck, Kidder Mathews SVP in LA, sees market softness continuing until enough post-rate hike volume closes, readjusting valuation expectations. Carter added that, despite the slowdown in the second half, 2022 will likely end up as the second-best investment sales year after the “banner year” that was 2021.

Supply’s Complex Picture

Developers might feel like they’re stuck in a never-ending obstacle course. First it was lack of land and community pushback impeding their progress, then higher construction costs, supply chain delays and lack of labor, and now it’s rising interest rates making project financing more and more challenging. The more risk piling on, the more likely lenders and capital investors will be to bail on a project.

“There are a lot of entitled projects seeking new owners today,” said Rosenberg, whose seller client was asked for a 19% reduction in price this summer on a development deal. “My clients have had a hard time finding opportunities that ‘pencil’ given the state of the market. Most of them believe that time will force meaningful corrections to land valuations.”

While the California Court of Appeals striking down the eviction moratorium in LA is “a big win for landlords,” the eviction backlog will be costly in both time and money for most owners, according to David Evans, Kidder Mathews senior associate in El Segundo, CA. However, he notes that some protections remain in place, including no-fault eviction protections for tenants who utilized the County’s non-payment of rent protections from July 1, 2022 through December 31, 2022 and are still within the 12- month repayment period. And there’s a new wrinkle for investors: the recently passed measure ULA, or the “mansion tax.”

“For owners who are looking to avoid being tethered to these restrictions wanting to sell their investment property in LA, they would be well served to sell prior to April 1, 2023,” says Evans. “Once measure ULA takes effect, it will add an additional 4% tax on properties above $5 million and another 1.5%, for a total of 5.5%, on properties above $10 million.”

Ossenbeck warned against housing policy that reduces the incentive for multifamily developers to break ground. State mandates for cities to finally get on track with regard to smart development of market-rate and affordable housing should be beneficial to all parties involved.

“This will allow for more housing in areas that need it, including tearing down old retail and even old office buildings on transit corridors to create options for the average worker,” she added. “I see this as the best answer for California’s future.”

The future of the multifamily sector as 2023 approaches will still see favorable supply and demand fundamentals with the revival of urban submarkets based on the return to the office, a trend to watch. Kidder Mathews’ brokers predict a future bounce back, but still plenty of opportunity amidst the present uncertainty.

Contact

GARY BARAGONA
Director of Research
415.229.8925
gary.baragona@kidder.com

Written by John Fioramonti
Senior Business Writer
Kidder Mathews Research