Continued Housing Demand Minimizes Multi-Family Market Downturn

Though the pessimism that has come with the recession has hit each of the multi-family markets in California equally, the view that rental and occupancy rates will not be as good as they are at present has not affected the rate of activity by developers, according to the Summer 2020 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey. While the UCLA Anderson Forecast is looking at a 30-month recovery in the state, and there remains a great deal of uncertainty with regard to the current public health crisis, it is likely that the market for multi-family housing will remain robust.

Multi-family housing industry leaders, Kitty Wallace of Colliers International and Tim Hutter of Allen Matkins, discuss what lies ahead for this sector of the California commercial real estate market.

1. The latest survey shows a significant drop in sentiment among participants; however, in both the Bay Area and Southern California markets, most participants stated that the pandemic had no impact on their plans for development activity. Why is that given the current uncertainties?

 
Wallace: While Southern California has seen a slight softening in the rental market due to the COVID-19 pandemic and developers face the ever-present risk of new legislation further constraining the industry, the fact remains that there is a housing shortage, and these submarkets in California remain some of the top job markets in the country. While many economists project little to no rent growth over the short term, most expect the market to fully recover and experience similarly high rates—likely even reaching historic highs—over the next three-to-five years. After many years of rising pricing, developers are now realizing price reductions and greater flexibility with their contractors and subcontractors. An enormous amount of capital is waiting to enter the California markets, and developers and capital providers alike are more likely to engage in ground-up development that will not come online for a year or more when the expectation is that this pandemic will be in the rearview mirror, rather than acquire an existing asset in the midst of lease-up that is experiencing temporary difficulties due to the pandemic as sellers are unwilling to reduce pricing.

Hutter: Multi-family development in California is extremely complex, and takes time. Most developers realize that projects can take a number of years, not months, and many plan for delays along the way. This particular delay is unique, and we all hope that its impact will be temporary. It is hard to envision a scenario in which COVID-19 and its fallout could remedy the underlying housing affordability issues that California faced coming into 2020. In light of that ongoing concern, we expect demand for multi-family housing to continue to be high.

2. With the current work-from-home requirements, do you anticipate people moving away from dense communities where you would typically see multi-family housing? Why or why not?

Wallace: As happens during and after each market downturn or major economic event, a portion of the population will re-evaluate their living arrangements. As the market sky-rocketed over the past decade or more, residents left home to rent on their own or rented newer and nicer units to reflect their desired lifestyle. When the housing construction rate didn’t keep pace with increased demand, rental prices increased exponentially in major markets. As prices continued to escalate, some tenants were forced to move to smaller units, add roommates, or move further away from city centers in order to live in the neighborhoods and buildings in their price range. Post-COVID-19, some of these residents are temporarily moving back in with family to manage unemployment or underemployment, as job prospects have dwindled. Others will move to different communities for lifestyle or financial reasons, some to less dense locations, and others to the suburbs or other markets. For each resident moving out of city centers, however, others who are faring better economically or desire to live in these major markets will continue to increase, filling in any gaps made by those who left.

Hutter: Recent trends in the state legislature have promoted increased density along transit corridors, but also opened up opportunities for more density in single-family neighborhoods. There are a lot of small-scale infill developers who are looking to create pockets of density in non-traditional areas, and we expect that will continue. For some people, working from home has inspired local interactions and a greater sense of community. Just think of how many more people have been out walking around their neighborhoods over the past few months. You might see a shift in community amenities—open-air spaces are probably getting more use right now than gyms or community kitchens—but multi-family complexes are still a great option for many people in the housing market.

3. Aside from the coronavirus pandemic throwing the economy into turmoil, what other challenges will the California multi-family market face over the next three years? What factors will allow it to prosper?

Wallace: Rent control is an ever-present challenge for multi-family landlords, and with AB 1482 placed into law, further tenant-friendly legislation is likely to be pushed in the coming years. The most recent example of this is Proposition 21, an attempt to modify Costa-Hawkins that will be on the ballot in November. If passed, it would allow cities to place all residential units older than 15 years under rent control and effectively eliminate the right that owners currently have to bring a unit up to market rates upon vacancy. This comes after Proposition 10, which sought to outright repeal Costa-Hawkins, was shot down in 2018. As long as we are supply-constrained, California should expect a continued effort by advocacy groups to push for such initiatives. Fortunately, despite such restrictions, California remains a top market for investors due to its resilient and diverse employment base, high-growth (and high-income) job sectors, and the resulting top-quality renter pool.

Hutter: Owners and managers of multi-family housing have already been grappling with the varied rules and regulations put in place across the state. That legal labyrinth will continue to pose a challenge, even after eviction moratoria expire or are lifted in the coming months, and the question will shift to a business call about whether to pursue evictions and hope to find new tenants amid economic uncertainty. As far as opportunities, as the calendar pages turn in 2020, cities are still facing the upcoming housing element cycle and the need to accommodate additional units as part of their Regional Housing Needs Allocation (RHNA) by early 2021. Many cities have been assigned unit counts that would dwarf production over the last decade. The upzoning required in many cities should spur activity for sellers, land brokers, and land acquisition teams, especially in the multi-family market where density increases might help to make projects pencil on parcels that were previously reviewed and rejected.

4. Coronavirus may have drastically slowed the economy, but has there been any positives in terms of loosening existing permitting laws? What examples could you provide in relation to the housing market?

Wallace: While cities have expressed a desire to keep development projects moving, especially considering current market conditions and a clear lack of housing in Southern California, COVID-19 has undoubtedly made it more difficult to get things done. Government offices have been closed, and with plan checkers working from home or with limited hours, current projects are being delayed. Utility companies such as PG&E are experiencing similar challenges, making it difficult for developers to get power to their construction sites or lines moved, even when work has been scheduled and bills have been paid. As the economy opens back up and people return to work, these projects should be able to move along, and cities will likely need the fees they provide more than ever, which should encourage their immediate approval. On a positive note, infrastructure projects have been able to be completed more quickly, due to a lack of traffic, and with unemployment numbers in excess of 10 percent, there is no longer a shortage of labor.

Hutter: It is too soon to understand the true impacts of COVID-19, but there do appear to be some silver linings. For projects that were in the entitlement phase, we saw many local agencies whose employees were nimble, responsive, and focused on pushing projects forward. Even on the logistics side of things, as one example, the City of San Diego shifted to online submittals for permits, which should represent a huge step forward. At the other end of a project timeline, for projects that were already under construction, many jurisdictions allowed construction to continue, especially for housing. That is a credit to industry organizations who worked with government officials to understand the potential devastation, both physical and economic, of pausing construction for an unknown period of time, and to develop safety protocols to keep projects moving.

5. There are a lot of proposed bills that are meant to infuse the housing market. Which would you consider will have the most impact to help ease the housing crisis in California? Which will create more roadblocks?

Wallace: A few notable bills that have been proposed would encourage developers to begin projects, most of them providing benefits in exchange for affordable housing. For example, AB 2580 removes some of the red tape required to convert a hotel, motel or commercial building into housing. Similarly, AB 1934 would require city planners to approve affordable housing projects within 30 days if zoning requirements are met. AB 10 would expand the LIHTC program by some $500 million a year. And the list goes on. Unfortunately, bills that could preclude increased development and exacerbate our housing crisis are also on the horizon. Proposition 21, the rent control measure on the ballot this fall, may limit the desire developers have to build more units if approved, further limiting supply in an already over-heated and under-served market, in turn increasing costs, rather than the inverse as is intended.

Hutter: Housing legislation has had a series of highs and lows over the past couple of years, and this summer will probably feature a similar theme. Everyone agrees that we need more housing, but we can’t seem to agree on (a) where it should go, (b) how much of it needs to be subsidized Affordable housing, or (c) how much people should get paid to build it. Laws promoting Accessory Dwelling Units (ADUs) continue to see support, perhaps because opponents view this as sufficiently incremental that you can skip over those three critical questions. Similarly, while some cities (primarily on the coast) continue to demonstrate hostility toward the state density bonus law, the trade-off seems to work, and developers produce mixed-income projects where increased numbers of market-rate units offset the cost of affordable housing, all without triggering prevailing wage requirements. Empirical data demonstrates the success of expanded density bonus programs, so we are watching AB 2345, among many others, this year.