While there are macroeconomic trends that drive the real estate market as a whole, each segment has its own strengths, weaknesses, and opportunities. This is particularly true for the development of multifamily units in the state of California. From San Diego to Northern California, demand for multifamily housing continues to increase — while is also creating challenges for developers.

Emily Murray, partner at Allen Matkins, and Kitty Wallace, senior executive vice president at Colliers, share their insight into the current state of the market as part of the Summer 2023 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey.

California is Still a Great Place to Live

The state of California has changed dramatically in the past few decades, from the rise of the tech boom to the struggles through the COVID-19 pandemic. However, our Survey respondents remain optimistic that California is a high-demand place to live and an opportunistic environment for developers.

“We have jobs, we’ve got a great climate. The fundamentals to be here are ideal, we’ve got an airport, we’ve got good weather, all of these things,” says Wallace. “But the affordability is something that’s costly for people to stay here. It would be much more affordable if we could build more units.”

Both residents and government officials are hoping developers can produce more units to keep up with demand. Between 1980 and 2010, the state needed to build between 70,000 to 110,000 new units each year to keep up with demand. Unfortunately, the number of annual new units fell well below that range annually, which has led to a housing shortfall of about 3.5 million units.

There is a tremendous opportunity for developers to change the face of California by meeting the demand for housing.

Governments Are Looking to Streamline Housing Approval

Murray and Wallace agree, the first step is to have the government get out of its own way. Legislatures want hundreds of thousands of new units built each year to keep up with demand, and at the same time there are roadblocks to development which will slow down proposed projects.

However, Murray sees legislation headed in the right direction. “Developers are remaining bullish on multifamily housing for a combination of reasons,” says Murray. “One being recent legislation at the state level that has created a myriad of potential avenues for multifamily residential development that streamline that development, and in some cases make it a more automatic approval.”

Along with removing steps in the approval process to build new multifamily units, communities are considering asking developers to renovate or reuse existing infrastructure.

“There are even some laws that would allow you to convert property that’s zoned for commercial uses to residential without having to go through a rezoning process, which again, would make it much faster, much easier to move your residential project forward,” says Murray.

These conversions are a popular idea because they allow developers to create housing in desirable locations rather than continuing to push development into the suburbs and out into rural areas. There are several demographics that prefer urban living and want development in vibrant neighborhoods.

Office-to-Residential Conversions Are in High Demand

An apparent element that is driving the commercial-to-residential conversion trend is the rise in remote work. A third of American workers who can work remotely now do so full-time, with 41% of workers enjoying a hybrid experience. Only 24% of people who can work remotely say they rarely or never do so.

The rise in remote work has significantly decreased the need for office space, and some real estate owners are looking to repurpose these buildings. If offices can be converted to multifamily units, California central business districts could experience new life.

“We have a lot of clients with office product who are interested in what they can do with it and whether those residential conversions are possible, what they cost, how long they take, what they look like,” says Murray.

This could have a significant impact on local economies. Many downtown businesses have struggled because of the transition to remote work. If these business districts become residential, there are opportunities for restaurant owners, retailers, and other business professionals to reach local markets once again.

“My general sense is that this is still in sort of the exploratory realm for both developers, owners, and also for the jurisdictions,” says Murray. “I think it’s something that makes intuitive sense, but it’s not actually easy. An office building doesn’t necessarily naturally lend itself to a residential conversion.”

Wallace agrees. While this program might be right for some businesses, there are still plenty of considerations that come with every commercial-to-residential conversion.

“Certain developers have done a good job,” says Wallace. “There are certain buildings that lean themselves to it, and for the right product and the right location, it’s working. And I think we’ll see more of it.”

multifamily Developers Can Benefit From Government Programs

While demand for multifamily units is high, many developers have shared their struggles to build affordable units. Teams need to make sure that their properties will generate a profit, and they need to set certain rent levels to meet their income goals.

“One of the big issues for many of our clients is how to balance affordable requirements [and] inclusionary affordable requirements with their multifamily residential projects,” says Murray.

It’s not that developers are against these inclusionary programs, but they need to make sense on paper. Strategic developers are working with local governments to reach fair compromises for all parties involved. In fact, there are several programs that developers can take advantage of to lower their costs, which can allow them to provide more affordable housing.

“There may be some funding available to help bridge the gap for the lost rent due to an inclusionary or an affordable component,” says Murray. “And in as sort of a general rule of thumb, the more affordable you include, the more benefits you may be able to avail yourself of under state and local law.”

There Are Opportunities But Also Complications

Developers who understand current and upcoming legislation can take advantage of various programs to move their projects forward. They can streamline the approval process and look for redevelopment opportunities and grants. However, many of these programs are complicated and need to be carefully reviewed.

“One thing to bear in mind about the state laws is that most of them have a significant laundry list of qualifying elements to them,” says Murray. “So it’s really important to look in detail at your project and see if any of those state laws are going to benefit what you’re trying to do and the risks and problems that you’re trying to solve for.”