While 2024 is expected to see the largest wave of new multifamily supply coming online since the 1980s, a significant decline in new construction activity is projected due to high interest rates, a scarcity of construction financing, and skyrocketing materials and labor costs. Construction levels are expected to start rebounding in the next 12-18 months as supply and demand find equilibrium and as capital markets and interest rates ease. Jennifer Jeffers, Senior Counsel at Allen Matkins, and Jordan Lang, President of McCourt Partners, discuss the positive trend in rent growth, continued remote- and hybrid-work strategies, and the push for regulations to make office-to-residential conversions more feasible as part of the Winter 2024 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey.

A Slowdown for Construction Starts

According to Jennifer Jeffers, “Analysts believe construction starts may slow down as much as 45% as compared to pre-pandemic levels and as much as 70% as compared to 2022 peak levels.” The reasons for this are multifaceted: rising interest rates, skyrocketing labor and materials costs, and financing that is expensive and difficult to procure. Long and costly permitting and entitlement processes and project litigation risks also add considerably to a project’s overall cost. Developers need to take the long view; construction is very closely tied to interest rates and capital markets, so as those ease, there should be a rebound in construction activity.

Rising Rental Rates

Rents skyrocketed in 2021 and the beginning of 2022 due primarily to people looking for new markets of affordability, as well as population centers increasing, leading to new projects and developments.

“In 2021 and 2022, the system saw a large influx of new supply based on underwriting new and greater rental growth rates,” says Jordan Lang. However, according to Jeffers, most urban sub-markets are showing a decrease in rent rates due to inflation, economic uncertainties, out-migration primarily in California as well as remote working conditions. Looking ahead, with higher mortgage rates and single-family home costs that lend themselves better toward long-term rental, rent growth will likely end up in the positive by the end of 2024 and beginning of 2025.

A Targeted View of Growth Markets

For Lang, the fundamentals that are driving the interest in various cities and regions today are the same reasons that had been present over the last several years, which is low regulation and high growth.

“Nationally eight out of 10 markets of growing multifamily inventory are in the Sunbelt area, dubbed by some analysts as the poster child for oversupply,” says Jeffers. She sees near term rent, growth and occupancy being strongest in the Midwest and the Northeast, and also in established urban centers like New York, Chicago, Boston, and Washington DC. In California, San Diego is poised to be the strongest and most successful jurisdiction, largely due to its muted supply growth and the strong and robust life sciences job market.

Looking ahead, Lang says that Las Vegas and Dallas are two of the markets that are well-positioned for multifamily development. Dallas Fort Worth is projected to be a top five population growth city over the next five years. And in Las Vegas, the influx of big businesses and sports franchises is indicative of the population growth that the region has seen.

Hybrid/Remote Is Here to Stay

Hybrid and remote working conditions are here to stay and both of those factors impact design and geographical locations for development quite significantly. Developers are looking to build out spaces that create community. “No more business center with two chairs that one person uses twice a week but rather a much larger communal, hospitality-focused space,” says Jeffers. From a geographical standpoint, remote workers are driving a large demand for areas outside of the more traditional downtown, areas that are centrally located around transportation hubs and mixed-use amenities.

Simplifying Office-to-Residential Conversions

There are currently a lot of economic realities that make the conversion to residential infeasible from a cost standpoint. According to Jeffers, “a new analysis recently put out by Gensler showed that only about 30% of existing office buildings are conducive to residential conversions.” But there's also been a strong push from the federal, state, and local level on office-to-residential conversions, so she expects over the near term to see a lot more legislation and regulatory changes to help make sure that the conversion to residential is more economically feasible.