California’s Multi-Family Market Remains Bullish Despite Economic Uncertainties

Developers and investors continue to build up California’s multi-family housing market despite economic and supply chain challenges. Marc Renard, Executive Vice Chairman and Executive Managing Director of Cushman and Wakefield’s Global Capital Group, and Spencer Kallick, Partner at Allen Matkins, shared their views on the current multi-family environment.

As part of the Winter 2023 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey, Renard and Kallick explain how the California multi-family real estate market is being impacted by the current economy, identify regions that are “hot,” and discuss impactful legislation that benefits investors.

Building Costs Remain Elevated

With inflation at a 40-year high, it should be no surprise that the price of raw materials continues to negatively impact development in terms of cost. Although some prices, like building, have dropped; materials such as brass, lumber, and steel products are still higher than a year ago. “The property production price index is currently at 148, but at the beginning of 2020 it was 118,” says Renard.

Renard continues, “Developers want to build, and while they’re still active, the rapid increase in interest rates has created a more challenging environment.” Previously developers had a 4.25% to 5% yield on cost, but now after seven interest rate hikes in nine months, that number has jumped to 6% or more. “This has created a dramatic and swift change in underwriting deals, making them harder to pencil,” notes Renard.

New deals are still “moving forward,” according to Kallick. While he’s not seeing a lot of people acquiring new property, they are working on getting existing plots entitled. It doesn’t take a lot of money to do this, and by having the processes completed, they will be the first ones ready to start when the next development cycle begins.

That said, because there’s such great demand for multi-family housing in California, and lack of supply, Kallick doesn’t “see interest rates and inflation creating a huge impact in regard to entitlement and development for multi-family because the market is hot right now.”

Legislative Policies That Will Positively Impact Multi-Family Housing

The California state government is taking action when it comes to passing legislation that will help foster new multi-family development.

AB 2011 is geared toward streamlining housing, making it a ministerial approval and eliminating the need to go through the California Environmental Quality Act (CEQA). It also alleviates entitlements, so there’s less time and money spent during the planning stages, and developers can focus on getting the units ready for residents.

The other bill, AB 2097, requires that there be no parking within half a mile of transit areas. Both of these bills help “fast track development” and aid in reducing costs, notes Kallick. Projects will be completed faster and with less expense, especially because being able to build with less parking makes multi-family projects pencil better.

The Future of Multi-Family Housing

Renard notes that there’s an abundance of supply, which has been elevated for a couple of years already. “We were averaging about 450,000 starts per year, which is considerably higher than the historical average of 350,000.” His prediction is that there will be a decline in new starts from 2025, which will strengthen the marketplace.

He believes the future holds a lot of promise when it comes to rent growth. Both 2021 and 2022 were record years in terms of average rent increases. In the U.S., there was a 15% rent growth in 2021, which was the highest increase in nearly a century. While 2022 didn’t see such a high percentage increase, 6.2% on average, that number puts it at the second highest increase.

As to where the hot markets for multi-family will be, both Renard and Kallick agree that suburban areas will continue to grow, though rents may decelerate. “Investors need to determine whether they’re going to triple down on the hot suburban markets of the last three years or focus on the urban areas where rents have not recovered as quickly,” Renard says, “I have a lot of conviction for strong rent growth in the urban cores going forward.”

Housing is being built almost everywhere, including existing parking lots and where malls once stood, because there’s so much demand.