SAN DIEGO — Multifamily properties in San Diego are in high demand — and not just among Millennials and empty nesters who long for convenience, walkability and beautiful ocean views. Panelists at InterFace Conference Group’s San Diego Multifamily Conference, held March 19 at the Sheraton Hotel & Marina, viewed this market as a hot one… if you can get in.
“There hasn’t been a ton of multifamily transaction activity in San Diego,” said Aldon Cole, senior managing director at HFF and moderator of the “Who’s Lending?” panel. “It’s an interesting market that we’re all trying to navigate. We have to adapt in a low-trade environment.”
San Diego’s reputation for being a stable market and one where people want to be are two of the factors contributing to this lack of opportunity.
“During the last downturn, San Diego was the most stable market,” noted Mark Gleiberman, CEO of MG Properties Group and Developers/Owners panelist. “It always tends to be one of the most stable markets that we’re in. It’s not totally resistant to a downturn, but San Diego tends to fare better in most recessions than other markets.”
Desirability paired with strong market fundamentals has created a very competitive landscape among multifamily investors, especially when you take into account the long-term positions most within the market tend to take.
“The main players are staying in this market,” Gleiberman continued. “They’re typically stable, solid, long-term holders. There’s going to be a recession at some point — no doubt about it — but San Diego multifamily investors will be in a place where they’re less impacted. We don’t see a significant drop in values or cash flow based on what’s happening in today’s market.”
Allen Chitayat, first vice president at CBRE and “Investment Highlights” panelist, noted that although transaction velocity was slow, it was picking up steam over 2018 thanks, in part, to new product debuting in the market.
“San Diego is a very low-velocity market,” he said. “Last year, volume was off 20 percent compared to 2017, but we’re very bullish on this year. In the first quarter, we’ve already had six trades that included more than 100 units apiece. In 2018, we only had 12 or 13 trades total, so we’re already at 50 percent of 2018’s pace.”
Some of the more notable sales last year included Goldman Sachs and Magnolia Capital’s $132 million purchase of Domain San Diego in the Kearny Mesa submarket; Pacific Urban Residential’s acquisition of Sofi Shadowridge in Vista for $115 million; and Sares-Regis Group buying Bella Posta in Mission Valley for $97.7 million.
Non-Core Creativity
Increased competition tends to bring out the creative sides of investors and lenders, and San Diego’s multifamily market is no different. While many remain focused on the existing and in-the-pipeline supply in Downtown and Mission Valley, others are looking at value-add opportunities in Class B and C properties, or they’re turning their attention to the county’s secondary and tertiary markets. Some even do both.
“This market has less velocity and more capital than I’ve seen in the past 10 years,” said Chad O’Connor, senior managing director of capital markets at Marcus & Millichap and “Investment Highlights” panelist. “It’s so competitive that lenders are constantly trying to reinvent themselves to find a niche and gain more market share. Investors are taking older, 1950s and ‘60s buildings and amenitizing and upgrading them.”
O’Connor noted many of these value-add investors are not looking for just straight bridge loans. Rather, they’re seeking fixed-rate loans and, once they’re able to push their rents to market rate, they’re obtaining additional funds. This is done, he said, in the interest of protecting their rate during the upgrade process.
Maria Kunac, executive vice president at Silvergate Bank and “Who’s Lending?” panelist, has also witnessed this trend as investors seek to stretch the value of their dollars during renovation.
“The majority of this activity is in smaller, multifamily, infill projects, [such as in] Pacific Beach, El Cajon and Spring Valley,” she said. “You’ve got a lot of apartments built in the ‘60s and ‘70s and many owners who want to refinance and upgrade the units.
“They’re doing a refi, cash-out refi and interest-only up to 24 months. They’re structuring these loans in a way that the prepayment penalty is in the advantage of what the owner or purchaser wants to do at the end of the renovation.”
These renovations are another solid investment route for those able to get in on the action. Darcy Miramontes, executive vice president of multifamily for JLL and moderator of the “Investment Highlights” panel, noted San Diego rent growth is averaging 3 percent to 5 percent a year, with most underwriting occurring around 3.5 percent to 4.5 percent.
Workforce housing in submarkets like Lemon Grove, La Mesa, Escondido, Chula Vista, Imperial Beach, Vista and San Marcos was also deemed a strategic long-term play, while co-living (think Millennials, the shared economy and Airbnb) was viewed by many panelists as an attractive alternative for renters in expensive markets like San Diego.
“Co-living has become a major force in the market right now,” said Larry Perry, vice president of loan originations at Parkview Financial and a “Who’s Lending?” panelist. “The income is much higher on those types of units than on normal units. It’s an upcoming trend, especially in markets that lack affordability.”
Factoring in the Unknown
As with most commercial real estate conversations nowadays, talk at the San Diego Multifamily Conference inevitably turned to how long we are in this cycle. Though the next downturn seems to be inevitable, panelists speculated about when it will occur and just how severe it will be.
Not everyone viewed this impending bump as a bad thing, however. Especially not in a market as tight as San Diego with little room to run.
“I hope the next downturn is a moderate one,” said Preston Underdown, director of development at Richman Capital and “Developers/Owners” panelist. “We could use a good reset, then we can start growing from there.”
Fellow panelists mentioned they were monitoring the default rates on car loans, the levels of credit card debt and the types of investors who were trying to jump into the commercial real estate game to get a sense of what’s on the horizon.
“The average car payment is $550 per month,” said Aaron Pacillio, “Developers/Owners” panelist and CIO of Davlyn Investments. “How is that going to affect apartment rents? Credit card debt is at a high level. This means consumers are at the end of their rope in terms of what they can spend. Doctors and dentists are the types of people jumping into the market, buying small properties.”
Other unknown variables panelists mentioned were the perceived (versus real) benefits in Opportunity Zones and talk of repealing Costa-Hawkins rent control bill. This act might have failed on last November’s ballot, but panelists weren’t convinced we’ve heard the last of this rent control issue.
“We are not out of the woods yet,” O’Connor said. “We can’t wait until the 11th hour to address Costa-Hawkins. We have to keep putting material out there to stay on top of this and let everyone know how this is going to negatively affect our industry.”
Rising consumer debt and possible rent-control initiatives are things to monitor, Pacillio believed, though they should be considered in the context of San Diego and of the larger multifamily investment fundamentals in general.
“We’re in a cyclical business,” he said. “Everyone seems to forget that. A downturn is going to happen. It’s just a question of when and how deep of a bump will we have to ride?
“But this is a healthy market. I don’t see a lot of over leverage. Banks are pretty disciplined. Value never goes out of style. We simply want to provide the cleanest living environment with the best amenities within a particular threshold without creating the Taj Mahal.”
— Nellie Day