Resilient apartment demand will continue to insulate the Los Angeles apartment market from the effects of the uneven recovery, though modest downside economic risks will persist. For example, the Eurozone crisis and economic slowdown in China – the Port of Los Angeles’ largest foreign trading partner – will limit imports and exports and moderate overall employment gains. Local manufacturers have already shed 5,000 jobs in 2012, and 2,400 transportation and utility positions were eliminated in the past two months.
Nevertheless, metro-wide employment expanded by more than 40,000 jobs in the past six months, a growth of 1.1 percent compared to 0.6 percent nationally. Additionally, gains have been relatively broad-based. The professional and business services, as well as education and health services industries, have added 25,000 jobs since the start of 2012. Resurgent tourism has also boosted leisure and hospitality payrolls by more than 10,000 workers.
Rehiring, combined with a still weak demand for single-family homes, has supported apartment leasing. Asking rents have particularly improved. In the first half of 2012, market-wide asking rents appreciated 5 percent to $1,730 per month, compared to a gain of 3 percent for all of last year. Rent increases have been particularly robust in the West Los Angeles submarket, with rents rising 7.5 percent year to date to $2,147 per month. Market rents in Northern Los Angeles advanced 2.8 percent to $1,463 per month year to date, while rents in Southern Los Angeles ascended 2.3 percent to $1,460 per month.
Vacancy, while low and nearing pre-recession levels, is the biggest reflection of the choppy economy. In the second quarter, metro-wide vacancy rose 50 basis points to 4.8 percent. Despite the uptick in vacant stock, the second quarter rate is 30 basis points below year-ago levels and is not far from the 3.9 percent recorded in the quarter preceding the recession.
While modest vacancy fluctuations are the most distinct sign of the erratic economy, investment demand in the Los Angeles apartment market is signaling that the economy has sufficiently mended and will continue to strengthen. In fact, prospective investors are realizing it is an evolving market and are becoming more competitive. Dean Zander, senior partner in Hendricks & Partners’ West Los Angeles office, notes that “investors who truly want to be the successful bidder are becoming more flexible and willing to comply with the seller’s hurdles, including increased deposit amounts and tighter closing periods.”
Cap rate compression is happening throughout the Class A and Class B markets. “Investment demand far exceeds the supply of available Class A assets,” adds Vince Norris, a partner in the firm’s North Los Angeles branch. “Cap rates in this segment have compressed an average of 25 basis points to the high 3 percent to low 4 percent range during the second half of the year.”
Supply of top-quality apartment stock has remained steady but low, though sales of distressed assets and performing Class B properties have kept overall velocity steady. Market-wide cap rates fell 20 basis points to an average of 5.7 percent so far in the third quarter. Cap rates are expected to compress further among these middle-tier properties, especially, as Norris points out, “the lack of Class A product will increasingly push investors to explore Class B assets, where value-add and repositioning strategies are being utilized to tap into the accelerated rent growth at the top end of the market.”
— David Delich, senior director of research, Hendricks & Partners