Rent an apartment or buy a home? That is the question now posed to many Millennials as they face the facts about the high barriers to homeownership that generations before them, at the same stage of life, could easily overcome. But since the Great Recession and the loose homeownership qualifications that helped spawn it, banks and other home-lending institutions have been under the tight-fisted control of government regulators who have demanded, rightly or wrongly, that prospective homeowners meet strict and often daunting qualifications to buy a house.
Brett Bayless, Colliers Irvine
Patrick Swanson, Colliers Irvine
While that’s bad news for a generation that was raised by families who owned homes and where a home was the primary financial asset for inheritance, it’s good news for multifamily investors, developers and contractors. The demand for apartments has risen to levels eclipsing demand for homeownership in one of the few times in modern history. This is especially true in Orange County where home prices have always been among the highest in the nation.
In fact, demand among multifamily investors is so strong that nearly every recent offering for well-located apartment properties has garnered multiple offers, creating a perfect-storm situation for the sellers. One sale that involved an investment portfolio of four apartment buildings in Orange County brought in 10 or more offers on each of the four buildings. In each of the four sales, not only was the asking price met, but was exceeded, and the sellers didn’t have to worry about the deal falling out of escrow since there were so many qualified backup offers. Since it was our team that managed and negotiated the sale, it could only be described as “frenzied” at times, demonstrating the continued demand for such properties.
This sale also demonstrates, in tangible terms, the confidence investors have in the multifamily investment market in Orange County as we head into a new year. But the question has to be asked: is this a short-sighted investment strategy, or one that will be viable well into the future?
Our only concern is on the supply side — will there be enough properties available for sale to meet the strong investor demand? It certainly will be more challenging to find good investment properties here, but our strategy is, and has always been, to broaden our search base. This is not just in geographic terms, but in terms of population growth and its impact on the multifamily market.
Interestingly, this latest four-property Orange County transaction did not involve new apartments, but apartments that had been well maintained over as long as 30 years, having been renovated, in some cases, multiple times. What they did have in common was their solid neighborhood locations with good schools, low crime rates, and all of the qualities home owners desire. But these were not houses. They were large family apartments and that’s what the Millennials seek because they have become resigned to the fact that they may never be able to afford a home in those parts of Orange County where they work, play and want to live.
Recent numbers show an Orange County average annual rent growth of 6.3 percent, but having about 10,800 new apartments under construction in Orange County now, that type of rise in rental rates will significantly drop in the next few years as supply and demand reach equilibrium. Colliers research shows that 2015 was the highest year yet for rental rate increases at 7.7 percent. This year that rate declined to 4.9 percent, or almost half of what it was a year earlier. Further decreases in annual rental rates are expected in Orange County at 3.5 percent in 2017 and at 2.6 percent in 2018, all of which will be good news to renters.
This shouldn’t affect investors much from what we’re seeing on the ground. Southern California and, Orange County in particular, will continue to be among the strongest rental markets in the country, but there are qualifications to that statement. Well-located and well-maintained properties that can house families will be at the top of investor lists as long as capitalization rates remain at a level where return on investment is acceptable and stable. We see no change there in Orange County. Our most recent experience proves that — when you can inform your selling client that you have multiple offers in hand, it alters the whole dynamic of the sales process. It puts the client in the driver’s seat and that’s what all brokers are attempting to do whether it’s multifamily, industrial, office, retail or mixed-use retail/residential. But, it should be emphasized, that we would never have had so many offers if the cap rates didn’t pencil out.
There is also a flip side to this entire equation. As Millennials enter middle age, their parents are impacting the multifamily market in a big (or even bigger) way as well. One look around Orange County shows that while the standard, family sized apartment market is going strong in terms of development, investor interest, construction and return on investment, there is a growing market for seniors, many of whom live on fixed incomes. However, while demand for these types of units is growing at a record clip, investor interest is not.
Multifamily developers, who are offered tax credits in return for building new over-55 projects, or renovating and converting older multifamily developments into units for seniors, are few and far between. That will change dramatically as we enter the next decade, however. Right now, we can count on one hand the number of developers in this sector active in Orange County. While these few developers are profitable and needed, the return on their investments simply cannot equal those of the developers with new and renovated apartments, at least for now. But all of that will change when the year 2020 dawns.
The Baby Boomers have always had a huge impact on everything they touched, and now they are transforming the apartment market. Simply put, they are not dying as fast as many social scientists predicted. That fact alone means their influence and power over everything from e-commerce to multifamily development remains so powerful that many in the commercial real estate market have missed it.
Downsizing is the byword of the Baby Boomer. While that in itself may create a bubble for the single-family home market unless barriers to homeownership are lowered, it will likely create a bonanza for smart, forward-looking multifamily developers who are the first to build, fill and sell well-appointed, subsidized, affordable multifamily units to investors. With Orange County’s family centric milieu, there would be no better place to begin that process.
— By Patrick Swanson, SVP, Colliers Irvine, and Brett Bayless, Senior Associate, Colliers Irvine. This article first appeared in the January 2017 issue of Western Real Estate Business magazine.