Coming Attraction: The Great Los Angeles Multifamily Recovery
Reducing the Los Angeles economy to the entertainment industry would be a serious mistake. In fact, the L.A. labor market is highly diversified with world-class healthcare, professional services, biotech and technology clusters providing co-sector leadership — no one-trick pony is this.
Nonetheless, the entertainment industry is the single element that separates this metro economy from all others, and its tentacles are long. In its absence, the metro’s financial and professional services, tourism and digital media sectors might seem almost ordinary.
Hollywood content production has been curtailed dramatically by social distancing demands. Active filming in the second quarter plummeted 98 percent from the year before, according to nonprofit industry group FilmLA. This has a devastating effect on thousands of employees on industry payrolls and many times more freelancers, sole proprietors and contract employees that make up the bulk of the film and TV industry’s creative workers.
Consequently, the L.A. labor market absorbed among the hardest blows dealt by COVID-19. Although second quarter L.A. County payroll employment declined only 12.4 percent year on year, in line with outcomes observed in the Bay Area and San Diego, total employment — a government statistic that includes the self-employed and gig economy workers — plunged 21.3 percent, a setback only exceeded in a few tertiary West Texas and Midwest metros with significant energy or auto industry exposure. The unemployment rate approached 21 percent in May and would have topped that figure easily if more than 350,000 residents had not exited the work force since 2019.
How quickly can Los Angeles recover from this deep hole? If history is any guide, the answer is several years. In each of the past two recessions L.A. employment returned to pre-crisis peaks only after 48 months or longer.
May a swift return of TV and film production accelerate the process? Absolutely. Our modeling exercises suggest that the coming L.A. recovery may require only half the time of the 2000 and 2009 events.
To date, the pace of content recovery has been slow, limited largely to commercials and daytime dramas. Producers are reluctant to expend much effort or capital on larger productions until the risk of public health shutdowns subsides. Filming on larger projects will gain momentum in September, but it may be months before activity shifts back into top gear.
Multifamily market performance hangs in the balance. The pace of both payroll and total employment growth are highly correlated to apartment space demand and rent trends in the L.A. market. With more than 10,000 units scheduled for delivery between July and year-end, slow employment growth will put property revenues at considerable risk, particularly in submarkets in and around Downtown, where supply will be heaviest.
To date, market performance under pandemic stress has been encouraging. A 236,000-unit same-store sample of properties stabilized for at least 14 months surveyed by Yardi suffered negative net absorption of only 863 units from March to June, and actually posted positive absorption (36 units) in July. Sample occupancy declined only 0.35 percent during the period to 94.95 percent, a notable improvement over the 57 basis point plunge recorded over the five months ended in February.
More stress was evident in rent trends. As in the Bay Area, average rents peaked early last fall and exhibited greater than normal seasonal weakness from October to February. Coronavirus restrictions and economic distress merely exacerbated an existing tendency. Sample rents declined 3 percent from February to July, with the largest sequential month decrease coming in April (0.8 percent). Class A rents were weakest, falling 4.2 percent in the same period, including a 1.1 percent April plunge.
Further occupancy attrition is likely even under the most optimistic economic assumptions. Unless enhanced unemployment benefits somehow can be maintained through winter, metro occupancy is likely to fall to the mid-94 percent area by spring 2021. Rents will be pressured lower, accordingly, falling another 3 to 4 percent from mid-year levels. Class A rents are likely to underperform the average.
Investors are exhibiting appropriate caution. Apartment property sales in the six months ended in August declined 70 percent from the same period 2019, and cap rates have increased about 20 basis points to about 4.4 percent for standard Class B assets.
Are Los Angeles assets compelling relative values? Not yet, but the best buying opportunities for recent construction trophy properties in a decade may be coming soon to a theater near you when the L.A. content factory gears up again.
— By Daniel J. Hogan, ORIX Real Estate Capital’s Managing Director for Research. RED Mortgage Capital, a division of ORIX Real Estate Capital LLC, is a content partner of REBusinessOnline. The views expressed herein are those of the author and do not necessarily reflect the views for RED Capital Group or of the author’s colleagues at RED. For further analysis from RED Capital Group, click here.
For Hogan’s insight into other markets, click here.