The Inland Empire: A Rare 2020 Apartment Sector Success Story
Someone once remarked that eighty percent of success in life is just showing up. Human experience verifies that being in the right place at the right time often is the intangible ingredient that leads to triumph. The strong performance this year of the Inland Empire multifamily market is a variation on this theme. During the pandemic, many renters sought refuge from the high density and high costs associated with big city life, and the work-from-home phenomenon made this objective feasible. For many Angelinos, Empire living was the best solution — close enough to Los Angeles to maintain contact with family and friends or to go into the office when necessary but substantially less densely settled and more affordable than most L.A. neighborhoods.
By way of quantification, the average Riverside and San Bernardino County monthly rent in July was about $1,578 — and that is 28 percent less than the L.A. County average. The percentage savings for Class A space were about 1 percent greater, and parking, an omnipresent issue for Southern Californians, is typically free. The cost economies found in the Empire are more than trivial.
Moreover, renters are more likely than in the past to find the unit and common amenities in Riverside/San Bernardino (RSB) they might expect in Los Angeles Class B+ and Class A space. Developers delivered nearly 8,000 Class A units to the interior counties in the last four years, nearly all offering the stainless-steel appliances, wood flooring, upscale countertops and inviting exterior design and social gathering space that the contemporary lifestyle renter places high on his or her wish list.
Shifting renter preference in favor of the Inland Empire is clearly demonstrated in recent lease-up behavior. Property occupancy figures published by Yardi reveal that the 12 professionally managed Inland Empire properties currently in lease-up absorbed an average of more than 18 units in July, twice the figure recorded in the year-earlier period. New Los Angeles County properties, by contrast, experienced negative absorption in July, losing an average of one leased tenant per property, comparing unfavorably to a gain of nine in July 2019.
Stabilized same-store occupancy data tell a similar tale. Between February and July, occupancy among a same-store sample consisting of 720 Inland Empire professionally managed apartments increased 28 basis points from 95.47 percent to 95.75 percent. Class A properties achieved the largest pandemic bounce, rising 51 basis points in the same period to 95.22 percent. By comparison, L.A. same-store fill rates plunged 35 basis points overall and 40 basis points among Class A properties, pushing this segment below the 94 percent occupancy threshold for the first time in the Yardi series.
Rent trends followed form. Average I.E. rents increased 1.7 percent between December 2019 and July, including a 1.9 percent pop in the luxury tier. Los Angeles rents plummeted nearly 4 percent in the same period, by comparison, led down by the luxury segment, wherein rents declined 4.4 percent.
The question facing investors is whether the Inland Empire’s success is sustainable or merely a windfall. The historical record isn’t encouraging. Empire rent trends meaningfully outperformed Los Angeles only once previously in the 31-year Reis data history: from late 2001 to late 2004, when L.A. rents returned to equilibrium after the dot-com bubble burst. Otherwise, Empire and L.A. rent trends were highly correlated. Indeed, L.A. occupancy (lagged by one quarter) and L.A. rent growth (lagged by two quarters) are by far the strongest independent predictors of RSB rent growth in RED Capital Research’s 95.3 percent adjusted R2 I.E. rent growth forecasting equation. U.S. personal consumption expenditure growth, which figures in the L.A. rent equation as well, is the only other statistically significant predictive variable generating unbiased results among those variable arrows in our quiver.
The implication is that I.E. rent trends will converge with L.A., more likely sooner than later. Under our elongated V-shaped recovery base case economic scenario, Empire rent growth is projected to outperform through the winter of 2021 but succumb afterward to the downward gravitational force of L.A. performance. If history is any guide, neither market is likely to fully emerge from the 2020 recession before 2023.
History, however, is not destiny. Householder preference for lower density living and telecommuting may become a permanent fixture of the housing landscape. If true, the relationship between Los Angeles and Inland Empire apartment performance will fundamentally change, and the roughly 60 basis point cap rate advantage applicable to Empire properties today will form the cornerstone of excess investor returns tomorrow.
— 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.