While the near-term outlook for the region’s multifamily market looks challenged as the effects of the pandemic persist, the durable tailwinds that have buoyed the sector over the last decade look certain to return in force once vaccinations are widespread.
COVID-19 has been the primary driver of the shifting demand to the periphery as people reconsidered dense urban living environments. As urban amenities and offices closed, 2020 saw an outflow of residents from dense urban multifamily properties with key urban submarkets (DTLA, Hollywood) experiencing a particularly significant impact on vacancy and rents. Vacancy has surged and is projected to peak in most submarkets at levels slightly lower than the Great Recession. Address change data shows LA County experienced 33% more move-outs since March 2020 than in the same period in 2019. Data are unclear as to the composition of the move-outs. Some are due to moving in with family, leaving a college environment and moving out of state. Data suggest that it is likely that the pandemic has accelerated relocation decisions, especially for the large cohort of formerly urban millennials who are nearing family formation age. While we fully expect some of the demand to return once urban amenities reopen and people are able to return to offices, the region’s evolving demographics suggest that the increase in suburban demand will be durable.
As this dynamic dragged down average rents for the region, demand for suburban assets held largely steady. Some clients report achieving modest rent growth in less dense suburban communities. CBRE estimates that Los Angeles’s apartment rents on average will bottom out at 11% below the pre-pandemic peak rents and will begin a robust recovery in mid-2021.
On the backdrop of this latest market dynamic, a substantial amount of capital is sitting on the sidelines for multifamily assets. Some owners are reluctant to put their properties on the market with rent collections impacted by COVID’s ripple effects. Owners have reported that before they consider selling their assets, they need to be able to stabilize their properties and thus their values. Sales will also struggle a bit more than pre-COVID times because conservative appraisal valuations will be down due to COVID rent discounts and non-paying tenants which will result in lenders offering less loan proceeds. Thus, buyers will have to come up with more equity for their down payments, causing a strain on sale transactions.
However, a number of sales are moving forward, albeit at a lower volume than during pre-pandemic times and cap rates are appearing to compress, primarily because market rental rates and collections are down, causing a temporarily lower yield. It appears that investors understand that current apartment buildings’ performances are artificially low and are willing to accept a lower cap rate today based on the belief that these effects are short term.
On the construction end of things, developers are optimistic that starts, while down so far this year due to higher labor and raw material costs and restraints on loan availabilities, will be improving by the third quarter.
All in all, the Los Angeles multifamily market seems to be well positioned for a robust recovery for rental rates, occupancy and sales volume. Once the vaccine is widely distributed, absorption should remain steady, building on strong employment fundamentals and a systemic regional housing shortage.
Laurie Lustig-Bower is Executive Vice President with CBRE.
