L.A.’s Apartment Market Stays Hot at 2018’s Midpoint

In Uncategorized by judycdchow0 Comments

CoStar Market Insights: Rock-Bottom Vacancies, Historic Levels of Demand and Record-Setting Investment Totals Keep Market Strong

CoStar Market Insights: Rock-Bottom Vacancies, Historic Levels of Demand and Record-Setting Investment Totals Keep Market Strong

The Los Angeles multifamily market has been one of the strongest in the country during the post-recession recovery and momentum continued to build over the first half of 2018.

The one-two punch of intense demand and limited new supply continues to define the L.A. apartment scene, as a variety of factors make it nearly impossible to build enough new housing to keep pace with the area’s needs. Despite the fact that more units are under construction than at any point this century, the vacancy rate is at its lowest level since 2006.

Rents Are at All-Time Highs, but Growth is Slowing

The rate of rent growth has been declining for several years despite these tight vacancies. This mirrors a national long-term trend of slowing growth as the cycle matures. But the slowdown in L.A. has been especially pronounced lately.

For much of this cycle, Los Angeles rent growth significantly outpaced the nation as a whole, besting the National Index rate of growth by around 200 basis points in both 2015 and 2016.

That spread, however, has disappeared and over the past four quarters L.A. rents grew at about 3 percent — the same rate as the nation as a whole. After ranking among the top markets for rental gains for the past several years, L.A. rent growth is now in the middle of the pack among the 54 largest markets tracked by CoStar. The 3 percent annual gains are still slightly ahead of L.A.’s historical average, though.

Given the healthy vacancy picture, a lack of affordability is the most likely culprit behind L.A.’s declining growth figures.

Several years of outsized growth earlier this cycle pushed rents to record highs, with more and more renter households needing to dedicate an unsustainable amount of their income to housing costs. The average asking rent for all Los Angeles apartments is now $1,850 per month, with one-bedroom units asking an average of $1,675 per month and two-bedroom units commanding around $2,140.

In the more-desirable submarkets close to major employment hubs, the cost of living is far higher. Average rents in every Westside submarkets are north of $2,000 per month and Valley submarkets like Pasadena and Burbank have crested that average as well. In Venice Beach/Marina del Rey, Beverly Hills and Santa Monica, average rents are closing in on $3,000 per month. And in Downtown L.A., average monthly rates have crested $2,500.

These types of monthly housing costs are not attainable for a large portion of L.A.’s rental pool.

As a result, more-affordable submarkets have seen an uptick in demand and a subsequent jump in pricing. Areas like the Antelope Valley, Inglewood and peripheral San Fernando Valley have posted some of the strongest rent gains over the past year. In the Antelope Valley, when average rents are only about $1,200 per month, annual rent growth was more than double the rate of the wider market. Because of the lack of new development to serve as a release valve in these less-expensive outlying communities, rent growth will likely continue to outperform.

Construction Concentrated in a Handful of Submarkets

Developers continue to target a handful of specific submarkets and the lion’s share of new supply is concentrated in just a few hotspots.

Downtown Los Angeles remains not just the busiest submarket for new multifamily construction in LA, but one of the busiest in the entire country. More than 2,000 new units delivered in Downtown in each of the last three years and more than 6,000 were underway at mid-year 2018. Submarkets close to Downtown like Koreatown, Studio City/North Hollywood, and Southeast Los Angeles also rank among the leaders for new construction in the market.

There are only a handful of development hubs outside of the Downtown area. Hollywood remains a popular target for both multifamily and office development. Woodland Hills, and specifically Warner Center, has also emerged as a popular target. The Warner Center 2035 plans, which envisions adding thousands of new housing units and millions of square feet of commercial space in coming decades, makes this one of the few communities in Los Angeles that is encouraging greater density.

Of the 36 multifamily submarkets tracked by CoStar, only eight had more than 1,000 units under construction at mid-year. In total, a little more than 27,000 units were underway across LA County. These are the highest totals seen in LA this century and the coming years should represent the peak of this cycle’s building boom. However, in a metropolitan area of more than 10 million people, with close to two million renter households, current construction levels are not sufficient to significantly alter the market’s underlying fundamentals.

Rising Costs Impeding Development?

Attempts to address this housing shortage through legislation may be backfiring.

Measure JJJ, a ballot measure designed to spur the development of more affordable housing, was approved by voters in late 2016 and implemented in the second half of 2017. Developers have reported that the affordable housing and prevailing wage provisions of the measure have driven up typical apartment construction costs by 20 to 30 percent.

Tariffs on building materials such as Chinese steel and Canadian lumber have also caused construction costs to rise dramatically. Opponents of Measure JJJ warned that increasing construction costs would lead to less housing being built, and evidence is now emerging those warnings may have been valid.

Construction starts over the first half of 2018 are well behind the pace established in previous years. Roughly 14,000 units began construction in 2016, but that number declined to around 10,000 in 2017 and only about 4,000 units broke ground in LA County over the first half of 2018.

If that pace holds steady, this will be the weakest year for new multifamily starts since 2013. This decline has been especially pronounced in Downtown LA, the submarket which has been the engine driving new residential construction in the metro. After 3,000 new starts were recorded Downtown in 2014 and 2015, and more than 4,000 in 2016, DTLA apartment starts have come to a screeching halt. Only about 1,000 units broke ground in 2017 and fewer than 300 over the first half of 2018.

Record-setting Investment Levels

The combination of strong apartment demand and limited new development presents an appealing scenario for multifamily investors — and capital has been flooding into Los Angeles as a result. The four-quarter period ending in the second quarter of 2018 was the most heavily traded in LA history, with roughly $10 billion in apartment sales recorded.

The average sale price per unit has crested $275,000 per unit, a record-high for the market and nearly doubles the average national price. Average cap rates continued their steady, years-long compression. The average cap rate for all multifamily sales is just slightly above 4 percent and it is not unusual to see high-quality assets trading at sub-4 percent yields.

The most notable deal of the first half of the year was Brookfield Property Group’s acquisition of a 49 percent stake in the Project Europa portfolio. The seven-building portfolio included four high-quality LA assets: the Altana in Glendale, the Alder in Northridge, Eighth & Grand and Atelier in Downtown LA.

These are some of the premiere new developments built in LA this cycle and help define the top of the rental market in their respective submarkets. Brookfield paid about $914 million to acquire a 49 percent stake in the portfolio from Carmel Partners, putting the value of the entire portfolio at $1.87 billion. Atelier was the jewel of the portfolio and was valued at more than $770,000 per unit.

As the first half of 2018 drew to a close, the Los Angeles multifamily market remained very healthy. The market’s large population, diverse economy and unaffordability of home ownership help to underpin consistent, strong demand for apartments. Concurrently, high construction costs, an onerous permitting process, and well organized community opposition limit the amount of new housing that can be built. Given strong demand and very tight vacancies, affordability appears to be the main factor limiting growth.

With the structural advantages enjoyed by those lucky enough to own multifamily assets in LA, the market should remain one of the most popular targets for multifamily investors in the country.  (Costar  25 July 2018)

Leave a Comment