What's in Store for Los Angeles Multifamily in 2022?
2021 ended up an extremely active year in every sector of commercial real estate, throughout the country. Los Angeles ended up with $31.7 billion in commercial real estate volume which ranked third in the country behind Dallas and Atlanta which saw incredible population growth over the past two years. Given our tepid population growth locally coupled with expanded regulation, being third in the country for commercial real estate volume is an incredible win.
Rental Growth
2021 was a year of strong rental growth throughout all of Los Angeles. Downtown LA rents which just a year ago had decreasing rents, major tenant concessions, and an oversupply of new construction came back strong in 2021 with 16% rent growth. Average rents in DTLA now are $2701 which is a record for the Downtown. Vacancy was hovering around 14% just a year ago and is now 6%. The absorption rate of new units is a very promising sign for LA as whole. Tenants want again to be walking distance to nightlife, entertainment even if they are working remotely.
Higher Interest Rates in 2022
Wall Street is expecting anywhere from four to seven rate hikes this year. Seven rate hikes would move the Federal funds rate to 1.75% - 2% by years end. Multifamily rates have not moved much yet based on 3 – 10 year fixed periods, however every investor needs to brace for higher rates that could go from the low 3s to the low 4s in a relatively short period of time. Before the pandemic multifamily interest rates were in the mid 4% range which will have adverse effects on cap rates and the overall value of assets especially multifamily. The average cap rate now in LA is around 4% with borrowing rates in the low 3s. Should interest rates go to 4%, cap rates will have an adjustment period.
Can multifamily owners benefit from higher interest rates?
The positive aspect of higher interest rates is it will deter many potential single-family buyers from purchasing a home. Single family interest rates have already risen 50 basis points and can only rise from here. As rates continue to rise many potential buyers will remain renters as higher rates will price certain buyers out of the market. Many economists expect rental growth throughout the country to increase around 10% this year and vacancies to fall under 5%.
Continued Regulation
LA County recently enhanced the eviction moratorium in some form through June 2023. Starting June 1st tenants that make up to 80% of the median income will continue to receive tenant protections from eviction meaning a family of four that makes $94,000 per year cannot get evicted for nonpayment of rent. The rent freeze will be in place for rent control units throughout the year at a minimum as well. Last year, most buyers looked past the regulation as there was some optimism the eviction moratorium would expire and there would be a defined date on when the next increase will take place. So far this year, buyers have attempted to ask for discounts just based on the enhanced regulation, however with low inventory throughout LA and very favorable rents we should continue to be a seller’s market for at least the first half of this year.
Should you build an ADU?
The ADU (accessory dwelling unit) law for multifamily has been in place for just over two years and the amount of ADUs built throughout the city has been somewhat limited so far. Many value add owners have been taking advantage of the program by converting storage, laundry, parking, and open spaces to units. Even with the high cost of construction now, ADUs pencil most of the time. When taking away tenants parking in high rental value apartments it may be a wash as those units will be in tougher to rent in certain submarkets.
Many savvy investors are underwriting adding ADUs to new purchases which helps deals pencil, especially with compressed cap rates and increased difficulty with cash for keys buyouts. Tenants are continuing to ask for higher buyout numbers so the ADU play may turn a tough value add play into a positive cash-flowing deal with brand new units. Many investors have also realized the cost of construction of the ADU is still cheaper than building a brand-new ground up unit.
Rent Collection Rates
Most of the articles and surveys on rent collection data is on the instructional side even though independently managed mom and pop apartment owners represent the majority of units, especially in the LA market. Over the past four months, on time collections nationally were at 78% while end of the month collections came in at 85%. Mom and pop independently managed buildings performed slightly lower in the 76% range for on time collections. There continues to be a pattern demonstrating that professionally managed and institutionally managed properties are better equipped to handle rental collections than independent mom and pops. As regulation continues in LA, there will more than likely be an uptick in inventory of buildings on the market from mom-and-pop owners.