California buildings

Insights for the Savvy Investor on California’s Multifamily Outlook

The Chief Economist at Reis, Victor Calanog, shared his perspective on what multifamily investors in California should be mindful of to drive lasting success—including tax reform, interest rates, underlying demographics and more.
Greg Newman, Managing Director and California Area Manager, Multifamily Lending
September 12, 2017

With so many factors affecting multifamily businesses in California today, it’s more important than ever for investors to stay informed. I recently met with Victor Calanog, Chief Economist at Reis, to discuss California’s multifamily market—and what key factors investors here should be aware of to drive lasting success in today’s constantly changing marketplace.

Here are some of the key highlights from our conversation:

What Macroeconomic Factors Should You Watch?

The current economy—as well as its near- and long-term trajectory—and how it might affect real estate fundamentals should be top of mind for multifamily investors in California. Due to the unlikelihood of infrastructure and tax reform passing in 2017, Reis has lowered its expectations of GDP growth from 2.7 percent to 2.1 percent. Although that might seem like a disappointing number, it’s 50 basis points higher than it was in 2016—so while the economy might not be growing as much as many thought, it’s still improving year over year.

At this point, it’s unknown exactly what’s on the table when it comes to tax reform, but one key component of tax reform Calanog encouraged our clients to watch is 1031 Exchange. “If 1031 Exchanges are eliminated, it would likely have a fairly chilling effect on transaction volume. I think the 1031 Exchange policy has really encouraged a lot of rollover into new properties. I am not sure it can be phased out completely in an expedited way, just because of all the benefits that come from such an exemption,” he said.

How High Might Interest Rates Get in the Coming Years?

Another factor that is on the mind of multifamily investors across the country is interest rates. If investors want to know what spreads will look like in the next two to three years, it’s important to know what is driving interest rates up. First, it’s essential to have a solid understanding of the Fed’s policies; second, without getting too granular, it’s important to understand that at the end of the day, the price of money is contingent on how quickly the economy can grow.

“If we are looking at an era of 2 percent growth, then you should expect interest rates to also remain relatively low. If you don’t believe that the US economy will hit a 4 percent growth rate in the coming years—our highest GDP growth rate this millennium was back in 2003 at 3.7 percent—then you should expect a period of relatively low interest rates,” Calanog said.

J.P. Morgan Markets Interest Rate Forecast

Hover over sections of the graph to show additional information. Click on a category to show or hide its data.


Source: J.P. Morgan Markets; as of September 8, 2017

Vacancies Are on the Rise—Should You Be Concerned?

Overall, supply growth in the multifamily asset class across most major markets in the US is at levels last seen in the late 1990s. But, it’s important to note that the influx of new units is being driven by robust rent growth, low vacancies and strong demand. However, with that said, vacancies have begun rising in some of the more expensive markets across the broader US and California.

Consider San Francisco, which in 2012, had vacancy levels at 3.1 percent—but by 2015 vacancies had jumped to 4.5 percent. While vacancies continue to rise, the speed at which they are increasing has tapered: In the first quarter of 2017, vacancies in San Francisco were at 5 percent. A couple of things account for higher vacancies. In markets like San Francisco that are very expensive, and though they might historically have low vacancies, when an influx of new properties come online, simply put: something has got to give if there’s not increasing demand to match increasing supply.

Multifamily Vacancy Rates in California

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Source: Reis

It’s important to note that a 5 percent vacancy rate is usually nothing to be upset about, in fact, it’s a solid place for vacancies to fall. As Calanog said, “I don’t think any multifamily investor should be too concerned about a 5 percent vacancy rate in their market.”

Is Class B Well-Positioned?

Due to rising costs, 99 percent to 100 percent of all new construction right now is being marketed as Class A. If it’s coming up from the ground, given how expensive it is to build, it doesn’t make economic sense to charge B or C rents. As a product of that, a lot of the competition that’s coming online that’s depressing overall market statistics is in the Class A segment.

In many markets, Class A vacancies are starting to spike, while Class B or C vacancies have remained somewhat constant. The Class B and C segments are more affordable, so occupancy isn’t taking as much of a hit and neither are effective rents.

Effective Rents by Market

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Source: Reis

To quote Calanog, “I think it’s a great play to wait in the wings in the B and C markets, because we have found that in this environment—when the economy isn’t growing by leaps and bounds—the more affordable property types tend to be more stable and usually benefit from any Class A exits during a downturn.”

In a slower growth environment, and with a possibility that there might be a recession at some point in the next decade, investing in Class B properties remains a strategic move.

Do Demographics Support Your Strategy?

One key topic many investors are looking at is millennials and whether they’re simply postponing the home-buying decision, or foregoing it altogether. The fact that millennials, who make up the largest generation, aren’t buying homes like previous generations has been a definite positive for multifamily investors, but it’s unlikely to last forever.

“Call it psychology, call it aspirational or call it the American Dream, at some point millennials will likely want to own their homes. However, they’re probably saddled with student debt and they’re likely trying to figure out if they want to settle into the expensive metropolitan area they’re in now for the long run,” Calanog explained. “Overall, data show that millennials have postponed things like getting married, having kids and buying a home—but the aspiration is likely still there for many of them.”


Sources: 1. US Bureau of Labor Statistics 2. US Census Bureau

Even if the older millennials—who are 30 to 37 years old today—stop renting, you still have significant drivers of demand from 17-year-olds who haven’t started forming households yet and likely won’t do so for years to come. “When you look at homeownership rates, 30- to 34-year-olds fall around 30 percent homeownership. But when you look at 35 to 39, that number jumps to 55 percent,” Calanog explained.

Millennials by the Numbers (in millions) 34-36 30-33 26-29 22-25 18-21Source: US Census Bureau Age: 17.1 18.5 18.1 17.4 8.6

“What we’re looking at is at least five to 10 very strong years for multifamily investors. Rents may go up or down. Recessions may come and go. But I suspect that multifamily will be solid despite some potential bumps in the road,” Calanog said.

Overall, if multifamily investors in California continue to stay informed on trends impacting the markets in which they do business, look for ways to enhance revenues and keep a close eye on expenses, they will be well-positioned to succeed.

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© 2017 JPMorgan Chase & Co. All rights reserved. Chase is a marketing name for certain businesses of JPMorgan Chase & Co. and JPMorgan Chase Bank, N.A., Member FDIC. The material contained herein is intended as a general market and/or economic commentary and is not intended to constitute financial or investment advice. Any views or opinions expressed herein by Greg Newman and Victor Calanog, are solely those of Greg Newman and Victor Calanog and do not reflect the views of and opinions of JPMorgan Chase & Co. or its affiliates. This information in no way constitutes J.P. Morgan research and should not be treated as such. Further, the views expressed herein may differ from that contained in JPMorgan Chase & Co. research reports. The information herein has been obtained from sources deemed to be reliable, but JPMorgan Chase makes no representation or warranty as to its accuracy or completeness.
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