Central Valley Multi-Family Real Estate Market Analysis

Over the past three years, there has been a significant shift in the multi-family real estate market within the Central Valley as well as nationally. The pandemic spurred fundamental changes for the industry as demand for housing surged in the following years to the great benefit of owners and developers eager to meet that demand. As of late, inflation, much higher interest rates, and a record number of delivered units have given tenants stronger leverage in the rental market.

New Development Trends

The rate of new construction has fluctuated drastically in the Central Valley since the start of the pandemic. In 2020, the multi-family market saw low vacancy and rents skyrocketing at never-before-seen rates, sparking large amounts of new development projects. Today, we are expecting 1,585 units to be completed in the Central Valley over the next 3 years. However, interest rate increases, along with softening market fundamentals, rising vacancy rates and more stagnant rent growth, have reversed that construction trend. While current projects are still being completed, there are significantly less new developments coming into the pipeline. In 2023, only one new multi-family project broke ground throughout the Central Valley. This trend is also a nationwide phenomenon. According to the U.S. Department of Housing and Urban Development and the U.S. Census Bureau, the country’s new multi-family construction starts fell by 33.7% over the past year.

Rent Growth Fluctuations

The Central Valley has also seen major swings in rent growth in the recent past. Between 2020 and 2022, rent growth exceeded 12% annually in certain areas. In contrast, going into 2024, projected rent growth is expected to be much more modest. It ranges from 1.1% YoY in Modesto to 3.4% YoY in Madera. National rent growth projections are also down as Freddie Mac projects a moderate 2.5% national increase in rent for the coming year, largely due to over a million units set to come online nationwide.

Rise in Landlord Concessions

The market is witnessing a rise in landlord concessions. To remain competitive against similar properties, owners are increasingly utilizing rent concessions to attract tenants. Common strategies include offering the first month free or providing a discount equivalent to one month’s rent, distributed across the year. These tactics reflect the intensifying competition within the rental market.

Impacts on Property Owners and Tenants

Reflecting on these changes, owners of multi-family properties have experienced both great prosperity and challenges. Property owners enjoyed significant growth in NOI and returns following the pandemic, with strong rent growth and low vacancy, along with robust development. Now, as the market evolves, tenants are emerging with greater influence, as evidenced by moderate rent increases and more rental choices. These developments signify a new chapter in the multi-family sector, balancing the interests of both owners and tenants and paving the way for future growth.

*Data courtesy Visintainer Group and CoStar Analytics, U.S. Department of Housing and Urban Development

Impact of the Slowdown on Commercial Real Estate

As originally covered in The Business Journal

The world of commercial real estate has been a rollercoaster of trends and shifts, with 2023 proving to be no exception. After a robust 2022 marked by strong investment sales, the current year has brought about a significant deceleration. Investors find themselves grappling with heightened uncertainty in the economic landscape, rising interest rates and tighter debt markets. These factors have led to a decline in sales, leasing, and financing, impacting prominent brokerages’ profitability by staggering margins of 50% to 100%.

A notable barometer of the commercial real estate market’s health is the RCA Commercial Property Price Index, which reveals a dip of 8% in the value of commercial real estate over the past year. The situation is even more pronounced in the multi-family sector, where values have shrunk by 10%. This decline shows the market’s current fragility, prompting investors to ponder a central question: How much longer will this trend continue?
 

Central Valley Multi-Family Market Analysis

In contrast to the strong apartment investment sales in 2022, 2023 activity in Q1 and Q2 has cooled down considerably. A significant change in the investment landscape has manifested through an increase in capitalization rates (cap rates), which now average 5.61%. This marks the fourth consecutive quarter of cap rate escalation. Alongside this, there has been a remarkable 62% year-over-year decrease in sales volume, plummeting from $353,960,818 in 2022 to $133,484,774 in 2023. The number of transactions has also decreased, with just 25 transactions recorded in the first two quarters of 2023 compared to 61 in the previous year. Multi-family was the darling of the dance after COVID but the music seems to be fading. The significant decline in sales raises questions about the impact of the new normal and higher interest rates on the once-thriving multi-family market.

 Central Valley Retail Market Trends

Similar to the multi-family sector, the retail market has witnessed a substantial reduction in sales volume, affecting both single and multi-tenant properties. Multi-tenant properties, in particular, have experienced a significant drop of 66% in sales volume year-over-year, while single tenant properties have seen a 43% reduction over the same period. The average cap rate for multi-tenant properties, 6.86%, is the highest average cap rate since the early stages of COVID recovery in Q1 2021. Further, transactions have decreased by a staggering 58% year-over-year. The data illustrates that sellers can expect a reduced buyer pool, prompting pricing adjustments aligned with the debt market, given buyers’ inability to match the previous year’s prices; consequently, the coming months are likely to reveal a notable shift in pricing expectations.

Potential Effects of the Exchange Extension on Market Activity

The recent extension granted by the Internal Revenue Service (IRS) for 1031 exchanges in regions affected by severe storms might hold promise for increased market activity. The extension is until October 16th for the 45-day identification period and 180-day closing term for 1031 exchanges. Investors who were awaiting this extension could potentially unleash pent-up demand, leading to an upswing in transactions. This scenario has historical precedent, as a similar IRS extension during the summer of COVID prompted a surge in activity as the deadline approached.

Charting the Future Course for Investors

The combination of rising interest rates and divergent seller-buyer perspectives on property values has left investors hesitant to commit to new investments. This will likely curtail sales activity as the year progresses, extending into 2024. Apart from the anticipated effects of year-end exchanges, investors are adopting a patient stance, observing how the economy and interest rates unfold before committing to major investment decisions. 

Consulting with an Investment Advisor for Strategic Decisions

Market volatility can create complexities in commercial real estate investing. Consult with an experienced advisor who understands your financial goals and can provide market expertise, with an understanding of elements that impact value.

Brett Visintainer, CCIM is a Commercial Investment Advisor and the Principal of Visintainer Group in Fresno, CA. Formed in 2018 and built on a foundation of investment real estate, the Visintainer Group is a client-first commercial real estate firm. The Group has executed over $715 million in transactions across the United States. Brett specializes in commercial property acquisitions and dispositions and 1031 exchanges for owners in the Central Valley, Sacramento, and Central Coast markets. He can be reached at 559.890.0320 or [email protected].

The Business Journal

The commercial real estate investment market in 2022 experienced a record year, particularly in the retail and multi-family sectors, as investors capitalized on the recovering economy and increased consumer spending. On the heels of Q1 wrapping up, it’s time to examine the performance of the market and explore how factors such as interest rates could impact the remainder of 2023 and beyond.

 Q1 2023 Performance in the Central Valley

In Q1 2023, the real estate market started the correction from the record-breaking year in 2022, attributed to raising rates, not seeing pricing adjustments, and buyer sentiment in the market. Here’s a breakdown of Q1 for each of the major sectors in the Central Valley:

Retail Sector Performance

• The multi-tenant retail investment market experienced significant reductions in volume and transactions. Q1 2023 sales volume was $121.4m, a 72% reduction from the $425.9m sales volume Q4 2022, while transactions were down 28% quarter-to-quarter.

Multi-family Sector Performance

• The multi-family sector saw a similar reduction in volume as Q1 dropped 75% from Q4 2022 – $183.2m down to $45.8m. The $45.8m total sales volume is the lowest since Q2 2013. With the $14,750,000 sale ($300k per unit), the median price per unit was pushed to the highest point we’ve seen – $125,000 per unit.

 Interest Rates and Their Impact on the Real Estate Investment Market

Interest rates play a crucial role in the market, influencing both borrowing costs and investment decisions. In Q1 2023, the Federal Reserve began implementing gradual rate hikes to curb inflation and stabilize the economy. These rate hikes are expected to have the following impact:

• Cost of Borrowing: As interest rates rise, the cost of borrowing for investors also increases. This could lead to a decline in investment activity, as higher borrowing costs may result in lower returns on investment.

• Capitalization Rates (Cap Rates): Higher interest rates can also lead to an increase in cap rates, which are used to determine the value of income-producing properties. As cap rates rise, property values may decrease, potentially making commercial real estate investments less attractive.
• Investment Alternatives: With higher interest rates, alternative investments such as bonds and fixed income securities may become more attractive to investors. This could result in a shift of capital away from the real estate market, affecting transaction volumes and property values.

Market Outlook for the Remainder of 2023 and Beyond

Considering the current economic climate, interest rate trends, and increasing competition from alternative investment options, the commercial real estate investment market is expected to face some moderate headwinds moving forward:

Retail Sector Outlook

• Despite the interest rate hikes, the retail sector is projected to maintain steady growth, driven by the continued demand for brick-and-mortar retail spaces and warehouses.

Multi-family Sector Outlook

• The multi-family sector is expected to remain attractive to investors, primarily due to the consistent demand for rental housing and affordable housing projects.

Office Sector Outlook

• Flexible office spaces and coworking models are expected to continue gaining popularity, potentially driving moderate growth in this sector.

Industrial Sector Outlook

The industrial sector is anticipated to continue thriving, fueled by e-commerce and supply chain optimization.

Strategies for Investors in a Rising Interest Rate Environment

As the market navigates the challenges of rising interest rates, investors need to adopt suitable strategies to ensure continued success. Here are some tips to consider:

• Focus on Quality Assets: It’s crucial to invest in high-quality assets with strong fundamentals, such as prime locations, creditworthy tenants, and long-term leases. These assets tend to hold their value better and generate stable cash flows, even in uncertain market conditions.
• Diversify Investment Portfolio: Diversifying your investment portfolio across various property types and geographic locations can help mitigate risks associated with a single sector or region. This approach allows you to capitalize on the growth potential of different sectors while reducing exposure to potential downturns.
• Explore Value-Add Opportunities: Value-add opportunities can help generate higher returns and improve the overall performance of your investment portfolio, offsetting the impact of higher borrowing costs.
• Consider Debt Strategies: It’s important to carefully manage your debt exposure. Consider refinancing existing loans to lock in lower rates or explore interest rate hedging strategies to mitigate the impact of rate fluctuations on your investment returns.

There continue to be opportunities for buyers, but they need to focus on the fundamentals when investing in commercial real estate in 2023. By focusing on quality assets, diversifying their portfolios, and exploring value-add opportunities, investors can navigate these challenges and continue to find success in the commercial real estate market. As we move through the remainder of 2023 and into 2024, keeping a close eye on market trends and adjusting investment strategies accordingly will be key to thriving in this ever-evolving landscape.

Consult with an Investment Advisor

Market volatility can create complexities in commercial real estate investing. Consult with an experienced advisor who understands your financial goals and can provide market expertise, with an understanding of elements that impact value.