Diverging market conditions across the state create challenges and opportunities
By Nigel Hughes
CoStar Analytics
September 24, 2024 | 1:17 P.M.
Buffeted by the diverse impacts of the COVID-19 pandemic lockdowns, stimulus funds, inflation and rising interest rates, the apartment sector has had a tumultuous time in the past few years, nationally and in California. As we head into the last quarter of 2024, where do California’s major multifamily markets stand and what challenges and opportunities lie ahead?
At the national level, the pandemic unleashed a surge in apartment demand. Safety concerns and lockdowns slashed demand for travel, entertainment and other activities, but they boosted new household formation. Forced savings and stimulus funds added to this trend, and apartment demand reached record levels in 2021.
That demand coincided with a locational shift as population, jobs and businesses moved from coastal markets to the Sunbelt, where multifamily rents increased significantly, prompting developers to break ground on numerous apartment projects. The peak in delivery of these projects has occurred over the past 12 months and has outpaced demand, bringing vacancy up and rents down.
Some California markets — notably Sacramento, San Diego and the Inland Empire — saw a similar increase in demand.
Sacramento
Sacramento’s population increased in 2020 as people relocated from the Bay Area, lured by a more affordable cost of living and the ability to work remotely. CoStar’s market analyst, Will Austin, notes that "this led to an increase in new construction, with new projects breaking ground in areas such as Downtown and Natomas.” By 2022, new construction amounted to 4.5% of Sacramento’s multifamily inventory, the highest percentage in California. Similar to the national trend, the increase in supply caused the vacancy rate to rise in the past two years, and at 6.8%, it is now the highest of California’s major markets. According to Austin, “the biggest challenge facing the apartment market in Sacramento is centralized construction. Nearly 60% of active development has been built in and around the urban core, creating a highly localized supply-side risk.”
San Diego
In San Diego, increased demand for apartments resulted in higher rent growth rather than extensive new construction. According to CoStar analyst Josh Ohl, it has always been difficult to build in San Diego, and starts have returned to relative historic levels after a surge of large developments from Downtown to Chula Vista early on in the pandemic. The lack of extensive development and higher housing costs have led to many households leaving the San Diego region for more affordable housing alternatives. However, there are positive signs on the horizon, and the lack of oversupply should spur rent growth in 2025 to more normative levels, particularly as renewals have begun stabilizing and demand has picked up.
Inland Empire
New residents flooded the Inland Empire after the pandemic's onset in 2020 in search of affordable housing, often migrating in from more expensive coastal California markets like L.A. and San Diego. The unprecedented population surge kicked off a flurry of new apartment developments, and ongoing migration into the market led developers to initiate additional projects in 2023. Construction starts hit a record high of 4,400 units last year, although fewer than 1,000 units have started in 2024 through August.
A record 14% increase in market rents in 2021 put a squeeze on some in-place tenants, but with occupancy wavering in 2022 and vacancy climbing higher through 2023, rent growth fell under 4% in 2022 and to less than 0.5% in 2023, improving to 1% on a year-over-year basis. Rent growth should ramp up now that demand has rebounded and vacancy is falling.
The pandemic hit the Bay Area hardest, with San Francisco and San Jose seeing an exodus of workers and residents. This negatively impacted all real estate sectors, including multifamily, where vacancies increased to more than 7% in 2021, the highest in the state.
San Jose
In San Jose, the recovery was rapid, with strong demand causing rents to rise and vacancies to fall in 2022. This led to a surge in development activity, with the number of units under construction accounting for 5.5% of inventory by 2023, the highest in California. With most of these units set to be delivered in 2024 and 2025, the question now facing San Jose is whether demand will be strong enough to absorb the new units. So far, the answer is yes, as evidenced by vacancies remaining below 5% and rents increasing over the past year.
San Francisco
San Francisco saw the steepest population drop during the pandemic, causing the multifamily vacancy rate to increase above 10%. Since then, the apartment market has slowly been recovering, and the vacancy rate has fallen back to where it was at the beginning of 2020. However, the growth in occupancy has come at the expense of no rent growth and very little new construction activity. Looking ahead, if demand returns to the levels seen in previous recoveries, there may be a supply shortage, and this could make San Francisco one of the nation’s best-performing markets for rent growth.
East Bay
In the East Bay, a surge in new construction has occurred in the past few years, mostly in downtown Oakland. In contrast, demand growth has been less strong, keeping the vacancy rate high and causing rents to fall as owners compete to attract tenants. However, new construction has slowed sharply in the past year, paving the way for a more positive trajectory next year as the new apartment units are absorbed.
Orange County
Orange County remains one of the tightest apartment markets in California. While vacancy has increased from record lows reached between 2021 and 2022, it remains the lowest among the major markets, at 4%. According to market analyst Jesse Gundersheim, Orange County’s limited capacity for new apartment development has helped to keep vacancies low and rent growth high. These conditions are unlikely to change in the coming quarters. Multifamily construction in Orange County is challenged by a lack of development land and difficult approval processes. Although limited in scope, the construction pipeline is just about as full as it has been over the past 20 years.
Orange County led the nation last year with a 4% rent increase. Since then, absorption has slowed, and owners are seeking to maintain high occupancy, only pushing rents 1.5% higher over the trailing year. Rent growth could reaccelerate towards its historical average of more than 4% annually in the years ahead, assuming a soft economic landing.
Los Angeles
Los Angeles is the largest of California’s apartment markets and has demonstrated stability over the past year. Recent renter demand for apartments remains relatively softer than most U.S. metros. Economic weakness, particularly job losses in the entertainment and tech sectors, and outmigration by residents in recent years continue to weigh on demand. However, the market has had the saving grace of one of the most measured completion schedules in the nation, keeping vacancy in a narrow range.
According to CoStar's Ryan Patap, new construction starts are moderating, with development concentrated in higher-end properties in denser neighborhoods receptive to new builds, including Downtown Los Angeles and Koreatown. Looking ahead, the forecast expects similar renter demand, but with the moderating pipeline, modest improvements in occupancy should surface in 2025.
While local dynamics will continue to drive the outlook for California’s major apartment markets, broader trends and issues will also play an important role. Interest rate cuts will likely boost renter confidence before the end of the year. Political considerations, particularly those related to rent control, may also play a large role. Finally, the changing nature of work will continue to define where people want to live and influence which kinds of residential buildings will see the highest demand from tomorrow’s workforce.
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