Surging demand is reinvigorating Los Angeles multifamily

June 2022, John Petersen, VP, KeyBank Commercial Mortgage Group

<p>Surging demand is reinvigorating Los Angeles multifamily</p>

The COVID-19 pandemic forced Americans—including Angelenos—to reevaluate the way they think about their living space. Residents of urban multifamily buildings across the country suddenly found their cozy apartments ill-suited for working remotely, facilitating social distancing and enduring lockdowns. 

People left cities like Los Angeles, New York and San Francisco in droves, setting off for smaller, more affordable areas. Los Angeles was hit especially hard. Between July 2020 and July 2021, U.S. census data shows that 180,000 people moved from Los Angeles County to other parts of the United States, the biggest drop of any U.S. county.1

Two years after the pandemic emerged, however, demand for multifamily housing in the Los Angeles area is not just returning to normal, but surging to new highs. At the recent BISNOW Los Angeles Multifamily Update conference, panelists discussed the area’s reinvigorated market-rate multifamily sector, how the pandemic changed aspects of the industry and potential headwinds that are appearing on the horizon.

Speakers on the panel, which was moderated by Sofia Szabo, president, Marc Szabo Studios, included John Arnold, partner at KFA Architecture; Sabine Grimes, founder and principal, Unison Group; Monique Lawshe, executive vice president, GHC Housing; Robert Montano, vice president, Adept Urban; Alex Valente, senior vice president, High Street Residential; and John Petersen, vice president, KeyBank Commercial Mortgage Group.

The following are highlights of the discussion.

Multifamily housing demand is high, from residents, local governments, and even NIMBYs

Despite Los Angeles County’s pandemic population drop, the median rent in April 2022 was up nearly 16% from the previous year, according to Stessa.2 Throughout 2021, the vacancy rate in Los Angeles dropped from 8.4% to 4%, according to Apartment List.3 KFA Architecture’s John Arnold posited that people crave the urban lifestyle, while also pointing to a critical housing shortage and dearth of buildable lots in Los Angeles as reasons for the rebound.

Surging demand has left developers scrambling to snap up vacant properties, and State and local governments are welcoming new multifamily development with open arms. Even developments that would have triggered “not in my backyard” (NIMBY) protests not long ago are seeing community support.

Arnold noted that the public has come to realize that the best way to address rising rents, housing price escalation and homelessness is to build more housing, a shift in sentiment that has hobbled NIMBYism. He also credited the positive impact new development can have on floundering communities. When people see neighborhoods around them changing for the better, they’re less likely to oppose projects in their own backyards.

High demand and the housing shortage have also made local governments more receptive to development. Outlying cities are struggling to meet their California Regional Housing Needs Allocation requirements, and Arnold observed that the Los Angeles City Planning Commission is now approving larger projects that it would have rejected just a few years ago.

Developers are being encouraged to build and build quickly. Concurrently, officials are also urging developers to design their buildings well, which is where the changing priorities and preferences of multifamily residents come into play.

More space and a sense of community are top priorities for multifamily renters

Urbanites who fled Los Angeles during the pandemic are returning, but that doesn’t mean they’ve forgotten the reasons they left in the first place. Returnees, new arrivals and current residents alike are demanding roomier units and more outdoor recreational and gathering space. This is not surprising, noted High Street Residential’s Alex Valente, considering that many people were forced to spend 18 hours or more in one place during the pandemic lockdowns. Valente said that experience has made consumers more deliberate and discerning about choosing a home. They’re also seeking a greater sense of community and easy access to mass transit. In short, people want some of the perks of small-town, single-family life, but with big-city amenities nearby.

“Simply having a little work area in a unit adds a lot of value,” said KeyBank’s John Petersen, “but we’re also seeing a rise in investor demand for townhome-style units, with a little bit of a yard and no neighbors above or below.”

In apartment-centered construction, the desire for a yard is most evident in the soaring interest in once-small towns that have been swallowed up by suburbia over the years. Arnold pointed to Monrovia, Duarte and Azusa as places that developed charming town centers when they were surrounded by orange trees. Those old cores are bustling once again with town leaders and developers offering newcomers cozy community charm just a half-hour from Union Station.

Whether they’re looking for a townhome in La Verne or an apartment in La Brea, potential tenants want to spend more time outdoors. Unison Group’s Sabine Grimes works on multifamily and hospitality projects across North America, and noted that people everywhere are trying to live outside as much as possible. However, only in warm-weather spots like Southern California can that notion be taken to the extreme. She highlighted one project in the Little Tokyo neighborhood where all of the amenity spaces have been moved outside, with the exception of the gym.

One traditional amenity—the outdoor barbecue area—is making a comeback, but now the barbecue may be next to an outdoor theater space that can double as a cocktail or party spot. Another new concept on the design side, according to Adept Urban’s Robert Montano, is to offer multiple common areas of varying sizes. He noted that residents may want to be amongst a group of 20 people sitting around the pool one night, but have a more intimate gathering around a firepit with just four friends the next.

Finally, some innovative complexes have married tenants’ desire to spend more time outside with the need to accommodate work-from-home, giving rise to outdoor coworking spaces. This blurring of lines between indoor and outdoor activities is carrying over to the interior design and architecture of new projects, and can even be seen as an offshoot of a wider shift in sensibility precipitated by the pandemic.

Sustainability and “designing for the user”

City dwellers have become more conscious of their environment in both the general and personal senses, a development that Grimes said has also made them more discerning and appreciative of good design. She noted that her clients now expect her to be much more deeply involved in sculpting the building from the inside out in a way that suits the user—the residents who live there and their guests. Designing for the “glam shots,” as Grimes put it, has taken a back seat to designing for the full life cycle of the building.

Today’s design approach involves increasing natural light and ventilation. Marc Szabo Studios’ Sofia Szabo said that multifamily projects are moving toward supporting health and mental wellness, and building a supportive community. Complexes are offering amenities like yoga facilities, enhanced cleaning procedures and air purifiers, while California building codes make projects in Los Angeles more attractive to investors and banks adhering to ESG standards.

“On the financing side, Fannie Mae and Freddie Mac have a suite of green products,” said Petersen. “They are directly incentivizing owner operators to go green, so if you implement these improvements, you get a pricing benefit.”

Arnold noted that he’s seeing multifamily developers phase out gas-powered systems and replace them with electric. Electric vehicle charging stations are now standard, as are energy-efficient appliances. These efforts dovetail with the LA100 plan, which aims to transition Los Angeles to 100% renewable energy by 2035.

Challenges: price escalation, labor shortage and rising interest rates

The Los Angeles-area market-rate multifamily housing market looks robust, but the ride isn’t all smooth, and there could be clouds on the horizon. While materials are flowing more freely now than in the second half of 2021, price escalation has put many subcontractors out of business because they couldn’t afford the price increases under their bids.

The pandemic, immigration challenges and other issues have also led to a dearth of labor in Los Angeles. Combined, these issues hinder both production and the number of bids developers are receiving. Price escalation has forced builders to get creative with risk mitigation. Finally, rising interest rates and compressed cap rates are threatening to make capital more difficult to access and transactions harder to close.

“Over the last two or three years, debt funds, floating rate execution and max leverage were really popular,” said Petersen. “Now, you’re seeing real concern about rising interest rates. We’re seeing kind of a flight back to longer-term fixed-rate products, especially with cap rates below 4% and borrowing costs over 4%. That’s not a great math equation.”

The saving grace may come in the form of rental rates that continue to grow at an astronomical pace.

“With the rent growth that we’re expecting, cap rates may be low, but in the year after you buy, property incomes go way up,” said Petersen. “So, it can work out, and some players are switching from value add to core plus so they don’t have to go through the stress. If you just hold the core plus and just operate as-is, growing rents by 10% is pretty good.”

Regardless of market cycle, KeyBank is there for our clients in Los Angeles and across the country.  For more information, visit key.com/rec, or contact John Petersen, 949-734-2095.

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