Near-term outlook

After multiple years of underbuilding, record low vacancies and outsized rental rate growth, the Sacramento region’s multifamily market is in the midst of a rebalancing period. The return of development to the region alone would have likely slowed rent growth in most markets simply because they would have eased the incredibly tight vacancy levels the region had been experiencing. However, it is doubtful that this alone would have flattened or reversed rent growth. That said, two consecutive years in which growth was at or nearing double digits is typically not a growth rate that is sustainable unless incomes are also rising.

They have been, but not at the pace of overall inflation over the past 18 months, hence, we are seeing a ceiling in rents increasingly emerge for now. This is why rents have shown the weakest growth (Davis/ Woodland excepted) in what have been the region’s most desirable and expensive submarkets. It is also why we have continued to see growth, albeit sharply slowing, in the region’s most affordable housing markets.

These metrics will create headwinds through the remainder of 2023 even in a best case scenario (I.E. the Fed succeeds in driving inflation towards the 4.0% they have stated as their goal for the year, without driving the entire economy into a recession by having raised interest rates too aggressively). Clearly, this has had a major impact on commercial real estate investment activity.

But those are still separate issues than the bigger picture longterm multifamily leasing fundamentals that are in play. The current population of the greater region is estimated at 2,215,000 people, up 1.3% from last year. In 2022 the growth rate was 1.4% and it stood at 1.5% in 2021. For most of the previous decade it stood between 0.6% and 0.9%. The Sacramento region has acted as a housing pressure valve for its pricier neighbors by the Bay for the better part of the last 40 years. This in-migration has come in multiple significant waves; in the early 1990s as the initial tech boom ramped up, in the early 2000s as the second tech boom arrived and, most recently, with the pandemic and its aftermath. This latest wave is now moderating, though Sacramento’s standing as the most affordable large city in California will continue to be a magnet for in-migration.

Meanwhile, interest rates on the typical 30-year home loan have effectively doubled from where they stood a year ago, resulting in a sharp slowdown in the SFR market and price resets that are playing out nationally. According to RedFin, the median home price in the United States stood at $400,706 in March 2023, down 3.3% annually.

In California, this has translated to a 7.8% drop as the statewide average median price has fallen to $743,200. Their data suggests an even sharper pullback in Sacramento; a current median sale price of $455,000, down 12% annually. This metric stood at $380,000 in March 2020 and peaked at $525,000 in April 2022. During this peak pricing runup period, Sacramento’s SFR market recorded record-setting (and unsustainable) pricing growth of 37.7% in just 25 months. Even with the current ongoing reset, the region’s SFR market values are still up from pre-pandemic levels by 16.5%.

Here is the key; if as the Federal Reserve has telegraphed most recently that there may only be one more interest rate hike this year, and providing the proverbial soft-landing of the economy, we may be nearing the end of this reset. Conversely, if the greater economy does fall into recession, the question will be if the Fed reverses course and slashes rates will that be enough to bolster housing even in a negative economic growth scenario. Either way, the likelihood of any sort of housing reset akin to the GFC is virtually zero, barring some immense black swan event, because so much of that was driven by toxic loan product that had infected every level of the mortgage markets. The outsized gains of the immediate post-pandemic years mean that most home owners still have more equity even in the midst of today’s faltering prices than they did before. There is very little exposure to adjustable rate mortgages—unlike in 2008, which means that recent buyers that find themselves upside down likely won’t face deep challenges unless they have to sell or move. SFR values are resetting downward, but they are not likely to crash.

Meanwhile, a return to near zero interest rates is also highly unlikely. SFR pricing resets may help some renters on the cusp make the jump to first-time home ownership, but do not expect much movement there. For the most part, the ability to move from being a renter to homeowner in the near and immediate term is going to be significantly strained. Most renters are going to remain renters. In the long run this still points towards continued strength for multifamily product, even if there are currently headwinds. That these are occurring at a time of elevated development levels simply means that we are in for a year or two of elevated vacancy levels and continued downward pressure on rents, starting at the top.

Sacramento Multifamily Market Average Sale Price Per Unit Vs. Average Cap Rate

Sacramento Multifamily Market: Average Sales Price Per Unit Average Cap Rate