Market Reports_Q1 2024 Multifamily

DEVELOPMENT WAVE SHIFTS TO SUBURBS

As of the close of Q1 2024, multifamily vacancy in the Sacramento region stood at 6.2%, reflecting a modest downtick from the revised 6.3% rate recorded at the close of 2023. The market recorded 609 units of positive net absorption in Q1, a modest decrease from the 665 units absorbed in the final quarter of last year. But this was enough to outpace new supply, as just four new projects came online adding a combined total of 504 additional housing units to the local inventory. The current average asking rent of an apartment in the region is $1,744 per unit. While this reflects a 1.5% increase over the $1,718 rate of a year ago, keep in mind that these numbers are not inflation adjusted. Since Q3 2022, year-over-year gains have not topped 2.3%, even while inflation during much of that period was peaking. In other words, in real dollars rents have gone backwards locally in the past two years. If there is any solace at all for landlords, it is that from 2025 through 2021, Sacramento rents were growing at a rate that far outpaced inflation—remaining at, or above, the 5.0% mark for four consecutive years.

Sacramento Multifamily Market

Vacancy Vs. Deliveries (Supply) & Net Absorption (Demand) Q1 2024

Multifamily Market: Vacancy/Average Asking Rent Per Unit

SUBMARKET REVIEW

Eight of Sacramento’s 12 distinct multifamily submarkets recorded positive net absorption in Q1. Downtown led the way, while the South Sacramento submarket recorded positive net absorption to the tune of 198 units, lowering its vacancy rate from 6.4% to 6.1%. Meanwhile, the Natomas/North Sacramento trade area also posted gains with occupancy growth of 119 units (sending its vacancy downward from 7.1% to 6.7%). None of the other submarkets in growth territory absorbed more than 100 housing units, but none of those that registered losses experienced occupancy declines of more than 30 additional vacant apartments. But nine of Sacramento’s submarkets currently have vacancy levels higher than where they were a year ago. The only exceptions are Elk Grove (where vacancy has fallen from 4.3% to 3.5% over the past year), Folsom (from 5.6% down to 4.8%), and—surprisingly—Downtown. We say surprisingly because Downtown has led all other trade areas in terms of vacancy the past two years, with this metric consistently landing in the teens. It now stands at 12.3%, the same place as exactly one year ago.

The Downtown submarket led all other trade areas in terms of occupancy growth in Q1. While one new project added an additional 137 units to the Downtown inventory, occupancy

Source:GallelliRealEstate;CostarGroup

Sacramento Multifamily Market Average Asking Rent Per Unit vs. Vacancy

increased by 214 units—accounting for more than one third of the entire market’s total net absorption over the first three months of 2024. As a result, overall vacancy Downtown fell for the second consecutive quarter. It now stands at 12.3%, down from last quarter’s reading of 13.2% and the prior quarter’s recorded rate of 15.0%. Downtown Sacramento has been one of the focal points of new development in the region the last couple of years, having added more than 2,600 new apartment units since 2022 as its inventory has increased by 31.7%. Not surprisingly, this trade area has experienced the highest vacancy levels of any Sacramento submarket as waves of new product are delivered and then gradually absorbed.

This roller coaster is likely to continue for the Downtown market, with eight projects currently under construction that will add 1,127 new housing units into the mix by the end of this year. But these projects have been in the works for a couple of years and the development pipeline appears to finally be emptying. There still could be some projects currently in the proposal stage that may move forward in the months ahead, but it appears the anaconda is in the final stages of swallowing the mongoose. Meanwhile, we are seeing the development focus increasingly shift to Sacramento’s suburban communities. As for Downtown, expect elevated vacancy levels to continue to be in place as the market digests/absorbs the remainder of this wave of building. The current average asking rent for Downtown apartments of all classes is $1,868 per month, down from a $1,884 recorded six months ago, while landlords are anecdotally reporting increased concessions like move-in discounts, free rent on longer lease terms and free or discounted parking. Class A average asking rents per unit are now at $2,268 per unit, down 2.8% year-over-year. We expect continued downward pressure on rents Downtown heading into 2025.

CLASS A REVIEW

The current vacancy rate for Class A projects across the Sacramento region is 9.2%. This is down slightly from the revised 9.8% rate recorded just three months ago, as well as the 10.7% level hit one year ago but this metric has proven to be the most sensitive to waves of new projects coming online—with it usually taking at least a couple of quarters for new projects to achieve 90.0%+ occupancy. Class A product only recorded net absorption of 96 units in Q1, however, there were no new deliveries of supply either. That is about to change as we are now tracking 12 projects across the marketplace in the development pipeline that will add more than 2,000 new apartment units to Sacramento’s inventory over the next two years, with most of these slated for completion in 2024.

There were just two projects delivered in Q3, totaling 312 units. Yearto-date, a total of four new complexes have been delivered totaling 663 new housing units. The market absorbed 307 Class A units in Q3 and outpaced new construction year-to-date with total positive net absorption of 879 units. However, there are now 10 Class A apartment projects under construction, accounting for 1,431 new multifamily units—most of which will be delivered in the next six months. The Downtown submarket accounts for the greatest amount of Class A product in the pipeline with 462 new units scheduled to be delivered over the next six months, this is followed by Folsom (278), Natomas/North Sacramento (190) and the Carmichael/Citrus Heights trade area (with 110 new Class A units).

The current average asking rent for a Class A apartment in the Sacramento region is $2,191 per unit, up slightly from (1.8%) the $2,153 rate of a year ago. We anticipate continued headwinds in 2024 for rental rate growth across all Classes of product, though these will vary by geography.

Sacramento Multifamily Market

Avg. Asking Rent Per Unit Vs. Annual Rental Rate Growth Q1 2024

Sacramento Multifamily Market: Average Asking Rent Per Unit/Rental Growth Rate

CLASS B REVIEW

Class B vacancy apartment vacancy in the region now stands at 6.6%, down slightly from Q4 2023’s 6.7%, but still elevated from the 5.9% mark posted one year ago. Class B product accounts for 44.4% of Sacramento’s apartment inventory and has benefited from strong levels of demand in recent years due to the longer-term trend of rising affordability issues, which were only exacerbated over the past 30 months during the recent inflationary wave. Class B product recorded positive net absorption to the tune of 550 units in Q1, compared to just 504 new units being delivered to market from four new projects that were completed. However, there is a significant wave of new Class B development about to hit the marketplace. There are currently 21 projects under construction throughout the Sacramento region totaling 3,416 units. Assuming current delivery timetables hold, at least 3,000 of these new apartment homes will be delivered by the end of 2024. Our data goes back to the year 2000. Since then, there have only been three quarters in which Class B deliveries have surpassed the 1,000-unit mark and this has only happened once since 2005. It is a near-given that Class B vacancy will climb over the course of 2024 and that there will be additional competitive pressure on rents until the market can absorb this level of new product.

Downtown leads all submarkets in terms of current Class B construction with 853 units in the development pipeline. Folsom follows this, with 563 units. But several trade areas will see substantial levels of deliveries ahead; Natomas/North Sacramento submarket has 496 units in the works while South Sacramento will add 469. But Davis, Rancho Cordova, Roseville/Rocklin, and West Sacramento all have substantial projects underway.

CLASS C REVIEW

While Class A product accounts for 15,000 housing units locally and the Class B market has an inventory more than three times that size at roughly 69,000 apartment homes, Class C projects account for the largest share of the Sacramento multifamily market with nearly 72,000 units. Vacancy currently stands at 5.3%, reflecting the third consecutive quarter that this metric has remained flat, as has occupancy growth. While we have no doubt that the recent inflationary environment benefited Class C product with some renters being priced out of higher-end product, it has also been challenged by price-sensitive tenants being priced out of apartment living completely. There is no solid data on how many consumers have either doubled-up with roommates, moved in with family, or— in worse case scenarios—become homeless. But we have heard anecdotally from multiple property managers and landlords that this has been a bigger problem over the past couple of years. An improvement in the economy over the course of 2024 could see some Class C tenants trading up, but it would just as likely bring back with it some tenants that had dropped out of the market.

Source:GallelliRealEstate;CostarGroup

Morningside at Carmichael Photo: Zillow

Savannah at Southport Photo: Apartments.com

Sacramento Multifamily Market

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

Source:GallelliRealEstate;CostarGroup

INVESTMENT OUTLOOK

The fact that there is little likelihood for rental rate growth locally has been an additional factor in chilling local multifamily investment activity. Though there are always some value-add projects in any market where investors may be able to achieve some rental rate growth on rehab projects, they tend to be few, far between, and hard to find.

The Sacramento market has traditionally been dominated by private buyers. They have accounted for 75% of all acquisitions and dispositions over the past five years. Over the past year, Sacramento’s limited private equity investment gave way to more private transactions, which rose to nearly 90% of total transactions. Slow/flat rent growth, rising vacancy, and increased financing costs have brought upward pressure on cap rates. The challenge is that most would-be sellers want to command no more than a 5.0% to 5.5% cap rate on their property, if they can. Most buyers want to see a 6.0% or greater cap rate on an acquisition if they can. This means that outside of extremely unique transactions, most of the deals that are happening today are deals of necessity (death, divorce, taxes, etc.). Meanwhile, loan-to-value ratios have also expanded as the cost of borrowing has increased, with deal financing remaining far more difficult, which has also impacted activity save for all cash deals. The reality is that large deals have simply evaporated since the Federal Reserve began its interest rate hike program to tame inflation. With interest rates remaining high until at least the second half of the year, we don’t see investment activity picking up in the near term.

Most investors currently are content to wait for pricing to fall. They are reluctant to make moves in an environment where vacancy is creeping up, rent growth is flat or stagnant and higher concessions are in play—unless the price is heavily discounted. Current cap rates are very close to BBB bond rates, yielding no premiums for the risk involved. Once we do see interest rates starting to come back down, the question is how quickly will buyers and sellers find compromises between the current bid ask gulf?

The real question is what will happen once the Fed begins to lower interest rates? There is $240 billion in dry powder from institutional investors currently sitting on the sidelines waiting to pounce. We anticipate greater deal flow in 2024 than what the market experienced in 2023 but suspect the real activity won’t begin until we see at least a couple of consecutive rate decreases. In the meantime, expect a lot of players to get themselves into position for the race to begin.