JKG
Q3 MULTIFAMILY market report
Gallelli Real Estate 3005 Douglas Blvd #200 Roseville, CA 95661 P 916 784 2700 GallelliRE.com
2023 | GALLELLI REAL ESTATE
market overview
Q3 23
5.9%
1,108 Units
$1,712
Vacancy Rate
Net Absorption
Average Asking Rate (NNN)
4,578 Units
4.5%
4.6%
3.8%
Under Construction
Sacramento Unemployment
California Unemployment
United States Unemployment
VACANCY HOLDS STEADY IN BETWEEN WAVES OF NEW DEVELOPMENT Fueled partially by heightened in-migration from the Bay Area, vacancy within the Sacramento multifamily market hit an all-time low of just 3.2% in Q2 2021. Not surprisingly, that quarter also saw the market set a record for year-over-year rent growth, as the region’s average asking rate hit $1,666 per unit, reflecting a single year increase of 11.5%. This peak came after years of outsized rent growth. It also came after an extended period of tight availability in the marketplace. Typically, market equilibrium for multifamily product comes at roughly the 5.0% vacancy level. When these conditions are present, vacancy is tight enough to allow for sustainable rates of rent growth, while still presenting options and some bargaining power for tenants. Below that level of vacancy, landlords have the clear upper hand while the converse is true above that level of vacancy. Between Q1 2014 (when vacancy fell to 4.8%) to Q2 2022 (when it measured 4.6%), the market never surpassed the 5.0% vacancy level—hovering mostly in the high 3.0% to low 4.0% range. But since that time, new development has ramped up significantly and, as we enter the final quarter of 2023, the construction pipeline is now at its highest levels in 20 years.
Overall vacancy within the Sacramento market now stands at 5.9%. Though this rate remains unchanged from Q2’s revised rate, the trend since early 2022 has been one of growing vacancy levels as more sorely needed product has come online. Not surprisingly, Class A multifamily has recorded the largest increase in vacancy levels, as most of the new multifamily projects being constructed are either Class A or Class B+ product.
CLASS A REVIEW The current vacancy rate for Class A projects in Sacramento is 8.9%. This is down slightly from the 9.0% 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. There were just two projects delivered in Q3, totaling 312 units. Year-to-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).
CLASS B REVIEW Class B vacancy levels have remained far more consistent; the current rate of 5.8% has remained stable since the start of 2023. Though there have been more new Class B projects delivered to the market than Class A, this class of product has commanded higher levels of demand from renters due to the rising challenge of affordability issues. Class B product
recorded positive net absorption to the tune of 913 units in Q3, bringing year-to-date totals to 1,903. On the supply side of the equation, there were five new units that came online in Q3, totaling 948 units—only slightly outpacing demand (as measured by positive net absorption). However, year-to-date there have been nine new Class B apartment projects added to the local inventory that accounted for a total of 1,426 new apartment homes. Demand for Class B multifamily has slightly outpaced supply through the first nine months of 2023. However, there is a significant wave of new Class B development about to hit the marketplace. There are currently 20 projects under construction throughout the Sacramento region totaling 3,147 units. Assuming current delivery timetables hold, at least 2,500 of these new apartment homes will be delivered by midyear 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 1,000unit 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. South Sacramento leads all submarkets in terms of current Class B construction with 704 units in the development pipeline. This is followed by Downtown,
Q3 23
multifamily market report
with 671 units. But several trade areas will see substantial levels of deliveries ahead; Natomas/North Sacramento submarket has 496 units in the works while Roseville/Rocklin will add 407. But Daivs, Folsom, Rancho Cordova, and West Sacramento all have substantial projects underway.
have heard anecdotally from multiple property managers and landlords that this has been a bigger problem over the past couple of years. This is the most price sensitive asset class in terms of its tenancy. Should the overall economy fall into recession in the next six months vacancy levels will likely creep up slightly. The opposite is also likely true, assuming the current economic fog lifts and we see a return to more normalized growth patterns. Either way, new development, by definition, does not impact this asset class. Thus, we anticipate that movement in either direction will likely be negligible.
RENT GROWTH CURRENTLY OFF THE TABLE CLASS C REVIEW While Class A product accounts for nearly 18,000 housing units locally and the Class B market has an inventory more than three times that size at roughly 64,000 apartment homes, Class C projects account for the largest share of the Sacramento multifamily market with nearly 73,000 units. Vacancy currently stands at 5.3%, up slightly from last quarter’s 5.1% rate and more significantly from the 3.6% level posted one year ago. While we have no doubt that in the current inflationary environment that Class C product has likely benefited from 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
The current average monthly asking rent in the Sacramento region is now $1,719 per unit. While this reflects a modest single-year gain of 0.4%, it is a decrease from the $1,729 per month rate that was recorded last quarter. This trend has played out against all classes of product. Class A average rents have been impacted most thanks to two factors; the competitive impact of new projects coming online and the very real boundaries of how far you can push rents in an inflationary environment. The average Class A asking rent is now $2,171 per unit. This number is down from last quarter’s reading of $2,198, but Class A projects are the only subset of the local apartment market to have seen asking rates decline year-over-year. Exactly one year ago, the average Class A asking rent was $2,189. Though it is modest, this metric has fallen -0.8% over the past 12 months. The current Class B average asking rent is $1,825 per unit. This is down slightly from the $1,837 rate posted three months ago, though it still reflects a modest year-over-year gain of 0.3% from a year ago. Class C
product follows the same trend. The current monthly average asking rate is $1,486, down modestly from last quarter but up 1.2% from last year. It is important to note that between 2015 and 2020, the Sacramento region was one of the top markets nationally in terms of multifamily rental rate growth, averaging 5.8% annually. Keep in mind that the overall inflation rate during this same period was averaging just 2.0%. In other words, before the pandemic hit and before the current the recent wave of heightened inflation began in the latter half of 2021, rent growth had already been occurring at rates that were simply going to be sustainable for much longer. Looking ahead we anticipate that rents will remain flat or even move slightly backwards at the Class A and Class B+ end of the scale as a robust development pipeline brings a significant amount of product to market. We don’t anticipate the same to occur at the lower end of the scale, simply because renters priced out of Class A or B+ projects are likely to land in Class B- or C apartments. However, for landlords and investors flat rents in a heightened inflationary environment effectively translate into negative rate growth.
INVESTMENT OUTLOOK The fact that there is little runway 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. Of course, the primary challenge to investment activity across all property types has been the impact of the Federal Reserve’s war on inflation. Though the Fed had temporarily paused interest rate hikes as this report went to press in early October, the unprecedented rate at which they raised interest rates by 500 basis points in just 13 months has been a shock to the system. The higher cost of money has put downward pressure on pricing. For the greater part of the late 2010s, the national and local trend for multifamily product had been aggressive cap rate compression where it was not uncommon for premium product to sell with cap rates in the low 4.0%, or even high 3.0% range as pricing continued to climb. Though pricing like this offered lower returns on investment, it was still possible when buyers could access cheap money. That is no longer the case and so the gap between bid/ask has become considerable. Sellers still want to hold out for yesterday’s pricing and simply are not bringing product to the market unless they must. Nationally, multifamily sales activity has fallen by over 75% in 2023 with distress and all-cash deals accounting for most of that activity. In Sacramento, we are aware of less than a handful of deals that have occurred in 2023 among commercially viable projects that are at least 25 units in size.
We do not anticipate deal activity to pick up until there is greater clarity with the macro-economy. Since April of last year, economists have been debating whether the Federal Reserve could engineer a “soft landing” in its attempts to curb inflation, or whether a recession was a given. In August 2022, 72% of the members of the National Association of Business Economists (NABE) anticipated a recession within the next six months. That pessimism has since reversed itself. In their recently conducted August 2023 survey, 69% of NABE economists said they see a “soft landing” on the horizon. So far, the economy has proven to be far more resilient than analyst expectations with both consumer spending and the labor markets defying forecasts and outperforming. As of Q3, with economic indicators remaining mixed, the US economy is in what could be best described as a “hold your breath moment,” where it will soon become apparent if the Fed has successfully engineered a “soft landing,” versus a bumpy one, or a crash landing. Economic readings regarding job creation, retail sales and inflation will have outsized importance over the next few months as the longer-term impacts of the Fed’s rate hike campaign increasingly become clear. However, most economic forecasters that see a recession as likely in the next six months believe it likely to be short and shallow. What is likely to be more challenging for the commercial real estate market is the continued possibility of future Fed rate hikes. August’s inflation report (the most recent data as this report went to press) reflected an uptick in from 3.4% to 3.5% annually. That number was thanks to elevated energy prices that were in place before the October Hamas attacks on Israel, which have initially resulted in additional upward pressure on oil.
Q3 23
multifamily market report
Meanwhile, September’s incredibly robust jobs report is another factor that makes it more likely the Fed will raise interest rates yet again. While it may seem counter-intuitive, an actual recession—assuming it was short and shallow, as most economists believe one would be—would probably be the fastest driver of a return to normalized activity within the commercial real estate investment markets. An actual downturn would almost certainly have negative impacts on leasing fundamentals for most, if not all, property types. However, it would likely provide the market with a sense of a pricing floor. Assuming it came with a reversal in Federal Reserve interest rate hikes, it would likely lure an immense amount of capital from the sidelines. But, assuming a “soft” or even “bumpy landing,” we believe what is more likely to happen is that the market will continue to slowly adjust to the new reality of not-so-cheap money. In this scenario, activity would likely slowly begin to pick up as economic clouds lift, but the process likely would be slow and it could be another 18 – 24 months before the investment markets return to normalized activity levels.
JKG
Criteria based on: 25+ Existing, Proposed, Under Construction, Final Planning Units, Market Rate & Market/Affordable Net Absorption Total Units
Vacant Units
Vacancy Direct (%)
Arden Arcade
16,813
1,088
Class A Class B Class C
252 4,173 12,388
5 274 809
17,962
Submarket
Total Units Delivered
Total Units Under Construction
Avg. Asking Rate PSF
Avg Asking Rent PSF One Year Ago
Average Asking Rent % Change Annually
Total Quarterly
Last Four Quarters
6.5%
(24)
(436)
-
-
$1.83
$1,409
0.5%
2.0% 6.6% 6.5%
(1) (22)
(1) (94) (340)
-
-
$1.38 $1.95 $1.81
$1,222 $1,520 $1,375
2.6% (0.2%) 0.7%
1,023
5.7%
(17)
(175)
-
110
$2.01
$1,604
0.2%
180 7,283 9,994
27 339 630
15.0% 4.7% 6.3%
(19) 20 (16)
(21) 37 (182)
-
110 -
$3.28 $2.00 $2.00
$2,869 $1,620 $1,566
2.7% 0.2% 0.0%
7,938
149
1.9%
108
130
-
200
$2.39
$2,133
2.3%
51 3,595 4,292
102 47
0.3% 2.8% 1.1%
126 (17)
166 (35)
-
200 -
$2.04 $2.46 $2.32
$2,456 $2,308 $1,973
1.5% 2.1% 2.4%
10,077
1,408
14.0%
225
781
593
1,133
$2.72
$1,878
(0.3%)
2,800 3,906 3,371
604 648 156
21.6% 16.6% 4.6%
217 15 (8)
580 230 (31)
312 281 -
462 671 -
$3.03 $2.71 $2.24
$2,316 $1,956 $1,237
(1.7%) 0.9% 0.2%
El Dorado Hills
5,626
243
4.3%
14
(76)
-
-
$1.95
$1,669
1.5%
Class A Class B Class C
1,018 1,675 2,933
56 64 122
5.5% 3.8% 4.2%
4 7 2
(13) (18) (47)
-
-
$2.72 $1.67 $1.73
$2,379 $1,488 $1,412
2.0% 0.9% 1.6%
Elk Grove
5,910
234
4.0%
(19)
(27)
-
-
$1.83
$1,723
1.0%
Class A Class B Class C
1,911 3,226 773
113 81 40
5.9% 2.5% 5.2%
(3) (14) (2)
(36) 9 -
-
-
$2.07 $1.75 $1.48
$1,947 $1,663 $1,316
0.3% 1.7% 0.8%
Carmichael/Citrus Heights Class A Class B Class C Davis Class A Class B Class C Downtown Sacramento Class A Class B Class C
Folsom Class A Class B Class C
9,703
443
4.6%
36
298
-
432
$2.24
$2,012
(1.2%)
3,075 4,685 1,943
146 235 63
4.7% 5.0% 3.2%
32 5 -
142 175 (18)
-
278 154 -
$2.23 $2.47 $1.67
$2,204 $2,134 $1,346
(0.7%) (2.6%) 3.0%
N Sacramento/ N Natomas/N Highlands Class A Class B Class C
27,024
1,630
6.1%
367
583
211
686
$1.97
$1,706
(0.4%)
3,263 12,126 11,635
314 698 618
9.6% 5.8% 5.4%
66 304 (3)
198 587 (201)
211 -
190 496 -
$2.24 $2.00 $1.85
$2,113 $1,750 $1,530
(2.9%) (0.9%) 1.2%
Rancho Cordova
8,670
608
7.1%
144
38
150
158
$2.02
$1,642
(0.1%)
3,768 4,902
264 344
7.0% 7.2%
171 (27)
196 (160)
150 -
158 -
$2.21 $1.81
$1,889 $1,406
0.7% (1.1%)
15,280
623
4.1%
7
207
-
407
$2.25
$2,047
1.3%
3,481 8,550 3,249
151 355 117
4.3% 4.2% 3.6%
4 2 1
17 178 12
-
407 -
$2.25 $2.30 $2.05
$2,243 $2,105 $1,602
0.2% 1.5% 2.7%
25,299
1,405
5.6%
247
146
266
704
$1.92
$1,516
1.4%
1,004 8,675 15,620
96 500 809
9.6% 5.8% 5.3%
6 277 (35)
(19) 425 (259)
266 -
704 -
$2.36 $2.08 $1.79
$2,352 $1,680 $1,363
0.3% 0.4% 2.2%
4,451
248
5.6%
17
82
40
748
$2.00
$1,607
(0.7%)
964 2,054 1,433
91 116 41
9.4% 5.6% 2.9%
(1) 2 15
70 (14) 25
40 -
391 357 -
$2.51 $1.85 $1.58
$2,099 $1,480 $1,206
(2.7%) 0.4% 0.7%
154,248
9,076
5.9%
1,108
1,558
1,260
4,578
$2.06
$1,712
0.4%
17,999
1,603
8.9%
307
918
312
1,431
$2.36
$2,189
(0.8%)
Class A Class B Class C Roseville/Rocklin Class A Class B Class C South Sacramento Class A Class B Class C West Sacramento Class A Class B Class C Totals Class A Class B
63,716
3,678
5.8%
913
1,875
948
3,147
$2.14
$1,820
0.3%
Class C
72,533
3,795
5.3%
(112)
(1,235)
-
-
$1.88
$1,468
1.2%
JKG
GALLELLI BROKER TEAMS INVESTMENT Gary Gallelli
CEO - Partner gary@gallellire.com
Pat Ronan
Vice President pat@gallellire.com
Aman Bains
Associate Vice President abains@gallellire.com
Adam Rainey
Associate Vice President arainey@gallellire.com
RETAIL Kevin Soares
Bob Berndt
Matt Goldstein
Kurt Conley
Robb Osborne
Brandon Sessions
Executive Vice President | Partner ksoares@gallellire.com
Vice President mgoldstein@gallellire.com
Executive Vice President | Partner bberndt@gallellire.com
Jeff Hagan
Senior Vice President | Partner jhagan@gallellire.com
Senior Associate kconley@gallellire.com
OFFICE Partner rosborne@gallellire.com
Senior Vice President bsessions@gallellire.com
CAPITAL MARKETS RESEARCH Kristopher Krise Capital Markets Advisor kkrise@gallellire.com
JKG Gallelli Real Estate 3005 Douglas Blvd #200 Roseville, CA 95661 P 916 784 2700 GallelliRE.com
Garrick Brown VP, Real Estate Intelligence & Business Development
gbrown@gallellire.com
Kannon Kuhn
Associate kkuhn@gallellire.com
Phillip Kyle
Senior Vice President pkyle@gallellire.com