Market Reports_Q4 2023 Multifamily

JKG

Q4 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

Q4 23

6.7%

251 Units

$1,720

Vacancy Rate

Net Absorption

Average Asking Rate (NNN)

4,229 Units

4.5%

4.9%

3.7%

Under Construction

Sacramento Unemployment

California Unemployment

United States Unemployment

*To provide the most accurate snapshot of market conditions, we revise our historical data in cases where new information is uncovered after the fact.

SOLID DEMAND NOT ENOUGH TO KEEP PACE WITH NEW SUPPLY Multifamily vacancy in the Sacramento region climbed over the final three months of 2023 to 6.7%, up from Q3 2023’s revised reading of 6.2%.

One year ago, this metric stood at 5.9%, but vacancy increased in all but one quarter in 2023.

Since reaching a local record low of 3.2% in Q2 2021, vacancy has inched up in eight of the last ten quarters. But as distressing as a three-year trend of increasing vacancy may sound to some, it is critical to note that typically multifamily vacancy in the 5.0% to 7.0% range is considered healthy.

At those levels there is enough available space to meet demand, but there is not so much availability as to create an oversupply or downward pressure on rental rate growth.

Yet, the market is experiencing significant headwinds on rents, with the greatest downward pressure at the top of the scale. The current average asking rent for apartments in the Sacramento region now stands at $1,720 per unit monthly, down slightly from a midyear (Q2) 2023 peak of $1,729 per unit. While increased vacancy has obviously been a factor, we don’t see that as being the primary driver of this trend. Sacramento ranked consistently among the top five national markets for rental rate growth between 2015 and 2021. Most local landlords aggressively rose rates

during this period of extremely tight vacancy. The data suggests that they had already pushed them as far as they could go before the recent spike in inflation started taking its toll on renters.

Rising vacancy hasn’t helped, but the one-two punch of past aggressive rate hikes combined with a tapped-out consumer has been the real culprit here. There simply is no room for overall rent growth now.

Historically, the Sacramento apartment market has been a tight one—since 2000 vacancy has only surpassed the 7.0% range twice. The most recent was in 2009 when vacancy hovered in the 7.0% range for a year in the aftermath of the 2008 Great Financial Crisis (GFC). It also hovered in the 7.0% range for an 18-month period between 2003 and 2005. While we have yet to cross the 7.0% threshold in this current cycle, we are about to.

The good news for landlords is that the recent uptick in vacancy has not been driven by declining tenant demand. Vacancy may have crept upward in nine of the last 12 quarters, but the market also has recorded positive net absorption in nine of the last 12 quarters. In Q4, Sacramento experienced positive net absorption to the tune of 251 units. Over the course of 2023, multifamily occupancy in the region increased by a total of 1,366 units (our survey only includes competitive market-rate apartment complexes that are at least 25 units in size).

Tenant demand is holding its own. It just isn’t keeping pace with new construction.

Sacramento Multifamily Market Vacancy Vs. Rental Rate Growth Vs. Deliveries Annual Average Annual Multifamily Statistics Vacancy Growth Asking Rent Deliveries (Total (EOY) Rate in Asking per Unit Units) Rents 2014

4.7%

$1,089

3.3%

647

2015

4.0%

$1,169

7.4%

506

2016

3.6%

$1,254

7.3%

208

2017

3.8%

$1,329

5.9%

1,067

2018

4.0%

$1,391

4.7%

1,493

2019

4.5%

$1,445

3.9%

1,689

2020

3.5%

$1,532

6.0%

1,318

2021

3.6%

$1,686

10.1%

2,156

2022

5.9%

$1,715

1.8%

3,619

2023

6.7%

$1,720

0.3%

2,750

In Q4, the market absorbed 251 units, but the delivery of five major new apartment complexes added 1,022 new units to the region’s inventory.

This trend of new supply outpacing demand was a theme for 2023. All told, 17 apartment properties came online in 2023 accounting for 2,750 new multifamily units, more than double the 1,366 units of positive net absorption that the market recorded. Deliveries have outpaced net absorption now for ten of the past 12 quarters. This is not likely to change over the first half of 2024.

We are currently tracking 28 properties under construction throughout the region, which will add 4,229 new multifamily units to the region’s inventory

through Q1 2025. We should note that our survey includes only market-rate projects of at least 25 units in size. Should developers maintain current construction timetables, half of that space will be delivered in Q1 2024, with an additional 1,200 units coming online in Q2. While we anticipate there will be additional projects currently in the proposal stage that will move forward with construction over the next six months, we expect development levels to slow over the course of 2024. We have already seen timetables being pushed back on a couple of projects in the proposal stages and have spoken to several developers who have shared with us concerns about “letting the market have a breather, to digest what is already out there.”

Vacancy metrics are certain to go higher at least through the first six months of 2024. The development pipeline will add about 3,600 additional multifamily units to the local inventory during this time and would have to absorb 1,800 units per quarter for vacancy to hold steady at its current level.

However, the market averaged just 342 units of positive net absorption per quarter in 2023. What is more likely is that local vacancy levels will surpass the 7.0% range by the close of Q1 2024 and are not likely to peak before the midyear mark of 2024. While renters will get some relief in 2024 from continued reductions in inflation and an improving economy by later in the year, rental rate growth will be off the table in the coming year.

Over the past 12 months, vacancy has crept upwards in nine of Sacramento’s 12 distinct multifamily submarkets. Only the Downtown, Folsom, Roseville/ Rocklin trade areas posted decreased levels of vacancy over the course of 2023. Perhaps not surprisingly, these are all submarkets with strong concentrations of Class A product.

The vacancy rate for Class B projects stood at 7.1% as of Q4 2023, down slightly from a reading of 6.7% a year ago, but up from Q3’s posting of 6.3%.

Lastly, Class C multifamily vacancy in the region now stands at 5.7%. Class C vacancy stood at just 4.1% a year ago but has climbed in each successive quarter since.

Q4 23

multifamily market report

CLASS A REVIEW

CLASS B REVIEW

The current vacancy rate for Class A projects in Sacramento is 9.0%. This marks the third consecutive quarter this metric has held steady. Class A product recorded positive net absorption of 273 units in Q4, bringing 2023 annual totals to 1,128. New construction added one new 285-unit project in Q4 (805 Riverfront in West Sacramento’s The Bridge District neighborhood), bringing total deliveries for 2023 to 1,299 units.

Class B vacancy jumped from 6.3% to 7.1% in Q4 2023. While Class B occupancy growth remained positive—recording positive net absorption to the tune of 175 units in Q4—this was not enough to offset the impact of four new projects coming online and adding 737 new units to the local inventory. As with the overall market, this was a consistent trend throughout 2023. Occupancy growth was positive throughout the year, totaling 1,429 units of positive net absorption. But new projects added 1,802 new units to inventory during that same time. Only three of Sacramento’s 12 submarkets experienced falling vacancy levels in 2023: Folsom, Rancho Cordova, and Roseville/Rocklin. In Roseville/Rocklin, Class B vacancy has declined from 6.8% to 4.7% over the past year. Along the Highway 50 corridor east of Sacramento, Class B vacancy in Rancho Cordova fell from 9.5% to 6.7%, while neighboring Folsom saw it fall from 8.6% to 6.0% over the course of 2023.

There are currently 11 new projects under construction throughout the marketplace, accounting for 1,479 units in the development pipeline all of which have scheduled 2024 deliveries. There are six projects totaling 812 units scheduled for Q1 completion, the largest of which is The Carlyle Group’s 278-unit Atwell at Folsom Ranch in the Folsom submarket.

Over the course of 2023, vacancy fell in only five of Sacramento’s 12 distinct submarkets. It fell in the Arden Arcade (1.6%, down from 5.3%), Downtown (14.8%, down from 31.7%), Folsom (5.1%, down from 7.2%), Roseville/Rocklin (4.2%, down from 5.0%), South Sacramento 9.3%, down from 10.9%). The Downtown submarket experienced the highest levels of occupancy growth in Q4, recording positive net absorption of 194 units over the final three months of the year. All told, the Downtown market absorbed 689 units in 2023, accounting for 61.0% of all Class A occupancy growth in 2023. Despite this, the current average asking rent for Class A space Downtown is $2,246 per unit, down -2.8% from the $2,311 rate of one year ago. Metro-wide, the current average asking rent for Class A space averages $2,166 per unit, down slightly (-0.4%) from $2,175 per unit one year ago.

There are currently 18 properties under construction throughout the Sacramento marker totaling 2,930 new housing units. Half of this inventory will come online in Q1 2024, the largest projects of which would include McClellan Park’s 345-unit The A.J. in Downtown’s The Railyards and Fulcrum Capital’s 160-unit Greenhaus Apartments in the Davis submarket.

While Class A projects have borne the brunt of downward pressure on rents, more affordable Class B projects have not been immune to the trend.

Half of the region’s submarkets (Arden Arcade, Carmichael/Citrus Heights, Downtown, Natomas/North Sacramento, Rancho Cordova, and South Sacramento) have recorded declining asking rates in the past year, while half (Davis, El Dorado Hills, Elk Grove, Folsom, Roseville/Rocklin, and West Sacramento) have seen this metric increase. The biggest decline in Class B asking rates in 2023 occurred in the Natomas/North Sacramento market where the current average stands at $1,740 per unit, down -1.7% from the $2,087 rate posted a year ago. West Sacramento recorded the greatest increase with rents increasing 2.6% from last year’s reading of $1,453 per unit to the current average of $1,491. Overall, the current average asking rent for Class B multifamily product across the Sacramento region now stands at $1,818 per month, or in the same place where it stood one year ago when it measured $1,815 per month.

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 MARKET AT BOTTOM Across the Sacramento region, we tracked only 26 multifamily investment transactions that closed in 2023, less than half of the activity we tracked in 2022 (56 transactions). From 2014 through 2021, the market averaged 82 closed deals annually (this is based on our criteria of market-rate projects of at least 25 units in size). The projects that changed hands in 2023 did so with an average cap rate of 5.3%, up from an average cap rate of 4.3% in 2022.

Deal activity for all commercial real estate types has plummeted since the Federal Reserve began their campaign of interest rate hikes. The fact that there is little runway for rental rate growth has been an additional factor in chilling local activity. That said, there are always some value-add projects in any market where investors may be able to achieve some rent growth on rehab projects. The challenge is that right now they are few, far between, and hard to find. However, there is a compelling case for optimism that sales velocity will finally pick up in 2024, though likely not until the final half of the year.

For much of the past 18 months, the central economic debate in the United States has been whether the Federal Reserve would be successful in engineering a “soft landing” for the economy. Unfortunately, the Fed only has one tool to deal with inflation: interest rate hikes. And those work more like a sledgehammer than a scalpel. Adding to the challenge is that while some sectors of the economy—like real estate—feel the impact of interest rate hikes nearly immediately, it can take up to 18 months for the full impacts to play out in other critical areas of the economy like consumer spending. All of which translates into an exceedingly difficult balancing act as the Central Bank attempts to raise interest rates just enough to cool the economy and tame inflation, but not so much that it freezes the economy and spurs a recession.

According to conventional economic wisdom, the Fed has only successfully managed to execute a soft landing once in eleven tries over the past 60 years. This Goldilocks moment took place in 1994 when the economy was in its third year of recovery following the 1990-1991 recession. Quickly falling unemployment and strong consumer spending had led to an uptick in inflation. Fed Chair Alan Greenspan would oversee seven rate hikes in 1994 as the FFR doubled from 3.00%/3.25% to 6.00%/6.25% by the end of the year. Then, when the economy showed signs of softening too much by early 1995, the Fed cut interest rates three times, which spurred significant economic activity. The result ended up being the late 1990s boom that was one of the strongest economic growth periods in the history of the United States and what Greenspan would describe in his memoirs

as “one of the Fed’s proudest accomplishments during my tenure.”

The Federal Reserve’s most recent rate hike campaign began in March 2022 when the Federal Funds Rate (FFR) stood at just 0.25% to 0.50%. By the end of 2022, the central bank had increased rates seven consecutive times bringing the FFR to 4.25% to 4.50%. They would raise rates four more times in 2023, pausing the campaign after they increased the FFR to the current rate of 5.25% to 5.50% in July 2023.

With the lion’s share of their actions (both in the number and size of interest rate hikes) having taken place well over a year ago, it suggests that the economy has already experienced the impacts of most of those moves without veering into an actual overall economic recession. If the goal of the Federal Reserve has been to engineer a “soft landing,” the airplane that is the US economy is touching down right now in what could best be described as a hold your breath moment.

As for the chances of a recession in 2024, the consensus forecast of the National Association of Business Economists (NABE) continues to improve.

In August 2022, 72% of the members of the NABE anticipated a recession within the next six months. That never happened. By the time the NABE conducted their August 2023 survey, 69% of NABE economists said they saw a “soft landing” on the horizon. That view has only gotten stronger with time; their December 2023 survey found that 76% of their economist membership believed the chances of a recession in 2024 were 50% or less. Of the NABE economists that see a downturn ahead, 40% believe that it will begin in Q1 2024 while 34% believe it will happen starting in Q2.

Meanwhile, Bank of America economists have also changed their tune—at midyear 2023 they were forecasting a strong likelihood of a recession by either Q4 2023 or Q1 2024. Their outlook now is for a soft landing.

What exactly would a soft landing in 2024 look like? The soft landing engineered by Alan Greenspan and the Fed in 1994 may give us some clues. Job growth was dismal that year. The economy lost jobs every month of 1994, averaging -321,000 jobs per month. But strangely, retail sales were phenomenal—posting significant gains every month and averaging year-over-year growth of 8.2% overall. In other words, it was an incredibly mixed bag. We do not believe the trends would be so contradictory in the months ahead, but our soft-landing scenario sees the next six months as

Q4 23

multifamily market report

having near flat retail sales and job growth—with both metrics likely to remain in positive, but extremely tepid, territory. But we are not out of the woods.

One potentially troubling development has come from the latest inflation numbers for December 2023 which indicate a 3.4% increase in the Consumer Price Index (CPI). While these numbers have vastly improved since the peak inflation rate of 9.1% recorded in June 2022, December’s reading indicates an uptick from the 3.1% rate that had been posted in November 2023. Whether December’s numbers were just a holiday shopping season blip, or the resumption of an upward trajectory in inflation remains to be seen—but this development is one of critical importance.

Following November’s inflation numbers, Fed policymakers said that current interest rates were likely at their peak level and that if their current forecasts held up, the central bank would be in the position to cut interest rates at least twice in 2024 by later in the year. The Fed has not commented on whether December’s modest uptick in inflation has changed that plan. We think it is likely that policymakers will wait to see January’s inflation data before changing course. But further upticks in inflation would clearly mean the Fed would feel compelled to resume raising interest rates further, which would cast a further pall over the economy. All of this means that the next few months of inflation, employment and retail sales report will have outsized importance in determining what happens next.

As for the Sacramento region’s multifamily market, while 2024 will be a year in which rental rate growth will not be on the table for most properties, it will be a year in which we expect overall improvement of economic conditions, though the first six months of the year are likely to be lackluster. Improved economics should result in the ongoing trend of positive occupancy growth continuing and increasing. It just isn’t going to keep pace with new construction that will come online in Q1 and Q2. But the development pipeline will begin to empty after that, giving the market some time to absorb space. While projects coming online in the first half of the year will send vacancy into the 7.0% range, we anticipate these numbers will peak in Q2 or Q3 2024 and begin to recede after that. We expect sales activity to pick up by later in the year even if the Fed is not able to cut interest rates by the second half of 2024 simply because market players are slowly adjusting to the new reality of “not so cheap” money. However, if the central bank can execute their current plan to cut rates twice by the end of 2024, we think there will be a flurry of pentup investment activity that will hit the market quickly for which would-be sellers need to be prepared.

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

16,809

1,169

Class A Class B Class C

252 4,233 12,324

4 295 871

17,963

Submarket

Carmichael/Citrus Heights Class A Class B Class C Davis Class A Class B Class C Downtown Sacramento

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

7.0%

(32)

(375)

-

-

$1.83

$1,419

(0.7%)

1.6% 7.0% 7.1%

2 (34)

2 (71) (305)

-

-

$1.36 $1.95 $1.79

$1,223 $1,532 $1,383

0.6% (1.0%) (0.7%)

1,094

6.1%

(48)

(293)

-

110

$1.98

$1,592

(0.7%)

180 7,283 10,097

28 349 693

15.5% 4.8% 6.9%

(1) (14) (31)

(23) (41) (222)

-

110 -

$3.26 $1.95 $1.98

$2,854 $1,590 $1,569

2.6% (0.5%) (1.0%)

7,938

122

1.5%

17

133

-

360

$2.44

$2,170

2.6%

51 3,595 4,292

59 63

0.5% 1.6% 1.5%

25 (9)

181 (47)

-

360 -

$2.05 $2.55 $2.34

$2,473 $2,386 $1,973

1.4% 2.1% 3.2%

10,206

1,318

12.9%

248

808

129

818

$2.71

$1,883

(1.1%)

Class A Class B Class C

2,800 4,035 3,371

413 730 175

14.8% 18.1% 5.2%

194 65 (12)

689 171 (52)

129 -

276 542 -

$3.03 $2.66 $2.30

$2,311 $1,939 $1,283

(2.8%) (0.5%) 0.9%

El Dorado Hills

5,626

268

4.8%

(16)

(62)

-

-

$1.99

$1,695

2.1%

Class A Class B Class C

1,018 1,675 2,933

59 72 137

5.8% 4.3% 4.7%

(2) (6) (8)

(15) (5) (42)

-

-

$2.69 $1.67 $1.86

$2,297 $1,489 $1,523

4.4% 0.9% 1.1%

Elk Grove

5,910

270

4.6%

(17)

(59)

-

-

$1.83

$1,712

2.1%

Class A Class B Class C

1,911 3,226 773

117 108 46

6.1% 3.3% 5.9%

(14) (3)

(32) (22) (4)

-

-

$2.06 $1.76 $1.49

$1,911 $1,667 $1,311

1.7% 2.3% 2.1%

9,705

510

5.3%

(55)

339

-

585

$2.24

$2,011

0.3%

3,075 4,687 1,943

158 280 72

5.1% 6.0% 3.7%

(8) (39) (8)

165 191 (18)

-

431 154 -

$2.23 $2.45 $1.69

$2,213 $2,095 $1,372

0.2% 0.1% 2.0%

27,294

2,043

7.6%

77

529

481

416

$1.97

$1,710

(0.6%)

3,263 12,396 11,635

268 1,118 656

8.2% 9.0% 5.8%

48 50 (21)

221 429 (121)

481 -

190 226 -

$2.23 $2.01 $1.84

$2,087 $1,770 $1,521

(2.1%) (1.7%) 1.5%

8,520

624

7.4%

(7)

(57)

-

307

$2.02

$1,653

(0.4%)

3,618 4,902

241 383

6.7% 8.0%

18 (24)

104 (159)

-

307 -

$2.21 $1.82

$1,908 $1,410

(0.2%) (0.9%)

15,318

653

4.3%

(6)

203

-

407

$2.24

$2,019

1.9%

3,481 8,412 3,425

145 398 110

4.2% 4.7% 3.2%

14 (13) (7)

29 177 (3)

-

407 -

$2.26 $2.28 $2.05

$2,206 $2,071 $1,616

2.3% 1.8% 1.5%

25,390

1,729

6.9%

66

89

127

763

$1.93

$1,534

0.3%

1,004 8,802 15,584

93 790 846

9.3% 9.0% 5.5%

3 82 (18)

16 307 (232)

127 -

186 577 -

$2.42 $2.04 $1.81

$2,441 $1,658 $1,385

(3.1%) (0.2%) 1.3%

4,736

511

10.8%

25

102

285

463

$1.97

$1,584

(0.8%)

1,249 2,054 1,433

353 92 66

28.3% 4.5% 4.6%

25 19 (20)

75 10 15

285 -

106 357 -

$2.40 $1.85 $1.60

$2,046 $1,453 $1,234

(5.2%) 2.6% -

Folsom Class A Class B Class C N Sacramento/ N Natomas/N Highlands Class A Class B Class C Rancho Cordova 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

155,012

10,290

6.7%

251

1,366

1,022

4,229

$2.06

$1,715

0.3%

Class A

18,284

1,640

9.0%

273

1,128

285

1,299

$2.36

$2,175

(0.4%)

Class B

64,016

4,534

7.1%

175

1,429

737

2,930

$2.13

$1,815

0.2%

Class C

72,712

4,116

5.7%

(196)

(1,191)

-

-

$1.89

$1,481

0.7%

JKG

GALLELLI BROKER TEAMS INVESTMENT Gary Gallelli

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 Executive Vice President 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