looking ahead continued

With interest rates on the typical 30-year home loan now effectively double where they stood one year ago, SFR activity has plummeted, though high population growth and lower cost of living markets have been spared the worst impacts. According to a January 2023 report from the technology-powered residential brokerage RedFin, 24.6% of the service’s users were looking to relocate to lower cost of living markets in Q4 2022. Their top relocation markets were Sacramento, Las Vegas, Tampa and Phoenix. Assuming this plays out, it will mean continued in-migration will have a mitigating impact on local price declines, even if much of the SFR deal activity will be driven by buyers relocating to the region. That is positive news for current owners and their existing equity. It’s bad news for renters—it means there won’t be a major reset in SFR pricing here and that with interest rates likely to be raised again by the Federal Reserve, the ability to make the jump from renter to first-time homeowner will remain significantly strained. The issue of affordability for first-time buyers is not likely to improve for a minimum of a couple of years. This means many renters are going to remain renters, which should bolster multifamily occupancy growth totals.

We anticipate increasing vacancy in 2023, but with strong net absorption as well. Ultimately, we see continued strong underlying leasing fundamentals for multifamily product. However, the potential for recession ahead remains a significant risk. The consensus among most economists is that if one occurs in 2023, it will likely be mild and brief, barring any unforeseen or “black swan” events. However, after the record rent growth of most of the past decade, a real question remains as to how much further Sacramento landlords can push rents. The ability for owners of Class C projects to push rents will be limited by the fact this asset class will be most exposed to tenants that simply may be priced out. Class A projects will continue to face a ceiling of where SFR rental units are priced. Class B projects likely have the most room for upside, but not without risk of lower occupancy rates if moves are too aggressive. Regardless, we expect modest rent growth ahead if, for no other reason, that new product built at elevated construction prices will set a new premium Class A rent and move the goalposts.

The real challenge ahead may be on the investment side. Demand for multifamily and industrial product has driven investment activity for the past five years. Cap rate compression has left little room for yield and a lack of available quality properties means that would-be sellers have little to trade into. Though we see underlying leasing fundamentals as remaining strong, we also see a disconnect between buyer and seller pricing that will likely continue for the short-term.