Market Report_Q4 2022 Multifamily

market overview

Apartment vacancy in the Sacramento market posted its sixth consecutive quarterly increase during the final three months of 2022, closing the year at 6.7%. Our data only tracks competitive multifamily projects with a minimum of 25 units and does not include smaller complexes or fourplexes, nor does it include senior, student, or Section 8 housing.

Vacancy is up from the 5.8% rate of three months ago as well as the 4.2% reading of a year ago. In fact, this is the sixth consecutive quarter in which the region’s apartment vacancy has climbed. Over the course of 2022, the market added over 2,200 new units from construction deliveries while simultaneously seeing unit occupancy fall by approximately 760 units. However, not all of this news is bad news for landlords. One reason for the vacancy creep has been loosening pandemic era restrictions that precluded many owners from carrying out evictions for non-payment of rent. For example, in the City of Sacramento, tenants were spared eviction if they could pay 25% of their rents due by the close of Q3 2021. However, evictions of those tenants were prohibited until April 1, 2022. Not surprisingly, unit occupancy growth turned negative as those restrictions were lifted. While every municipality in California had their own twist on the state-mandated eviction moratorium, that also ended with the start of Q2 2022. So while vacancy numbers have increased,

market overview continued looking ahead

this at least reflects an improved situation for landlords that were not earning income on many of these units but whose hands were tied in respect to finding new tenants.

Even while vacancy numbers climbed in 2022, the reality is that Sacramento’s population growth has increased since the arrival of the pandemic. 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 arrival of the pandemic. For example, it is estimated by the Census Bureau that in the year 2020 the City of San Francisco lost approximately 140,000 residents, or nearly 19% of its population. Only a small percentage of these movers actually left the state. Most of the movement was temporary—it is estimated that roughly half of these residents had returned by mid-2022. Many were first-time homebuyers (primarily Millennials) that drove a suburban housing boom and national spike in singlefamily residential (SFR) pricing. Others were renters that took advantage of remote work capabilities to leave town. Many landed in Sacramento where average asking rent per unit typically are near 50% below those of San Francisco, the Peninsula and San Jose.

The in-migration trend is demonstrated clearly by occupancy trends in 2020 (the Sacramento apartment market absorbed over 2,500 units) and 2021 (positive net absorption of just under 1,800 units). New deliveries in both of those years were also below 2022 levels. Developers added just over 1,300 new units in 2020 and another 1,800 the following year. Incidentally, that

construction pipeline remains strong going forward. As of the end of 2022, there were over 4,400 units in development throughout the region with delivery timetables slated through early 2024. This is the highest number of units under development that we have tracked in 20 years. But it is important to remember that in the wake of the housing collapse and the Great Financial Crisis, very little new product came to market. Less than 1,600 new apartment units were delivered in the region between 2008 and 2014. This shortage of product resulted in Sacramento taking its place as one of the top US markets for multifamily rent growth multiple times over the last decade. That rent growth, obviously, has also fueled the aggressive return of new development. That being said, the current rate of new development accounts for less than 3% of the existing inventory. Years of underbuilding and the recent surge in in-migration since the pandemic mean this level of development isn’t just sustainable but it is simply not enough to return the marketplace to equilibrium.

The current average asking rent per unit throughout the region is $1,832 per month. This reflects an increase of just 1.1% from the $1,813 per unit reading of one year ago. But it is still up 18.7% from where it stood prior to the pandemic. Over the past decade, this metric has climbed a whopping 70.9%.

So with supply (new deliveries) outpacing demand (net absorption) in 2022 and multifamily rent growth slowing after years of recordsetting trending, where does this leave us for 2023? Development levels are going to remain elevated at least through the remainder of this year. However, due to the lifting of eviction moratoriums, we don’t think 2022’s net absorption tallies are a good indicator of what will happen in the coming year. If anything, this was the market finally clearing its books of a challenging issue—especially for mom-andpop landlords or smaller property investors.

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.

MULTIFAMILY MARKET STATISTICS: Criteria based on: 25+ Existing, Proposed, Under

Final Planning Units, Market Rate & Market/Affordable

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