By BARRY KNUDSON
With a national economic slowdown, Orange County’s apartment market has begun to see noticeable changes. From a fundamentals standpoint, OC remains more positive than the national average, but local players are somewhat wary of a fragile local economy.
OC saw job losses in 2007 for a variety of reasons. Significant contributors to this receding growth were the mortgage, financial services and housing development sectors. Although it is anticipated that these industries will continue compressing, OC has a well diversified job base. With the healthcare and professional services industries steadily growing, the county should be well poised to weather this storm and head toward more stable job growth in the latter half of the year.
Rental rates and occupancy for apartments have been directly impacted by negative job growth. During the past two years, rent growth has been strong, but it is gradually softening. In 2007, rent grew 5.2% to 5.3%, down from more than 6% in 2006.
Rent growth should still outpace inflation, but landlords will be more cautious about significant rental rate increases. We are starting to see more concessions in the market and landlords are focused on improving their buildings with cosmetic improvements to help achieve rent growth. Trends and research from a variety of sources reflect that rent growth should be around 3% for 2008.
Apartment occupancy has also been affected by the slowing economy, although the numbers are mild when compared to less stable markets, such as the Inland Empire.
OC occupancy still outperforms the national average of about 95% with occupancy hovering around 96%. This trend should continue to remain at that level as long as landlords adapt to renter demands and grant limited concessions. The region has sustained occupancy rates for the past decade hovering between 92% and 97% depending on the submarket, building location and property class. With housing affordability still low, a diverse job base, a mature economy and high quality of life, occupancy for apartments in OC will likely remain stable.
From a transactional standpoint, volume for apartment building sales is down. We are trending away from one of the best investment markets for apartments OC has ever seen. The high asking prices sellers were achieving in the past 18 months are no longer attainable. This is partly driven by the aforementioned economic drivers but also by the fact that underwriting standards have changed.
Lenders are no longer willing to lend based on future rents and instead are looking at actual rents and actual operating costs. While loans are still favorable for apartments, lenders are scrutinizing every minor detail on properties and less willing to take substantial risks. Since potential sellers can no longer achieve huge profits from short-term holds with little value added to an investment, we are seeing more people hold on to their properties a little longer and focus on improving their investment to increase cash flow.
There is still a plethora of well-funded private investors who have been sitting on the sidelines waiting for pricing to soften. Many of these active buyers have significant holdings in OC and believe in the market fundamentals. With capitalization rates trending upward 50 to 60 basis points, many buyers are actively pursuing opportunities on and off the market. As with any type of real estate, there are still a good amount of sellers unloading buildings out of necessity. These types of sellers are starting to gradually adjust their pricing downward which will help bridge the gap between buyer and seller expectations.
With apartments still experiencing positive cash flow and OC’s solid fundamentals in place, well-managed and maintained properties have been and will continue to be a strong investment in OC real estate.
Knudson is a senior associate at Colliers International’s private capital advisors group in Orange County.
