The breakneck rental growth seen for Orange County apartments since 2020—during which some cities have seen nearly 30% increases in rent prices—appears to have come to a close.
Last quarter, the local multifamily market saw demand fall to its lowest level in more than a decade, according to CoStar Group, which tracks occupancy changes to determine demand. Occupancy levels were negative for the final three quarters of 2022, with average rents down 2.5% over the past four months to about $2,540 per month for the county.
Industry players are bracing for the shift, with this year likely to serve as a reset for the market as it works to maintain the gains drawn since the onset of the pandemic.
“It’s going to be a bumpy year, with lower pricing and fewer construction starts,” Bill Shopoff, chief executive of Irvine’s Shopoff Realty Investments, told the Business Journal. “There will be some owners who are stretched a bit. Overall, many will look at 2023 as a year to catch their breath.”
Capital markets will take a hit as well, with a limited buyer pool for Orange County multifamily projects.
“The cost of debt has gone up so much, it’s essentially stalled the transaction market,” CBRE Executive Vice President Dan Blackwell said, adding that capitalization rates for the sector, previously in the 3% to 4% range, are now hovering near 6%.
“That negative leverage has sidelined a lot of investors.”
Rent Losses
The recent decline in rent is negligible on a relative basis, when compared to the double-digit rental increases seen across the county in 2020 and 2021, as residents benefitted from stimulus incentives and concessions implemented as a result of the pandemic.
“Some of that rent growth was inflated due to stimulus efforts and the broader economy,” said John Drachman, co-founder of Newport Beach’s Waterford Property Co. “It’s natural for us to be in a period of slowdown, and we will give back some of the gains from COVID.
“Even if rents are off 10%, we’ll still be far ahead where we were at the start of 2021.”
Drachman notes that recent declines in occupancy are in part due to eviction increases, as pandemic-era incentives have gone away. Orange County renters are also dealing with worsening fundamentals, including high inflation and interest rates and a troubled labor market.
Waterford in early 2021 partnered with the California Statewide Communities Development Authority to acquire two large Anaheim apartment projects—The Parallel and the Jefferson Platinum Triangle—for nearly $320 million combined, kicking off a series of workforce housing deals that would total $2 billion by the end of that year. The Jefferson has since been renamed the Paramount Platinum Triangle.
“People thought we were paying more than we should for those properties, which were about 91% leased at the time,” Drachman said. “But rents in the Platinum Triangle have skyrocketed since April 2021 and vacancies have plummeted. Those two assets have been fully leased for about a year and a half.”
Drachman attributes the strong showing to lower rents, with average monthly prices dropped for the “missing middle,” or those typically making 80% to 120% of the area median income.
“It’s amazing what happens when you have rents that are lower than the market.”
Class B properties in Orange County have been among those seeing large rent increases over the past two years; those properties are at risk of declining occupancy levels should those rents continue to rise, Drachman notes.
“Everyone is likely to feel the impact of the softness that’s in the market, but Orange County will withstand the downturn like it’s done in previous cycles.”
Waterford invested about $15 million in new deals last year, a far cry from the $2 billion spent the year prior.
“We were pretty patient in 2022, and we will be in 2023 too,” Drachman said.
Luxury Sector
Orange County’s luxury rental properties may be somewhat insulated from the rent drops, Shopoff notes.
“Those renters are renters by choice,” said Shopoff, whose firm counts notable housing and mixed-use projects in Newport Beach, Huntington Beach, Westminster, Fountain Valley and Fullerton.
“Most of our renters could own as well as rent, and with the cost of buying having essentially doubled in the past year, it’s been a net good for the luxury rental market.”
The company has seen “more turnover than we expected” for its luxury rentals, but occupancy has remained largely unchanged with additional interested renters backfilling space.
“Our occupancy levels are in the high 90s,” Shopoff said.
Shopoff has not lowered its prices; in fact, it has increased pricing for its for-sale luxury condominium project, Parkhouse Residences, at Uptown Newport as the company moves further along in the development process.
“We are mindful of the market, but we aren’t going to put our product on sale today,” Shopoff said.
The company expects to sell out Parkhouse Residences this year. Prices for the 30-condomiunium project range from $2 million to just under $5 million.
Next quarter, it will begin construction on another 60-unit luxury condo building, citing the two-year development timeline as reason for starting the project during the downturn.
Uptown Newport currently has 458 rental and for-sale homes completed; it is entitled for 1,244 units.
Shopoff is also planning a mix of for-sale and multifamily units on a 19-acre site in Fountain Valley, where it paid $65 million near the end of 2021 for land long used as a strawberry farm.
The company is still working through the zoning process.
In Westminster, Shopoff is part of a group of builders looking to redevelop the city’s mall from an outdated shopping center into a mixed-use hub.
The Westminster Mall, which at its peak counted some 1.3 million square feet of retail space, has been rezoned to include up to 2,550 housing units, 425 hotel rooms and commercial uses including offices and retail.
Inventory
Helping to insulate Orange County’s rental market is a somewhat limited development pipeline; Drachman estimates new apartment projects coming online in the next year or so represent just 2.5% of the region’s total inventory.
“Markets like Austin will deliver 8.5% of overall apartment stock in new units over the next 15 months, while Phoenix is delivering closer to 11%,” Drachman said.
The Irvine Business Complex has the most new projects coming online, according to CBRE’s Blackwell, with several Class A projects expected to deliver in the next year totaling more than 1,000 units.
However, Class B projects have historically performed the best during a downturn, Blackwell notes.
“It’s an affordability issue,” he said.
Discounted Deals
As cap rates rise and rents fall, apartment investors are scouting discounts—a trend that has yet to materialize on the seller side.
“There’s a gap between pricing expectations as buyers manage new financing conditions and sellers continue to enjoy strong fundamentals. Both camps are right,” Blackwell said.
Transaction volumes are down at least 50% year-over-year, Blackwell notes, with many buyers in a wait-and-see mode. This presents opportunities for those looking to make deals, he adds.
“With less competition, there will be buying opportunities in the next six months.”
Shopoff and Waterford are scouting such opportunities.
“In the long run, these are times for us to redouble our efforts and take advantage of the repricing in the market,” Shopoff said.
“It could be a good time to buy assets,” Drachman echoed.
Market players maintain bullishness on Orange County and its ability to withstand market downturns.
“We are very resilient,” Blackwell said.
“When the market crashed in ’08, we were one of the last to feel it and one of the first to recover,” he said, adding that the market fundamentals of today are much stronger than 15 years ago.
