The high cost of living in Los Angeles and San Diego is driving renters and businesses toward Inland Empire’s apartment markets.
MINNEAPOLIS, MINNESOTA (June 16, 2022) – The Inland Empire multifamily market has thrived through the pandemic and is well positioned to continue its growth. Its affordability relative to its neighboring counties and its flourishing economic drivers, especially in the Iogistics and healthcare sectors, are driving unprecedented demand for apartments, which has pushed rents to new highs.
The Inland Empire recorded its strongest rent growth on record in 2021, and investors took note, pouring capital into the region. Despite economic headwinds relative to the Fed rate hikes and global turmoil, investors will cautiously remain on the hunt for opportunities. This especially holds true for hard-to-replicate real estate that garners yield. The capital to deploy remains plentiful, and investors will seek safer haven in higher barrier-to-entry markets, which Southern California has historically proven to be.
We recently worked together providing not only the sale but additionally the financing on multiple lnland Empire multifamily transactions. We believe lnland Empire is emerging as one of the top markets in the country.
The past year in investment sales
Throughout the past year, the market transitioned in what has historically been called a “fight to the suburbs.” This occurs when renters flee high-cost-of-living locations like Los Angeles, San Diego and Orange County and follow more affordable lifestyles and jobs.
The Inland Empire is one of the most affordable places in Southern California. It’s also one of the nation’s top logistics markets with 40,000 jobs at Amazon alone. Additionally, it has a strong healthcare sector, with nearly 300,000 jobs.
ln 2021, we saw the most apartment transactions ever in the Inland Empire at just over $2.8 billion. Much of that was driven by rent growth. The market recorded more than 15 percent rent growth last year. The forecast is still on the upturn, with a 6 to 7 percent increase over the next three years.
The buyer pool has been robust. Just about every private equity institutional player now wants a presence in the Inland Empire. With surging rents, it’s been a different underwriting environment. We were used to seeing deals with up to 20 percent loss-to-lease because of the rent growth story. Additionally, when buyers close, it’s at the lowest cap rates we’ve seen in the region.
We recently closed a $45 million sale of a property in Riverside at a 2.4 percent cap rate, which is an incredibly low cap rate for not only the Inland Empire, but anywhere. Why? Becauce we can forecast the rent growth, and that low-two cap soon becomes a mid-three to 5 percent cap rate eventually. We arranged the sale of the value-add property, and the price per unit was one of the highest ever for that type of vintage product in the Inland Empire. Northmarq additionally provided the financing.
Deals in the works
The Northmarq investment sales platform was started just over three years ago, and since then we’ve successfully transacted about four deals per year in just the lnland Empire. We tend to target the $25 million to $100 million space, often properties that sell as “value-add.”
In recent transactions that were sold with a value-add strategy, the buyer was able to capture the underwritten rent push without having to do any capital improvements. We’re currently working on a few transactions that are expected to close soon in the newer construction space, which is real estate that is very high end and irreplaceable with the high construction costs.
As we navigate into the next phase of the cycle, these assets will be in much higher demand versus where we saw most trades in the market run up, which were pure value-add plays.
Financing takes many forms
As it’s been said many times, rates have been at historic lows these past couple years. The agencies (Fannie/ Freddie) led in overall multifamily loan volume in the lnland Empire last year; however, when it comes to acquisition deals, the majority of financing was primarily bridge loan done by a debt fund, insurance company or bank.
ln fact, the past several sales that we financed were bridge loans via debt funds and insurance companies. These options provided the buyer higher leverage, but, more importantly, flexibility to successfully complete their business plans. Our clients have found the Inland Empire to be very attractive due to the overall market fundamentals and the recent upswing in rent growth. Lenders have also found it to be a great market for investment. More deal hit the market in the second quarter, and we’re clearly in the flux of a correction. Our deals are moving forward because they are quality real estate that’s irreplaceable. But anything that’s not, is often getting re-traded and pricing is getting beat down. Irreplaceable assets that are economically irreplaceable due to today’s extremely high construction costs are seeing the most pent-up demand, especially in situations where the original owner hasn’t pushed rents to meet the market. As for financing, we see huge demand for this type of product from sponsors.
With interest rates rising, borrowing is going to get more expensive. Lenders are likely to focus on a flight to quality. Multifamily will continue to shine and to be a preferred asset class. We are still seeing huge demand for multifamily from our lenders. That translates to multiple options for borrowers and lenders getting competitive to aggressively win that business.
Class A with a minor value-add component are the most highly contested deals. For class A, we’re seeing investors underwrite to what we typically see in high barrier-to-entry markets like San Diego. Meanwhile, properties in great locations that support a value-add play make a lot of sense, because investors are willing to fund the renovations and will reap the benefits of higher-paying tenants.
How inflation and interest rates will play out
We have a good sense of the Fed’s mindset on rates, which offers some guidance. However, that can change. The past few weeks have been very volatile in the financial markets. The Fed is trying to combat inflation while still allowing our economy to grow. This rise in rates will affect the bottom line for our clients. That said, multifamily still offers a great investment in inflationary times with its operating margins and annual lease trade-outs. Even with the looming interest rate hikes, the Inland Empire is well positioned to continue to be a market of demand for our clients and lenders.