What’s ahead for San Diego’s multifamily market?

Whether you’re a landlord or tenant, you’ve likely noticed some pretty powerful dynamics in San Diego’s multifamily market right now. The primary trend drivers fall into four categories: jobs, the overall housing market, baby boomers and cap rates.

Jobs: Millennials 25-34 years old — the largest renting demographic — are benefiting the most from the economy’s accelerating recovery. According to the Bureau of Labor Statistics, Americans aged 25-34 years make up 17 percent of the U.S. population but accounted for 30 percent of the job gains made over the past 12 months.

This job growth will allow them to pay higher rents in more desirable parts of town, perhaps closer to their jobs or in trendy parts of town that offer the lifestyle they are looking for.

San Diego has the fifth-largest concentration of millennials in the United States; 27.1 percent of the metropolitan area’s residents are between the ages of 18 and 34.

Housing market: Young people are renting longer and buying their first homes later in life. Many factors contribute to this. The slow recovery after the recession hit young Americans hard when they otherwise would have been saving for their first home.

Additionally, the rising cost of higher education means that young people with college degrees have record levels of student debt delaying home purchases until later in their careers. Furthermore, a cultural shift towards urban living makes apartment rentals in trendy parts of the city more attractive than suburban single-family homes.

The resurgence of apartment and condominium developments downtown — in addition to new retail and entertainment venues — is helping to fuel this shift to urban living in San Diego. Downtown has seen 825 new apartment units delivered so far in 2014, and another 476 units are under construction.

Baby boomers: Despite millennials’ stereotyped obsession with talking about themselves, it turns out that not everything revolves around them. The term “millennial” has become a real estate buzz word and a necessary focus for the industry, but another great generation is making a significant impact on the multifamily market.

Some 10,000 baby boomers hit retirement age every day in the United States and many of them are too healthy and active for retirement communities. As boomers look to downsize their homes or move to more desirable neighborhoods later in life, they are confronted with an inconvenient housing conundrum.

Many of them bought their homes in the 1980s and 1990s during the housing boom, but younger generations have less desire and ability to buy these large suburban homes. Faced with disappointing resale values, many baby boomers will opt to rent rather than buy when they move.

Cap rates and interest rates: Cap rates, or capitalization rates, are calculated by dividing annual net operating income by cost or value. Generally, the higher the cap rate, the more revenue the building owner realizes. Don’t be fooled into thinking that cap rates only follow interest rates.

In fact, a study by Moody’s Analytics found that during the seven periods of sustained interest rate growth between 1983 and 2013, cap rates actually compressed during five of these periods. Interest rates may not be the best predictor of cap rates.

Historically, cap rates have been heavily influenced by three other factors. First is credit availability. When banks are more likely to lend money for multifamily development, cap rates tend to fall. In our current climate, where it is hard to obtain financing, cap rates tend to trend up.

Second is supply and demand. When apartment supply grows faster than demand for that product, cap rates tend to rise. In San Diego’s supply-constrained market, cap rates are kept in check.

Third is inflation. When the rise in interest rates is driven by inflation alone, real estate values tend to be negatively impacted. Recent interest rate hikes have been driven by improving economic trends, such as rising net operating income in real estate, which helps to keep real estate values up and cap rates in check.

While the Fed is expected to start raising interest rates, local market conditions will continue to be more important to multifamily cap rates, especially in a supply-constrained market like San Diego. San Diego continues to have extremely low vacancy, and it will take a while before significant new supply starts to be constructed. Expect San Diego cap rates to remain below the national average.

Miramontes is executive vice president at JLL and a member of CREW San Diego.

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