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Investors line up for San Diego apartment properties

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In the short term, it looks like the San Diego multifamily market should remain strong, supported by solid economic and demographic projections.

In the investment market, exchange buyers and condo converters are driving the pricing on the buy side, while a number of apartment owners are taking advantage of the sellers' market to consolidate their assets into less management intensive, single-tenant investments for a long-term hold.

Moving into 2005, much will depend on the stock market and interest rates; however, expect investment activity to continue at a brisk pace.

In the long term, San Diego appears to be better positioned than most key capital markets due to its physical location -- bordered on three sides by Camp Pendleton, Mexico and the Pacific Ocean -- unparalleled climate and positive employment growth.

Job growth is expected to reach 2.3 percent this year, with employers on track to add a total of 29,000 positions. This will help unemployment drop to 3.8 percent, one of the lowest rates for any major market in the nation. The service and construction industries remain the driving forces of growth, along with the resurgence of the leisure and hospitality industry.

Apartment development is expected to be down 27 percent this year, with only 3,000 units slated for completion in 2004. Condos present a viable housing option for first-time buyers and are economically more sensible for an individual to buy vs. rent. If you consider the incentives given by converters, along with the tax benefits and principal reduction, most buyers can purchase a condominium with a minimal down payment and realize the inherent value in gaining property ownership at a lower cost than renting the same unit.

The driving interest in condo development is an immediate and substantial return on investment. Virtually every project that has been built has been sold out before the project was completed, at or above expected prices. The costs and resources for converting an existing apartment complex are minimal compared to building a project from scratch. Condo conversion is more efficient and drives a higher return for the developer's input.

The condo movement bodes well for local apartment owners. While for-sale condos may remove some renters from the tenant pool in the short term, the long-term effect of reducing rental market inventory will prove quite beneficial.

By year-end 2004, apartment vacancy is expected to register approximately 3.5 percent, and further tightening is projected for 2005. Downward pressure on vacancy is coming from the growing economy, but the overheated housing market is the predominant driving force of tenant demand as a growing number of residents are priced out of homeownership.

Home sales activity has slowed as the housing affordability rate is at a record low of 10 percent. Apartment investors, seeking to act before a change in market conditions, have produced a buying frenzy that fueled a 40 percent increase in values as of third quarter on a year-over-year basis. Apartment owners are reaping the rewards.

One of those rewards is a 4.5 percent increase in asking rents to $1,165 per month. The luxury sector is leading rent growth this year, with an expected gain of 5 percent to $1,445 per month.

In terms of sales, properties will continue to command record-high prices in 2005. Prices are forecast to increase 6 percent this year to nearly $125,000 per unit. On a risk-return basis, real estate still ranks high compared to other investment alternatives.

In the past few years, it is clearly evident that pricing has outpaced rental market fundamentals, i.e., gains in occupancies and rents. Investors are buoyed by the promise of improving NOIs based on healthier fundamentals fueled by a growing economy.

And, long term, the San Diego economy and apartment market are well positioned for future growth and prosperity.

However, investors shouldn't lose sight of the cyclical nature of investment markets, including real estate. A significant shift in interest rates accompanied by a capital shift to alternative investments will serve as defining factors for all real estate markets, including San Diego, and will affect product supply and demand, as well as pricing.

Williams is first vice president and regional manager of Marcus & Millichap's San Diego office. He can be contacted at (858) 452-8300 or via e-mail at kwilliams@marcusmillichap.com.>

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