The other month at Gabhart Investments, we hosted a workshop on the outlook of the San Diego Apartment Market in 2019 with CoStar Managing Analyst, Josh Ohl. In this workshop, Josh discussed

  • Rent Control
  • Investment
  • Rents and Sales Numbers
  • Apartment Pipeline
  • Where Are We Building
  • Vacancy
  • The San Diego Economy
  • and much more

Below we have posted the entire transcript from the workshop. We will be posting the full video on Thursday, May 30th, so please stay posted.

San Diego Apartment Market Outlook for 2019

Josh Ohl:          So my name’s Josh Ohl. I’m a managing analyst over at the Costar group. Today we’re going to spend some time just kind of giving you an idea of what our shop’s view on the numbers is, kind of an agnostic approach, if you will, to the market. We’ll look at fundamentals, then we’ll try to jump into some pipeline activity, rinse, and then sort of look at the capital markets a little bit in San Diego to give you an idea of what we’re tracking in all of these categories.

Rent Control and San Diego Economy

Josh Ohl:          Think we might as well start off with some of the things that are in the news right now. We saw the city council pass earlier this month removing parking requirements next to a high-transit priority area. The idea being that developers are going to pass those construction savings on to their tenants, sort of they’re going to be able to build more units as a result of being able to build fewer parking spaces. The numbers floated around are upwards … if you start digging underground for a parking space, you’re probably spending about $90000 a space. You know, if you’re paving a space aboveground it’s probably $20000, $15000 a space. So the idea is it will save money. Whether that cost is going to be passed on to the consumer, I mean that’s anybody’s guess whether the developers are going to be altruistic enough to pass that savings on.

Josh Ohl:          You know, also the idea being, too, that it’s going to lower costs for renters. If you look at properties that we’re tracking that are within about a half a mile with a high-transit priority spot, we’re still looking at about a $350 premium for those units compared to units that are spread out across the balance of San Diego, so you already are banking on a higher premium to begin with at those spaces. So whether or not it’s going to save money is, you know, I guess we’ll find out. I think Jonathan Siegel’s probably going to have one of the first projects that’s going to probably test that down in Little Italy. About 42 studio units. I guess it’s probably worth saying … he’s not in the room, right? Okay, it’s probably worth talking about, I think the initial thought was that those studios were going to come online at about $1300. Probably going to be a little bit closer to about $2000 a month, so … it’s just the cost of doing construction, too, right?

Josh Ohl:          That’s one of the first things in the news. I think the other thing that’s relevant in news, too, I think this was about two weeks ago, is that with the support of governor, it looks like the state legislature, regardless of what the state of California voted on regarding proposition 10 in 2018. It looks like the state legislature is going to start trying to pass through some sort of rent control measures across the entire state, taking their cue from what Oregon did. They passed theirs at rent control cap at seven percent growth and with inflation … so you’re talking about a point that’s probably on average about nine percent. That’s a pretty high level. What that’s going to probably do is, you know, it’s going to impact, obviously, the value-add opportunities across the market. They’re going to likely pass tenant-protective measures, and it seems like they’re going to have a willing governor who is going to pass these measures once they’re written and get through committee. So that’s another thing to take into account. It looked like we had passed that level last year and gotten past proposition 10 and what that had done to the market, but perhaps that’s something worth keeping an eye on as far as what they’re going to do this year.

Speaker 2:        In Long Beach they denied the vote, FYI. And it’s been going berserk ever since.

Josh Ohl:          Yeah, and National City, I think, voted it down, too, last year, so this is just the state of California right now, right? It seems like they’re full speed ahead on passing [inaudible]

Speaker 3:        They never learn.

San Diego Apartment Fundamentals

Josh Ohl:          So with that being said, let’s jump into some of the fundamentals supporting San Diego right now. Here we’re looking at just an employment growth chat. This is going through the end of 2018. More recent job growth numbers suggest through February we added about just a shade under 20000 jobs year over year in San Diego. The eds and meds category spurred a lot of that growth. The business sector, in particular professional, scientific, and technical field added about 3000 jobs. That’s good. When we look at [qualt coms 00:04:14] did it to those jobs. They took about 1500 out in 2018. So you know, the good news is San Diego’s pretty well poised to continue adding jobs in those scientific and technical fields going forward. We saw Apple announce last year in December that they’re going to add 1200 jobs over the course of the next three years. They took 100000 square feet down in UTC. Being that they’re going to continue building out more jobs and space here, they want to turn San Diego into an engineering hub and compete with [Wa Com 00:04:44].

Josh Ohl:          So the that’s good news for all those laid off workers, is that you already have a lot of talent that Apple can apply and look for to start building their own base here in San Diego. So I guess that’s also one of the things that we take into account. We have a lot of these jobs in the tech fields that are open and there’s job wanted signs out for them. We probably just don’t have enough employees that are ready to be able to take down those jobs, and as we look at some of the other fundamentals here, it’s probably one of the reasons that it’s difficult to attract the outside talent into San Diego.

Josh Ohl:          Here we’re looking at demographic chart in San Diego, just to kind of lay of the land and talk about populations. We have one of the highest densities of millennials in the entire country. We have about 25 percent. Maybe only Austin comes in higher, Seattle’s pretty competitive at that number, but we do have a very high concentration. You know, I’d be remiss if we’re going to talk about real estate and in particular apartments, it’s a buzzword, talking about millennials. They drive demand in some regard, but I don’t know how many 25-year-olds are taking down $3000 a month apartments, per se, but it is a good stock of those people that are the primary renting age and who are doing a lot of the renting. Maybe not at the high end, but those are supporting demand for a lot of the interior and sort of mid-level demand for apartments.

Josh Ohl:          One of the good signs for San Diego, this is just looking at cumulative income growth across households over the course of a cycle. San Diego is in orange versus the national benchmark in blue. We’ve beat the national benchmark be about five percentage points over the course of the cycle. That’s good news. One point in September of 2018, we had about five percent year over year income growth. That’s really good for San Diego. That was one of the highest numbers across the entire country. Started to slow a little bit here through the first quarter of year over year. Weekly earnings were up one and a half percent. Little less than inflation, but that’s sort of the nature of this cycle, it seems to be. It’s just sort of stagnant wage growth to begin with, so we haven’t necessarily seen the three and a half, four percent year over year income growth that maybe perhaps we could have expected with an expansion. It’s just the nature of our expansion. It’s happening to San Diego, as you can see, where the national number.

Apartment Vacancies

Josh Ohl:          So we’ll lead that into sort of looking at this is Costar’s sort of bread and butter, if you will, when we’re looking at fundamentals, whether it’s in the apartment market or whether it’s in any of the commercial segments. This is a supply/demand vacancy chart. Here you’re looking at demand, which is absorption in blue. New new supply is in orange, and then we’re looking at vacancy in San Diego in green versus the national vacancy in black.

Josh Ohl:          I think it’s safe to say vacancies are really in good shape in San Diego. For the most part, we’re at about four and a half percent; that’s a really good number. You know, it’s better, probably, than when we were at sub four percent. It allows for a little bit more turnover, plus apartment units. That’s another good thing if you’re a landlord. Probably get little bit more rent growth when your unit turns over as opposed to trying to rely on just renewing that rate at maybe three or four percent. I know a lot of landlords like pushing the rents 15 percent when it turns over, so that vacancy a little bit higher is probably a good thing for San Diego.

Josh Ohl:          Looks like we’re, too, probably coming off our peak level of new units of supply on the market. In 2018, we had about 4200 new units of supply come across in San Diego last year. 40 percent of those were downtown. It’s all about downtown; I don’t think I have to tell anybody that. 40 percent of the market’s … when we talk about San Diego as a market, we’re talking about market rate apartments across the entire county. 40 percent of the under construction stock right now is in downtown; that’s where everything’s being built. Demand sees to be holding up largely downtown. I mean we’re looking at vacancies at at 15 percent, but when we’re talking about the flood of inventory that’s coming on line, that’s not a terrible number. In particular, when we look at absorption numbers downtown, it’s pretty good, you know?

Josh Ohl:          The East Village units that are being delivered where there’s a ton of construction, you might have some more challenges with the neighborhood amenities, if you will, in the East Village, but you’re still looking at about almost high 20s, maybe 30 units per month for those communities that are in lease up. East Village probably the best … or I’m sorry, not the East Village, Little Italy, probably the trendiest and best neighborhood in San Diego. There are probably about 15 units a month in absorption but you’re also looking at average rents of about $3100 a month in new units. So demand is a little bit slower. Obviously the community sizes are a little bit smaller there, too. Probably on average a little less than 100, so that’s sort of their leasing strategy and it’s doing well.

Josh Ohl:          We’re going to look at absorption across the county as a whole. Look at Mission Valley, you know, there’s 1500 units under construction in Mission Valley right now. The properties that came on line in 2018, you have Mission Valley, Millennium Mission Valley, that’s right there at the edge of the eight. That one came on line and it’s averaged about 25 units a month. That’s a really good number. Concessions are picking up a little bit more in Mission Valley as units are piling up there. [inaudible] over Mission Gorge. That came on line last year. That’s averaging a similar number, so it’s a little bit, you know, pretty strong demand for the most part there. You’re getting numbers in Carlsbad for absorption in new communities. Similar levels, the low 20s. I think when you go out to more of the suburban areas, perhaps the interior parts of the market, that’s where you’re going to find that slower absorption a little bit, areas where they’re not accustomed to receiving sort of the luxury units which all developers are sort of compelled to build these days and they’re getting less than 20 units of absorption in those properties.

Speaker 4:        Question on that subject. What is the rent you’re dealing with in each of those places? [inaudible] one bedroom at these newer constructions in Mission Valley? Do you think it’s struggling?

Josh Ohl:          So in Mission Valley, you’re looking at average rents in the new communities at about $2400 month.

Josh Ohl:          In the East Village, you’re looking at about properties that delivered last year at about $2650 is the average for the new units that are coming on line.

Josh Ohl:          Two bedrooms are about $2900 in East Village-

Josh Ohl:          $2600 would be the overall. Yeah. And then when you’re going over to Little Italy, you’re looking at overall average of about $3100 for new units. Studios are at about $2300, one beds are about $2800, two bedrooms

Speaker 4:        Where’s all that data?

Josh Ohl:          In CoStar.

Josh Ohl:          What is supporting our rent observations and being able to track absorption in this, we have a secret shopper that calls properties in lease up one to two times a month, so they’re doing that constantly.

Speaker 4:        You guys also own or no?

Josh Ohl:          We do own So with the help of, we get about 40000 rental observations in San Diego alone per day. It helps us be able to track the market on a day to day basis to see exactly what rents are doing. And I’ll kind of show you in one chart later in particular to rents on how we’re able to do it and what wort of insight that provides.

Josh Ohl:          So we’re talking about absorption across the county. This chart’s just sort of looking at the lease up time and the amount of months or quarters it takes for new communities to stabilize over the course of properties that delivered in 2015, and then vintage 2016, ’17, and ’18. It held largely consistent in properties from 2015 and ’16. It was about six quarter lease ups was about the standard. Started noticing 2017’s new inventory. It was about a seven quarter lease up. You know, granted, the same thing it looks like for 2018. Deliveries were on track for about seven quarter lease ups. A lot of that, it’s just where it’s all coming online.

Josh Ohl:          It’s a lot of competition downtown. The properties that delivered downtown in 2017, they came on line at the very end of the year, largely, and they competed with everything that started delivering in mass largely in 2018. So it’s just needed competition. But again, I think when we take into account that year over year hiring in the construction field has largely been flat, it’s not, I think, wholly unsurprising, especially when you’re looking at trying to find increased skill labor for the amount of projects that we’re trying to build, that construction timelines might slow a little bit; it might take a little bit more time to get projects off the ground, too.

San Diego Apartment Pipeline

Josh Ohl:          So with that, we’ll turn to the pipeline, just to give you an idea of where they’re building and sort of just give you insight on that. I think when we’re talking about the market and sort of when we … you know, I don’t like to use the word “crisis” for San Diego’s housing. I think the state legislature likes using that. “Crisis” seems hair-on-fire type of environment. Environment’s probably just frothing, if you will, right? This chart right here is looking at just essentially total residential building, single family residential, and multi-family building over the course of the last 35 years, to give you an idea of the change in supply that’s delivered in San Diego.

Josh Ohl:          Beginning a little bit earlier than this chart, in about the mid-70’s we had built about three percent of new inventory on a year over year basis. Beginning in about the mid-aughts when the recession hit, and in taking a long time coming out of that. We kind of stalled. We only were adding about half a percent of inventory per year. And one of the things that, too, stands out is when you look at history, we generally have built about 75 percent of our inventory in single family housing.

Josh Ohl:          We don’t do that anymore, and I think that’s one of the reasons that we find for-sale housing supply is, what, about two and half months of supply that’s on the market. It makes it very typical, and it also keeps people in apartments, too, right? You’re less willing to sort of trade your maybe starter home to buy another home when there’s just very little inventory available for stock. I’m probably not alone in knowing people that sold their home, tried to find another, couldn’t, and ended up having to rent a place because they’re just stuck and the market’s extremely tight right now.

Josh Ohl:          So this is one of the reasons I think that we’re looking at our sort of frothy housing situation: we just don’t build enough. Everybody knows it; we just don’t. Any time you start saying that you’re going to build a project and it’s going to cast a shadow on a house, on a parking lot, on a tree, there’s going to be a neighborhood opposition to it, right? Construction cost has gone up, the cost of labor has gone up, so all of these things work against building. There’s a project called Merge 56 out in Rancho Penasquitos that’s probably not alone. Got approved by the city, there was going to be about 256 market rate units, build a little sort of mixed-use environment, and then a labor group decided that they were going to just press a lawsuit against the project, that they didn’t follow certain environmental regulations to the T. That, again, speaks to the difficulty of building.

Josh Ohl:          The city of San Diego knows this; everybody knows this. We should be building probably about 18000 housing units per year to keep up with population growth and household formation. That’s for every year for the next decade, that’s where we should be building. But this chart just gives you an idea of just building permits alone. This doesn’t mean we’re building this many units every year, but this just gives you amount of building permits that are approved year over year, and you can see we’ve largely plateaued at about 10000.

Speaker 3:        The only thing that I’m wondering is where the heck you going to build them, unless you just tear down stuff. There’s no other room, and like you go out to east county, they’ve got all this stupid zoning. You can’t go below 40 acres and all kinds of garbage, because they’ve passed it with, “Do you like little furry animals?” And they got it through and people didn’t know what they’re voting for. Where you going to put it unless you tear down old junk?

Josh Ohl:          Well, I think one of the big targets is probably going to be the Morena Corridor, up through like Balboa. They’re going to put three trolley stops there on the way to UTC. I think the … just if you have a bay view and you know you’re on the hill behind there, there’s going to be a lot of opposition against that. There’s probably going to have to be a lot of infrastructure improvement on the surface streets in particular, but if I had to guess I would presume that that’s going to be one of the corridors where we’re going to see a lot of units coming on line over the next several years.

Josh Ohl:          A lot of cities are sort of updating their master plans. You look at what they did down in the Midway district. They just updated their master plan to go from about 2500 housing units to over 10000 in that area. The thought of that frightens me; I live at the end Rosecrans. I can’t imagine how long it would take me to even get to the Eight if they were to build all those units down there. You know, Old Town, they improved theirs, that they added about another 1000 housing units in their master plan. [Curry] Mesa’s up next. They’re going to address theirs. I think they did theirs in the East Balboa Corridor, the Morena Corridor. There’s updates to address these; now it’s just a matter of sort of overcoming the neighborhood opposition that’s likely to follow. Now when you’re talking about like-

Speaker 7:        How about City Heights?

Josh Ohl:          City Heights, probably. I mean, and they, I think, in a lot of those Balboa Park neighborhoods, they increased the height limit on maybe upwards of 100 feet, so I think you could see it around there. But again, as soon as anything pops up over there, it’s just opposition. Yes?

Speaker 8:        What about the one in Mira Mesa?

Josh Ohl:          Yeah, so there’s a lot of projects that are on the books. I think the city is just … you lack sort of the mass transit and the trolley stations out there that I think the city is really moving toward. That’s why, in my opinion, I think they’re going to focus on this corridor coming up from Old Town up to UTC first, and I think that’s where they’re going to start pushing them in. East County presents its challenges, obviously, just because fires are prevalent out there, so that’s one of the challenges if you’re going to increase infrastructure and increase density. That’s certainly one of the challenges.

Josh Ohl:          So there’s a lot of challenges. So you know, when they had the ballot measure in 2016 to build 1600 units out there, what was it, Lilac Hills Ranch out there in Valley Center? I voted against it. I don’t go out there. It has no impact on me. I just didn’t like … we live here because we like San Diego as a big town, not a big city, right? We don’t like-

Speaker 3:        Not in my back yard.

Josh Ohl:          Yeah, exactly. So I know there’s an NIMBY movement here and there …

Josh Ohl:          “Yes in my backyard” as opposed to the “no in my backyard” movement, but it’s increasingly likely that we’re going to have to go in this direction if we’re going to address this housing situation. So where are they building right now? Well, the red spot right here. This is taken out of CoStar just to kind of give you a heat map. You know, where they’re building, and you can see they’re not building in East County at all. It’s largely downtown, to largely Mission Valley. You get some spots up in the Carlsbad area, the Oceanside area. That’s smart, you know, you’re taking advantage. There’s a lot of industrial construction up there, the sort of corporate HQ industrial construction, where you can definitely get some demand for these apartments based on that. We get a little workforce housing down there in Otay Mesa and Chula Vista and down in the Millennia area.

Josh Ohl:          But it’s spread out, but it’s going to be concentrated in downtown. Downtown developers and landlords are probably just going to have to hope, really, if they’re going to continue to sort of increase demand down there, and some of these office projects downtown also take off. I know Stockdale purchased Horton Plaza last year for $175 million to convert into sort of a tech office hub to bring in 4000 jobs. The city council has to take that up because there’s a requirement for 600000 square feet of [inaudible] in that space. Manchester Gateway, they started breaking ground, but that’s largely just on the Navy complex because the Navy’s build to suit.

Josh Ohl:          What you need is sort of the Apples of the world, instead of Apple taking 100000 square feet in UTC, you need an Apple to take 100000 square feet downtown that’s going to bring some tenants with them on their coattails, and so far when Amazon decided to expand here, they took UTC, right? Google up in Rancho Bernardo area. So this is where all the tech companies want to be. This is where all the sort of panache is up in this area. Yes?

Speaker 3:        How about the SPAWAR’s area? I know there was sort of an odd discussion about putting a lot of housing there. Where are they on that?

Josh Ohl:          Well I know …

Speaker 2:        That’s supposed to be the hub.

Josh Ohl:          They want to do perhaps like a transit hub that’s going to link to the airport, would be right there.

Speaker 3:        But I thought … well they would also put housing there, sort of like they did downtown with the big transit hub, where the train and the buses and everything go.

Josh Ohl:          Exactly, I know SANDAG really likes that idea of putting it right there at the SPAWAR site. Again, I think just because of where it’s located right there on the coast, we’re looking years and years and years, I mean. You look at the big retail projects on the market, whether it’s Amara Bay, the Seaport Village, Manchester Gateways Retail, all these are big, shiny projects, but they’re all near the water and they all just take years and years. You have fault lines running down along the water, which makes it just difficult for building right there. So seems like a good spot for it, right? The defense department doesn’t need the space, but we’re years away. And again, selfishly, if I’m coming from Point Loma and I wanted to get on the five south, it’s going to [crosstalk]

Speaker 4:        But you don’t need a car.

Josh Ohl:          Yeah, that’s true. We’re all going to ditch our cars and maybe take Ubers to trolley stations to and from work and to and from our offices. So when we talked about the transit priority areas, I just pulled this out of CoStar really quick to give you an idea of residential land, and also proposed properties that are in these areas, to give you an idea of maybe these are going to be construction hot spots. I think there’s about 50 total residential land parcels that could accommodate without sort of having to adjust zoning next to high transit priorities right now. So we might see some pick up, but I don’t think we’re going the see any large developments that are going to remove parking altogether. Maybe instead of one and a half spaces, you’re going to be down at half a space per unit. We’ll see.

San Diego Rents

Josh Ohl:          Let’s move into rents. What are rents doing right now? You know? We ended 2018 at about three point four percent rent growth; that’s a really good number across the whole county. That’s still better than the longterm average of three percent. Each one of these orange bars on here represents 12 months trailing rent growth. San Diego’s had a very good run. We had some of the best performance of major metros in the country last year. We’re San Diego, right? We expect it. It’s high demand. We’re at about $1800 a month on average rents in San Diego. Again, that’s a high number, but we do anticipate rent growth slowing. Part of this is just the nature of the cycle. We’re very deep into it, and we have noticed rent slowing a little bit right here, as you can see.

Josh Ohl:          So here we’re looking at one and two in blue, three stars in orange, and green is in four and five star with all of San Diego in yellow. So what stands out is rents actually fell about one percent, just in the fourth quarter alone across all of San Diego, and it impacted the high-end communities the most. Obviously, that’s where rents are the highest. It’s got to be hard pushing rents in brand new communities when you’re already at the top of the market, so those rents did claw back a little bit here in the fourth quarter, and that’s something we expect to happen a little bit more in 2019 and definitely in 2020. We expect that sort of seasonality to extend to the second half of the year a little more noticeably than it has.

Josh Ohl:          You know, when you look at ’18 Q4 in particular, you had areas like Mission Valley, UTC, and sort of the coastal area down in like Point Loma and the peninsula and Coronado, where rents came back from more than two and a half percent in the fourth quarter in those areas. Some of the biggest dips that we’ve had or that we’ve recorded in over 10 years in any quarter. So some of these markets that have high rents are starting to feel the heat a little bit as renters are just having trouble keeping up with rent growth.

Josh Ohl:          And I think this is one of the reasons, too, is when you look at cumulative income growth, blue, versus cumulative rent growth in orange, and you can see we’ve had a good run of increasing our household incomes over the course of this cycle. But landlords have also had a really good run over the course of this cycle, raising their rent, and you can see through the end of 2018, there was about a 14 percent difference where rents grew faster than incomes grew over the course of a cycle. That’s a really big dent, as far as in your wallet that you’re having to pay out every month.

Josh Ohl:          So that’s, I think, one of the reasons that we’re seeing some of the rents pull back a little bit, and in particular at the high end of the market. And I think when you look at some of the metrics, one of the reasons I think landlords are beginning to approve renters, a couple years ago 40 percent was sort of unheard of, where landlords were approving renters and their rent to income ratios. We’re even seeing 50 percent of incomes to rent now being approved by property managers. So that’s something that we never saw in San Diego, but that’s starting to creep up now, just because of having to … trying to fill demand in a new apartment.

Speaker 7:        Can you say that again?

Josh Ohl:          So I was saying landlords are now increasingly moving above 40 percent of approving tenants for rent to income ratios, where generally the standard was 30. A couple years ago we started seeing 40 a little bit, and that’s becoming pretty standard, especially downtown. 50 percent’s not unheard of. It’s not crazy, too, when we looked at that where rents have grown in particular versus household incomes have grown. You know, right now when you look at median renters’ household income, it’s about $53000 across San Diego. You look at median household income, it’s about $78000. But median renters’ household income, it’s only about $53000. When you look at where average rents are across the entire county and about $1800, doesn’t really matter if you’re looking at El Cajon, National City, Chula Vista, North County, you know, areas that are prone to be more of our affordable areas, renters are on average paying more than 40 percent going toward rent right now. So it’s just crept across the entire market. Yes?

Speaker 3:        So maybe that might be fueling people’s choice to rent rather than own. You know, there’s some like a big mystery in a lot of the journals about why the millennials aren’t buying houses, and if you can rent the house at 50 percent of your income but you can only get a loan on a house at 35, that’s going to kind of push you, I think, into life in the rental cycle.

Josh Ohl:          That too.

Josh Ohl:          Yeah, I mean, that too, and you look at where savings rates have plummeted to about three percent right now, where historically the standard has been closer to 10 percent but now it’s about three percent, so that’s definitely playing into it, I think, and it’s just a very [crosstalk] I think with median housing prices right now in San Diego versus median household incomes, I think, what is it, the average household income would probably go to like 70 percent toward a mortgage based on what median housing values are right now, so the market’s just overheating. Maybe that’s it. I’d like to buy another house. I don’t like where the market is. They want like $1000 a square foot in Port Loma right now. That’s nuts. Yes?

Josh Ohl:          Like granny units and whatnot, and I think they anticipate in a decade about 5500 units might be built. They thankfully lowered the permitting cost from maybe upwards of like $80000 to only about $35000. Of course, you’re assuming people want to give up their back yard space and become landlords. I think that’s a large assumption, that there’s going to be a lot of people to do that. But again, trying to address some of the issues. We’ll see whether it makes a dent or not.

Speaker 2:        La Mesa’s getting into that act, too. They just passed an ordinance.

Josh Ohl:          Yeah, and I’ve seen that, so … yeah. And I think they also putting forth blueprints, so at least it makes the construction of them a little bit easier, too, so. And I think this is my last slide on rent growth, and this sort of speaks to where the market is. This just looks like our five year trend in a heat map. And you can see on the left, you’re looking at only the coastal areas up here, where we are right now, down in UTC and downtown, largely, where rent growth has averaged over three and a half percent, and that’s the most expensive areas in the metro, but it’s more the interior parts of the metro where’s you’re averaging over five percent that sort of speaks to why, I think, we looked at a demographic chart earlier that speaks to where population and migratory trends are suggesting we don’t have end migration anymore. We do, but it’s a net negative. We have more people leaving the market. You know, they’re going to Inland Empire, Sacramento, Phoenix, areas that have pretty good employment markets, for the most part, but also much more affordable to live in those areas.

San Diego Apartment Investment

Josh Ohl:          So let’s wrap up with a couple, look at a couple slides on investment. Here we’re just looking at quarterly sales volume, stacked bar rank over the last decade. I think what stands out is I feel like proposition 10 played a large role last year in just keeping some investors on the sidelines with just kind of “wait and see” approach. It’s just very sluggish. Investment largely didn’t start picking up until we started seeing those polls come out in September suggesting that it likely was not going to pass, and that’s when we started seeing some volume and some better deals go down. And that momentum has largely carried over into the first quarter of this year. We see some big deals; we see some strong sales activity as well. But it is worth noting last year was the lowest sales volume since 2014. Interestingly enough, that sort of trend was unique to San Diego in California. It didn’t happen in the Bay Area, L.A., Orange County, or Inland Empire. So maybe just San Diego investors are a little bit wiser. I don’t know.

Josh Ohl:          Here we’re looking at San Diego’s apartment market pricing and index, just to give you an idea where pricing is, and also a pricing index. We’re indexed to 100 at the end of 2008, so we’re looking at essentially the last decade. And you can see apartments that [crosstalk] over 100 percent in value on the index since the end of 2008. You can see pricing hit about $300000 a door as well through the end of 2018. I think it’s worth looking at, too, though, when we forecast it looks like that rapid appreciation has started to slow a little bit. We anticipate that leveling off throughout 2019 and even through 2021 falling back a little bit. It’s not unique to the apartment market; we anticipate that happening, too, largely in the commercial market, as well. Again, it’s the length of the cycle. You know, there’s some headwinds that are out there on the horizon so-

Josh Ohl:          You know, pricing we anticipate, you know, we hit about $300000 a door, probably falling to about … again, it’s a forecast, right, so maybe by end of 2021 falling to $290000, $285000 a door, somewhere around there.

Speaker 2:        No way in Hell.

Josh Ohl:          You don’t think so?

Speaker 2:        No, because your new starts are getting way too much rent, and the inventory here is all crap, so as long as you put the value in, upgrade your units, make them look like new, should be able to get at least $2000 a month, and $2000 a month is worth way more than $250000 a door.

Josh Ohl:          Possibly, but at the same time [inaudible] pass rent control across the state, so you might have had less of those value add opportunities. You know, we have slowing income-

Speaker 2:        No one wants rent control with rats.

Josh Ohl:          No, nobody does, but that’s one of the concerns, right? That’s why I think the state legislatures seem to be the only one that want rent control passed. But this is, you know, I think part of it is where we are in the cycle. You look at Moody’s; they’re anticipating negative job growth in 2020, for instance, and largely slow employment growth thereafter for a couple years, and I think that plays into it. When we’re looking at San Diego transactional versus market cap rates here, the market cap rate or transactional cap rate is in … i think we’re looking at just before [inaudible 00:33:04].

Josh Ohl:          So you can get an idea, transactional cap rates, we’re just basically looking at properties that are traded, what are the recorded cap rates that we’re recording with the comps. Market cap rates are essentially if the entirety of a market is going to sell, what kind of cap rates would we notice instead of sort of banking on maybe high-value trades or sort of low-end trades that may be influencing a little bit more. We’ve seen sort of flat cap rates over the last … they’ve sort of stopped compressing. Obviously it depends where you are in the market, what you’re investing in. We’re looking at maybe four and a half percent cap rates on average.

Josh Ohl:          Go up to the coast, finding cap rates in the three percent neighborhood is probably pretty common. Go out to the interior, you can still find cap rates in a five percent area. But again, slowing [inaudible] growth and rent gains I think is going to play into it. The fed has pulled back on pushing interest rates for the next at least 2019, but in case they go back to 2020, we anticipate that playing a role going forward. So one of the big things that we’ve seen … yes?

Josh Ohl:          It depends, you know? Like [inaudible] Mission Valley, which delivered last year, sold at I think about a four-four cap?

Josh Ohl:          You know, and I think we’re seeing Mission Valley, a lot of those properties, that’s where you had tons of the institutional product. You see a lot of turnover there; that seems to be right where they are for Class A space.

Speaker 4:        I’m building a new product in western Chula Vista. I think that modeling my cap rate for the rate of return calc at like four two five or four four or something like that.

Josh Ohl:          Okay. yeah, that seems to be pretty much in, you know. So opportunity zones is something obviously that’s been in the news lately. CoStar you can search on opportunity zones. You can look at what properties, you know, what rent growth looks like, what properties are trading for. This is just … it’s, I think, hard to take any conclusions in it right now because obviously there’s still, I think there are some cobwebs involved in the law and trying to sort out what is and what isn’t considered the investment or the capital improvements on the property, but this sort of gives you an idea of the level of pricing increase on properties that have been sld in San Diego’s opportunity zone in 2008, just to give you that idea of maybe a 10 year return, but you have to hold your money there.

Josh Ohl:          As you can see, pricing has hit about $250000 a door. That’s a pretty good number, especially for some of these areas that are perhaps less high glamorous, if you will, than other parts of the San Diego area. You know, we do-

Speaker 2:        Sorry, what’s that? What’s an opportunity zone? Sorry to interrupt.

Josh Ohl:          I think in the tax act that passed in 2017, designated census tracts that have median household income 80 percent below or at 80 percent of the MSA’s median household income, and then I think census tracts that are tangential to those also have some benefits as well. It’s a long write-up; if you want to [inaudible] tax accountant will probably into it [crosstalk 00:36:07].

Speaker 2:        It’s also all linked to all the new transit.

Josh Ohl:          Yeah, so you look at like National City, Barrio Logan, some of those areas down there. City Heights has some. You see a little couple pockets El Cajon and Vista. But this just kind of gives you an idea of where pricing has moved over the last decade. Maybe that would be the case, maybe not. I don’t know if the state decides to pass a rent control measure, what that might do, especially if you have to reinvest 100 percent of the capital improvements into that property, what that might do to sort of impact especially the multi-family market here.

Speaker 2:        Like what do you mean, capital improvements back into the property?

Josh Ohl:          So you have to invest 100 percent of the … I think it is … I don’t know, it depends on who you ask. I have not been able to get a straight answer from, you know. It’s either 100 percent of your purchase price back into to property, so you invest $1 million, you have to invest $1 million in improvements on the property. Or the other part is I’ve heard you get the assessed value of the structure on the property, so if the structure’s $600000, you would have to spend $600000 on kind of improvements, so.

Property Example

Josh Ohl:          I think this might be my last [crosstalk] here, just to kind of give you an idea from the investment market. Just look at this property. This is out in Lake Murray. This is pretty standard property, 24 units … I’m sorry, 35 units. A bunch of one bedroom, one baths and some two bed, one and a half baths. Built in 1975. Or built in 1970. This is largely considered it was a Class C property, but just to kind of give you where this property has moved over the course of this cycle, it sold in February 2012 at $4.95 at a five point eight cap. They put almost $1 million in improvements on the property. It then sold in 2013 for $7.1 million for a 20 percent appreciation. This buyer, a San Diego developer, decided they were going to put $351000 in further capital improvements. You can see it looks great from the outside now, and then it just sold in August for $10.25 million at a five cap, 38 percent appreciation.

Speaker 2:        It’s across from Lake Murray.

Josh Ohl:          So it kind of gives you an idea about the strength of the market and just people keep renovating properties. Even if properties have been renovated earlier in the cycle, it seems like the value add component still exists in a lot of these properties and you can see the price appreciation [crosstalk] pretty strong over the course of the cycle.

Summary of the Presentation

Josh Ohl:          And to kind of put a bow on everything we talked about today, local economy is strong. We’re poised to continue adding jobs in the market, especially the kind of jobs that help support high rents and that are good for the market, if you will. If we were only adding sort of service industry jobs, hospitality jobs, that would sort of be a strain on the market, but we’re adding a lot of tech jobs, which is good.

Josh Ohl:          We still aren’t building enough, but maybe a change in parking requirements could help. I think we’re going to see that. I think that is just part of our future in San Diego, that we’re just going to have to grin and bear those projects that we don’t otherwise want to see. I think the days of, you know, in my neighborhood there was a four unit condo project that the mayor stepped in on a four unit condo project and would not allow them to issue a certificate of occupancy for 10 months on a property that was ready to go, just because there was some questionable concerns about the height variance on the property. I think those days are going to be part of our past. [crosstalk]

Speaker 2:        I’ve got a question. Why would you say last year may have been the end of cap rate compression and pricing growth?

Josh Ohl:          It just seems like we saw that trend in the end of the fourth quarter, is that cap rates started being pretty steady for the most part and pricing, just based on what we’re looking at over the next couple years, I don’t know that we’re going to see overall pricing appreciation, especially like we’ve seen over the last couple years.

Speaker 2:        But cap rate’s directly correlated to the interest rate.

Josh Ohl:          Okay. Again, this is what we forecast with our inputs, so you don’t like it, you don’t have to take it into account. So annual rent growth has definitely decelerated over the last couple quarters. That has moved into the first quarter here. It has slowed. We ended 2018 at three point four percent rent growth. Right now this morning we’re at about two point six percent annual rent growth, so we are slowing a little bit. And is the state legislature going to try to pass rent control measure? Probably, right? And along with some tenant protective measures, as well, I would imagine.

Speaker 3:        They’re not smart enough to get out of their own way. It’s going to absolutely destroy the market temporarily, and then they’ll finally figure it out after they’ve destroyed the place.

Josh Ohl:          Yeah, well, Oregon’s going to definitely be a good test case for it. They’re sort of doing it right now, so we’ll see what happens.


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