Southern California cap rates are among the lowest in the country. According to a new report from CBRE analyzing cap rates, the greater Los Angeles market and Orange County both ranked among the top 10 tier one markets for lowest cap rates in the US. Year-over-year, cap rates compressed across asset class types, but multifamily, which has already experienced substantial cap rate compression, pricing increased only 10%, the lowest of all asset classes in the two markets. Still, cap rates are continuing to trend down, a good sign of investment perspective in the greater Los Angeles area.
“There is an almost insatiable demand for apartment properties and a relative lack of new product is continuing to drive multifamily cap rates down,” Dean Zander, EVP at CBRE, tells GlobeSt.com. “The continued abundance and influx of capital has been one of the primary drivers in suppressing cap rates in Orange County and Greater Los Angeles. Additionally, debt pricing is still very attractive to investors. Other than certain pockets in the urban CORE, we are not seeing a lot of new construction in the pipeline in either markets, which makes the existing stock of product even more enticing to investors. Steady rent growth, helped by the continued increase in jobs and migration to both Los Angeles and Orange County has also been playing a significant factor in keeping cap rates low. Lastly, single-family homes are very expensive in these markets, which in turn begets a significant amount of the population to remain renters.”
While the low cap rates are a good sign that investors continue to be bullish on the greater L.A. area, they also come with some challenges for investors. “Underwriting has become much tighter in the low cap rate environment we are seeing in Los Angeles and Orange County,” says Zander. “Investors are favoring the stronger locations, and the assumptions that buyers are more laser-focused than ever on quality of multifamily assets. We have seen the slowing of deal volume, but this is less about a lack of demand but more due to the reluctance of owners to sell as operations are so strong.”
As a result, suburban product is outpacing urban infill product. Investors are finding slightly better pricing and better returns in suburban markets. “There is more value-add potential in suburban areas, as new construction is limited. Investors are also learning that not all renters are millennials who want to live downtown,” explains Zander. “There is still a substantial number of renters in both Los Angeles and Orange County who value being part of suburban neighborhoods that are near good schools. Lastly, most of the new supply we are currently seeing is in urban markets, which are beginning to see concessions, something we are not seeing in suburban markets.”
Zander expects cap rates are going to continue to compress, particularly as the cycle continues to mature. “I do believe there is more room for cap rate compression,” he says. “As investors flock to the safety of multifamily versus other investment opportunities, prices are likely to continue to climb.”