WESTERN SNAPSHOT, JUNE 2006

Inland Empire Multifamily Market

Andrews

The apartment market has reached a point of equilibrium after several years of being an owner’s market. However, renters won’t enjoy any leverage since rental rate growth and occupancy is expected to improve by early 2007, according to REIS.

This year, though, the Inland Empire economy is expected to expand more slowly than the extraordinary growth of 2004 and 2005, according to John Husing, a prominent Southern California economist who focuses on the Inland Empire. He forecasts a gain of 46,200 jobs, which would equate to 3.7 percent job growth, down from 4.4 percent and 5.5 percent for 2005 and 2004, respectively. The unemployment rate in the Inland Empire is hovering right around 5 percent, slightly higher than it has been over the past several years, according to the Bureau of Labor Statistics.

The region consisting of San Bernardino and Riverside counties boasts a population of more than 4 million residents, which exceeds the population of 24 states, Husing points out. Over the past several years, the population in the Inland Empire has grown nearly 3 percent annually. In 2006, however, the population will increase by just 2.4 percent, according to Husing.

Nonetheless, people continue to be attracted to the Inland Empire because it offers more affordable housing. The average home price in the region was $386,000 — roughly 30 percent to 60 percent less than the average home prices in other parts of Southern California, according to Dataquick. (The average home in Orange County sells for $670,000, while San Diego County has an average home price of $542,000, and Los Angeles County’s average home price is $510,000).

However, single-family home prices in the Inland Empire increased an average of 21 percent in 2005, according to the California Association of Realtors. Because of the steep appreciation, condo developers and converters have found an emerging market in the Inland Empire. While the condo market in San Diego and Orange County is mature, condo activity is just now burgeoning in the Inland Empire. REIS estimates that about 2,000 rental units were converted during the 18-month period concluding at year-end 2005. Hammer Ventures, for example, is currently converting the Crossing, a 296-unit apartment complex in Corona. The San Diego-based firm purchased the 17-year-old property for $53.9 million from Archstone-Smith in November 2005.

Even with the amount of rental units taken off the market in 2005, vacancy rates rose to 5.1 percent at the end of the first quarter, from 4.6 percent at the end of 2005 and 4.1 percent at year-end 2004, according to REIS. The research firm is forecasting a 4.9 percent vacancy rate at the end of 2006, but expects occupancy to pick up again in 2007.

Rental rates are expected to increase only 4.6 percent this year, compared to 5.7 percent growth last year and 6.5 percent growth in 2004, according to REIS. In fact, last year's growth was the smallest amount recorded since 1998. Rental rate growth is not expected to reach 5 percent or more over the next 4 years.

Because of the slowing rental rate growth and increasing vacancy, national research firm MP/F YieldStar no longer ranks the Inland Empire as one of the tightest markets in the nation and has downgraded the market from Grade A because of the number of units planned for delivery over the coming months. REIS forecasts another 3,933 units will be added to the market this year, but MP/F YieldStar expects that nearly 6,000 units will come online in 2006. Of that total, condo conversions will pull anywhere from 1,000 to 1,800 units off the market.

Major rental projects in the works include Piemonte at Ontario Center, an 806-unit project by Panattoni Development, and the nearby Piemonte Apartments by Sares-Regis Group. Whether rising interest rates or the slight softening of market fundamentals are to blame, investor interest in the Inland Empire is cooling. Last year, the region had a near record level of transactions with $1.1 billion worth of apartment deals closing, compared to about $800 million in 2004, according to Real Capital Analytics Inc.

However, 2006 got off to a slow start, with just less than $300 million worth of apartment properties trading hands — nearly 35 percent less dollar volume than in first quarter 2005, according to Real Capital Analytics. Even the average price per unit and cap rate moderated: the average price per unit in 2005 was $218,000, but fell to $129,000 during the first quarter 2006. Cap rates in 2005 were in the 4 percent range, but during first quarter 2006, the average cap rate was 5.5 percent, according to Real Capital Analytics. Investment activity may well pick up over the second half of 2006, but condo converters will likely drive the market.

— Larry Andrews is a senior vice president in Sperry Van Ness’ Ontario, California, office.

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