IRVINE, CA—Interest rates are going up; the uncertainty is how much and when—but demand for multifamily over any other product type has really driven the Orange County market because people always need a place to live, NAI Capital's SVP Steve Heri and VP Steve Gim tell GlobeSt.com. According to the firm's Multifamily Market Outlook, average asking rents for multifamily units rose in Q1, continuing a trend that has seen growth for the past 22 consecutive quarters.

The report shows that apartment renters in Orange County paid an average of $1,806 per unit, 2.7% more than the average at the same time last year. In the first quarter of 2017, vacancy held tight at 3.2%, down 10 basis points from last year.

In addition, the report showed that demand for multifamily housing is expected to remain strong in 2017. Southern California is experiencing a shortage of available housing units, particularly in Orange County. In the construction pipeline, 4,000 units are scheduled to deliver this year. A total of 3,047 units sold in Q1. up 139% over the prior year, and sale prices averaged $239,723 per unit, up 18.4% over last year. Cap rates fell 20 basis points over the year to 4.43%, and 718 new units delivered during the quarter, up 7.6% over first quarter 2016.

Heri and Gim point out that historically an uptick in interest rates is followed by an increase in cap rates. However, because there has been such strong rent growth, the impact may be minor this time around. Heri says, “Cap rates continue to be depressed with an abundance of capital demanding product. That being said sellers do not have anywhere else to place their capital other than exchange. And we are seeing more exchanges in the market. In addition, when looking historically into the previous real estate cycles, when the Federal Reserve begins to raise interest rates, we see an increased number of sales and refinances due to uncertainty in the marketplace.”

We spoke with Heri and Gim about rising interest rates, market uncertainty and how this plays out with Orange County multifamily investors.

GlobeSt.com: How do rising interest rates correlate with market uncertainty?

Heri: When the market's moving in either direction, especially if interest rates are going up, people want to take action sooner than later. The reason for that is their concern—everybody realizes interest rates are going to go up; it's just a matter of how much and when. Some of it's factored into the marketplace, but people do want to take action when interest rates start to rise because they want to get lower rather than higher interest rates.

GlobeSt.com: What does this uncertainty lead Orange County's multifamily investors to do?

Heri: Moving forward, if we're not at the top on rents, we're pretty close to the heights. We will see leveling of transactions, although transactions have been driven recently because of exchanges, which is the primary driver of the marketplace. More and more transactions are exchanges rather than outright purchases.

Gim: When interest rates rise, typically people look for a better spread on the return, so cap rates rise as well because investors want to protect their return on investments. We are at a point where rents are basically at the top; we're not seeing 3% to 5% rent increases we have seen over the past six years. It's going to be flat.

GlobeSt.com: Do we expect more uncertainty in the future due to rising interest rates?

Heri: I see that it's probably a little more predictable that interest rates are going up; the uncertainty is how much and when, but demand for multifamily over any other product type has really driven this market because people always need a place to live, and for that reason there is a comfort level—particularly here in OC—with multifamily.

GlobeSt.com: What else should our readers know about rising interest rates and market uncertainty?

Heri: Last year, we had more institutional [buyers] in OC than in the past—we had the same number of transactions, but more institutional.

Instant Insights /

Rising Rates, Uncertainty and the OC MF Investor

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