How is the California Multifamily Investor Affecting the Portland Market?

Plenty of real estate opportunities exist as occupancy rates remain high in area

Eric Shreves, Senior Real Estate Broker, NAI NBS

The condo-converting developer and the perceivably aggressive California investor have been leading actors shaping the expiring market cycle for local mid-market apartment properties. One need not be too bright to guess that condo developers are more cautious than they were 18 months ago. The California investor’s status has not received as much attention, but is equally important.

In 1999, mid-market multifamily investors from California represented 4 percent of buyers. That number skyrocketed to 27 percent in 2005, slipped to 25 percent in 2006 and dropped to 14 percent in 2007. Conventional wisdom says that these California investors drove cap rates down and values up. But was this really the case? If true, have values dropped as Californians have become less active in the local market? How do investors navigate this new climate?

About 70 percent of California investors come from the northern part of the state. What was happening in Northern California and the Portland metro area in 2005 to make the California investor such an influential player in our market? In the San Francisco-Oakland-Fremont market, the average price per unit was $167,825 and the average cap rate was 4.84 percent. In the Portland area, investors were enjoying an average price per unit of $61,057 and a 6.65-percent cap rate.

So California investors were simply chasing better returns than what was achievable in other major markets on the west coast. Through 2006, Portland offered the best cap rates on the west coast and was surpassed west of the Rocky Mountains by only Salt Lake City. However, family connections are another motivating factor influencing these investors to become active in the market.

Institutional investors may be purely focused on rate of return, but private entrepreneurial investors have more complex motivations. It’s not unusual to speak with a California investor who has a relative who recently moved to the Portland area and is looking for a project they can work on together. As more Californians move into our metro area, they will bring with them family and social connections that provide capital and expertise to make them real players in our marketplace. This is a difficult dynamic to quantify, but it is common enough to consider it a substantial influence in the rise of the California investor.

Many property owners expect California investors to pay prices previously unheard of. On its face it makes sense. Homeowners moving from San Francisco, where an average home costs $700,000, see similar houses for $350,000 in Portland and think this is a bargain basement price. A multifamily investor facing an acquisition cost of $167,000 per unit in San Francisco might find $61,000 per unit in Portland attractive. Most developers can’t replace a unit for $61,000. However, has the California investor consistently paid more for multifamily units than local investors?

The facts reveal that California investors have not paid substantially more for mid-sized multifamily property than their local competitors. Starting with the current market cycle in 2003, following the last local recession, California investors actually paid less than local investors on both a price-per-unit and cap-rate basis. Since 2003, California investors have paid an average of $5,482 less per unit than local investors and 26 basis points higher than local investors with cap rates. Of course, there are enough examples of aggressive buying to nurture this conventional wisdom. One subplot has been the activity of California investors in East Multnomah County.

Since 2003, California investors have made up almost 30 percent of East Multnomah County property buyers. Have they been paying premiums in that submarket above what local investors have been paying? Not exactly. If we analyze the highest achieved values on a price-per-unit basis in East Multnomah County, we find that 26 percent of that segment was from California and 70 percent were local investors.

Although California investors have not been primarily responsible for pushing values up and cap rates down in our market, they have played a substantial role by providing competition for limited local product. And that has indirectly affected values. However, they have been increasingly less interested in our market. In 2006, 25 percent of buyers hailed from California, but that number dropped to 14 percent in 2007. Did the decreased competition from California result in lower pricing in 2007 for local investors? Fortunately for sellers and unfortunately for buyers, this was not the case.

The average price per unit in the metro area in 2006 was $66,036 with a 6.43-percent cap rate. In 2007, after a 56-percent reduction in California buyers, the average price per unit increased slightly to $66,920 with a 6.15-percent cap rate. Now, 2008 seems to be a transitional period.

For the first two quarters of 2008, the main story of this market hasn’t been the emergence or disappearance of the California investor, but the slowdown in transaction velocity. To date this year, the Portland area has seen 48 total transactions for mid-market apartments. In context, the market has been averaging 115 in the first two quarters of each year during this market cycle. There is increased inventory available on the open market, but the bid-ask gap is wider than we have experienced in recent times.

Investors still have much to cheer about. The Portland market shows strong occupancy across the board that yields vacancy rates reflective of typical turnover rather than economic distress or increased supply. Most submarkets will be supply constrained for the foreseeable future due to land constraints and construction costs. Surrounding oneself with good counsel from an informed broker and property management professional will continue to be essential. For investors interested in selling an asset, it will be important to ensure expectations and pricing is in accord with emerging market conditions to capture a prospective buyer. For prospective buyers, it will become more important to identify value-add opportunities or core assets with reasonable sellers. No matter the market situation, active investors can always find opportunities.