High Interest Rates Cloud the Market
By Joshua Ohl CoStar Analytics October 31, 2022 | 12:30 P.M.
Interest rates are wreaking havoc on apartment investment in San Diego, according to more than one local investor. The disconnect that often exists between what buyers expect to pay versus what sellers are offering is a chasm that will likely take time to overcome, often eclipsing 20%. Since the start of 2021, the delta between the asking price and sale price has averaged closer to 1%.
That is evidenced in transaction activity, which has fallen to the levels seen at the onset of the pandemic, when uncertainty had spread across the region due to the coronavirus. The number of transactions during the third quarter of 2022 was about half of the quarterly average in San Diego in 2019 and 2021.
Total sales volume dropped to the lowest level since 2020, as well. After an average of $1.4 billion in investment volume from the final quarter of 2021 through the second quarter of 2022, the third quarter’s haul came in below $400 million, with only one property selling for more than $30 million.
It’s not only the disconnect between the expectations of investment parties but also dwindling availability. Many stakeholders, including local to institutional investors, have noted that their options are no longer sufficient in the current environment, with some sellers opting to pay capital gains taxes in lieu of exchanging into a property that doesn’t make financial sense given the cost of debt and asking price.
Similarly, policy goals announced by the city council have added a further layer of uncertainty for value-add investors. Some members would like for the eviction moratorium, which recently expired, to be extended, while also ensuring that improvements completed to a property do not raise rents and push out renters reliant on naturally occurring affordable housing.
Some local lenders have found that their clients are turning away from coastal markets to other states, with Arizona becoming a popular landing spot. Investors are finding that they can find higher capitalization rates in other cities as opposed to San Diego, where the average transactional cap rate since the beginning of 2021 was 3.9%, one of the lower rates in the country. For comparison, the average transactional cap rate in Phoenix since the start of last year was 4.5%.
Given the stated policy goals of the Federal Reserve to rein in inflation, another rate hike is expected at the start of November. As a result, we may see more of the same in the investment market in the coming months.
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