San Diego Market Report - 7/28/23
Updated: Sep 8
The trend that commenced last year that saw the moderation in household formation due to a combination of persistent inflation, the rapid rise in interest rates and broader economic concerns has yet to reverse course completely in 2023.
Downtown San Diego faces the most supply-side pressure, but that has been the case for more than five years. Vacancy there had fallen to a historic trough earlier this year, and the vacancy rate has been below 10% since the beginning of 2021. That will likely change in the coming year as deliveries mount in the East Village and Little Italy, stifling rent growth and raising what are already the region's highest concession packages in the process. Year-over-year rent growth has moderated to 2.5%, yet that is still the strongest among all major markets on the west coast.
Local property managers have uniformly noted that renters have become much more price conscious since the end of last year. Although rent growth fell during the final four months of last year, which was the longest consecutive streak in more than a decade, rents have been on the rise in 2023. Rent growth through the first half of 2023 was above the first-half trend between 2015 and 2019. Traditionally more affordable neighborhoods in East, South and North Counties have seen the strongest rent gains in the past year, a trend that was similar to pre-2020. That is antithetical to demand trends since most of these areas are filled with mid-tier and workforce housing that have gleaned less demand in recent quarters.
The explosive growth in interest rates since last year has “wrecked havoc” on the investment market, according to more than one participant. They have noted that they are navigating a period of pricing discovery and there continue to be wide bid-ask spreads and an expectation that cap rates need to rise to make deals pencil. Deal flow has fallen 50% year over year to a level last seen at the start of the pandemic. However, some properties, particularly some newer stabilized assets, have traded at cap rates between 4.5% and 5% in recent quarters, which is about 100 basis points higher than what had been typical before the rise in interest rates.
In order to attract new renters and retain existing ones, many landlords have focused more deliberately on property management. Well-maintained properties with responsive management and pride-of-ownership units have been successful for some landlords in keeping their properties full. That has helped many to report that the spring leasing season in 2023 was the first normal one since 2019. Apartment landlords have little to worry about from homeownership pulling demand from apartment renters. Mortgage rates have risen that have made the purchase of a home even more expensive. That should continue to keep many renters by choice locked into the rental market. Only an estimated 25% of locals are able to afford a median-priced home in the region according to local analysis.
Rents have grown by 2.5% year over year, and average rent levels in the region sit at roughly $2,430/month. For context, the average rent growth between 2015 and 2019 was 4.1%. Rent growth has outpaced every major West Coast market during the past 12 months even as it has moderated. The level of concessions has increased modestly over the past few months, and they are most prevalent in new properties. Renters in Mission Valley's newest communities still regularly receive four weeks, and sometimes up to six weeks, of free rent on select units. Concessions Downtown are offered in roughly one quarter of properties.
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