Investing In California Multifamily, With Erik Hayden

California, and Silicon Valley specifically, offer tremendous opportunities for multifamily developers and investors. On this episode, Erik Hayden, Founder of Urban Catalyst, joins the show to share insights on successful multifamily development in The Golden State. This insightful discussion was recorded live from the ADISA Spring Conference 2022 in Orlando, Florida.

Click the play button above to listen to the conversation.

Episode Highlights

  • Why California remains an attractive place to live with significant housing needs, which provides opportunities for investors and developers.
  • What the multifamily market in Silicon Valley looks like currently.
  • The story behind Urban Catalyst, and how they’ve found success.
  • Erik’s thoughts on the historical and current housing supply and demand challenges in California.
  • What labor challenges developers are facing currently, and how that impacts projects.
  • How CA lawmakers can support multifamily developers in addressing housing supply challenges going forward.
  • What’s next for multifamily in CA and Urban Catalyst.

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Urban Catalyst has the knowledge and experience to build out investments in one of the most lucrative areas in the country. With a world-class team focused on each detail to ensure customer investments make the most impact, socially and financially, Urban Catalyst provides lasting, market-based solutions for economically-distressed areas and rewarding, long-term profits for investors.

About The Multifamily Investor Podcast

The Multifamily Investor Podcast covers trends and opportunities in the multifamily real estate universe. Host Scott Hawksworth discusses attractive offerings in the space, including direct investments, DSTs, opportunity zones, REITs, and more.

Show Transcript

Scott: Hello and welcome to another episode of the “Multifamily Investor” podcast. This time I am live from the Spring 2022 ADISA Conference here in sunny Orlando, Florida. And I’m so happy to be joined by Erik Hayden, who is the founder of Urban Catalyst. And Erik, you have a tremendous amount of experience when it comes to multifamily development, really, specifically, in California as well, right?

So today, that’s really what we want to focus on, is, I guess the landscape, particularly in Silicon Valley. So to kind of kick things off, what does the multifamily market look like in Silicon Valley right now?

Erik: Well, I mean, it’s as strong as it has ever been. It might be the strongest in history. And we’ve seen that, especially from CAP Rate Compression that’s occurring in Silicon Valley. But really the larger story is, there’s a housing crisis in California, and that housing crisis has manifested itself in Silicon Valley to the point where we’ve created 6 jobs for every housing unit that we’ve built for over 30 years straight.

And now we have some of the most expensive housing both for sale and for rent in the world. So to say that there’s a strong demand for multifamily in Silicon Valley is really an understatement.

Scott: Right, right. And there’s clearly a need, and that, of course, creates great opportunity for folks in multifamily, whether it’s development or investing. And, I guess, before we dive into all of that with California, can you share a bit more about the story behind Urban Catalyst and where you guys really fit into the picture?

Erik: Sure. So, I started Urban Catalyst in 2018. And really, I’ve been a developer my entire career. I’ve done several billion dollars worth of projects, a lot of those, multifamily, a lot of them in Silicon Valley and San Jose, California. So, we wanted to take advantage of the downtown San Jose market. We really saw that as an opportunity to do development on a large scale.

We formed Urban Catalyst, and just so happened that everywhere we were planning on building these buildings, was also in an opportunity zone. So Urban Catalyst is an opportunity zone fund. We’re now raising money in our second fund. Our first fund we had two multifamily projects. One is a 200 unit, just traditional apartment complex, the other is a thousand-bed student housing high rise. In our second fund, we have a 400-unit multifamily project.

So multifamily, definitely, a big part of our portfolio, mainly because of that strong demand and our experience building those projects.

Scott: Right, right. Can you tell me a bit more, because we kind of teed it up, about the supply and demand challenges in California, and particularly in the Bay Area? Maybe some of the origins of it and, sort of, how it’s all, kind of, come together to create this kind of environment?

Erik: Well, in general, California, you know, it was a place where people wanted to move to over the last, you know, 50 years. And the way that Silicon Valley developed, it really is more of like a suburban neighborhood. However, it also was a place where jobs were created. I mean, some of the largest tech companies in the world have their headquarters there, and most of the big tech companies in the world have a large presence there.

Because there are so many jobs and jobs is really what creates housing because people want to live close to their job, we have found that the demand for multifamily has become extremely strong.

Scott: Right.

Erik: Yeah, sure. So, in Silicon Valley, the demand is very strong because of the jobs. I mean, they always say, “Jobs equals housing.” Now we haven’t had the ability to build housing at a density and scale even close to what is necessary to support those jobs. In fact, a lot of economists in Silicon Valley feel that the thing that will hold back the Silicon Valley economy, eventually, will be the lack of housing, a lack of people that are able to work those jobs.

Scott: Sure, sure. I guess what this brings to mind… You were talking about how, you know, Silicon Valley is such an attractive place to live, and, you know, the attractive labor market, and all of this, there’s been a lot of talk of this California exodus. And, you know, in the wake of, maybe, COVID-19 and all of this, and people saying, “Oh, it’s too expensive here, we’re all leaving California.”

Is that true? Is that accurate? Is that impacting multifamily development specifically? What have you seen?

Erik: So, I have not seen that impacting multifamily development at all. The California exodus really was mainly a myth. It was a lot of talk in the newspaper. You know, California has 40 million people. In 2020, during COVID, California lost about 150,000 people. That is not a significant amount.

Scott: That’s a drop in the bucket.

Erik: Maybe the big news is that California, for the first time in 100 years, lost population.

Scott: Yeah, maybe that was the real news, right?

Erik: And there’s always been folks leaving California to move to Texas, and Oregon, and Colorado, but what the news doesn’t take into account is the number of foreigners that move to California every year to take the jobs. In fact, in Silicon Valley, what we’ve seen very consistently, is our population grows exactly as fast as we build new housing.

Scott: Wow.

Erik: Which, that doesn’t surprise me at all.

Scott: Right, right. When you’re talking about building housing, there’s a lot of this focus on the market rates and can you develop below market rates and really reach that? I’m curious to your perspective on that. Is that really where the need is, is just going that way, or is the multifamily housing need across the stratosphere?

Erik: In the news, you see a lot of talk about below-market-rate housing because the news likes it that it’s solving a problem. Poor people will be able to live in a place where they typically couldn’t afford, or the housing prices in California have gotten so high that even just regular folks can’t afford to live there anymore, which also is somewhat true.

But, at the same time, it’s those same folks that are stopping regular development from happening. They are electing officials to their local city councils that stop development projects from going on. And because of this, you’re seeing these housing prices go up because we can’t build any type of housing fast enough. Below market-rate housing is totally needed, so is every single level from very low, all the way up to market rate.

If you think about how much below-market-rate housing is actually created, it is a drop in the bucket as to what is actually needed. Sometimes I like to call it a band-aid on a bullet wound.

Scott: Right.

Erik: I mean, it’s to the point where, in Santa Clara County where Silicon Valley is, there’s about 2 million people. Recent statistics just came out and said, “If we wanted supply to equal demand so that we could have a balance in these, you know, increasing housing prices, we need to build 150,000 housing units in a single year.” And we’ve never built more than 5,000 in a single year in history. So it’s like we’re never going to be able to get there.

Below market-rate housing, market-rate housing, it shouldn’t be as dissected as that or as focused on as it is, it should just be, we don’t just need below-market-rate housing, we need housing of all kinds, and we need it now in order to solve this problem.

Scott: You know, I think this brings to mind something that a lot of folks, and particularly, investors are concerned about, and that’s inflation, and how is this impacting multifamily. So I’m curious to your take on that and what you’re seeing. You know, as you’re developing housing and as you’re going through, what’s really inflation’s impact?

Erik: So, I can speak as a, you know, market-rate housing developer.

Scott: Sure.

Erik: Inflation does some interesting things. The first is it increases our construction costs, although, it is not necessarily the main driver in our increase in construction costs in Silicon Valley, that’s labor. Now, labor could also go up because of inflation. But in our models, if rents go up at the same pace as construction costs, that actually makes our proformas better because rents, in general, are more sensitive in our models than construction costs.

So, from that perspective, we’re okay with inflation. But from the perspective of inflation usually causes the Fed to increase interest rates, interest rates that we get on our construction loans, and our permanent loans, so that could increase our cost. But even more importantly, when interest rates go up, there’s a direct correlation to CAP rates going up. When CAP rates go up, that devalues our projects.

So when we go to refinance our projects, or if we got to sell our projects at the back end, we won’t get as high a value. So that will impact development significantly. It’ll make less projects pencil, which means less housing, which, of course, throws us back into the housing crisis.

Scott: It throws us back into where we were before.

Erik: Right.

Scott: Interesting, interesting. So, I guess, given this environment, given, you know, the Feds signaled, “Okay, we’re going to start bumping those interest rates up,” I guess, how are you navigating it as… How do you, I guess, as a developer, try to stay ahead of it, and really, I guess, yeah, navigate through it all?

Erik: So, as a multifamily developer in Silicon Valley, I mean, it’s one of the reasons why we do business in Silicon Valley, is it’s one of the strongest markets in the country. It has been historically for many years. So, it isn’t like we’re not going to have tenants. And from that perspective, our market is great. From the perspective of construction, which is really our limiting factor, is construction cost.

I’d like to say, just, kind of, in general, there’s always a window in any market as to when development should occur. It isn’t always open. The development window for multifamily in Silicon Valley was wide open from 2012 through 2018. And we saw developers just build like crazy. And in 2018, it’s like they shut off the spigot.

And the reason was is construction costs went up 100% between 2012 and 2018. And it was all caused by labor. And here’s the big problem. In Silicon Valley, the labor is so expensive, not because of, like, Union Labor or any of that, it’s because the people that build our buildings can’t afford to live there. It’s like this vicious cycle.

Scott: Right.

Erik: You can’t build the housing, so people can’t afford to live there because of the housing crisis, so they can’t afford to live there to build the housing. We import almost all of our labor from the Central Valley. Every Motel 6 in Silicon Valley is booked 7 days a week with laborers that work for subcontractors that build buildings. So, because of that, in 2018, we saw rents kind of level off. In 2018, we saw construction costs go up 30%.

And that flipped everybody to perform upside down, and we stopped seeing new development from multifamily perspective, at least at the same rate that it was occurring before that time. It’s only recently coming back and switching directions. And a lot of that has to do with the CAP Rate Compression, making the buildings more valuable. Back to our point, if interest rates go up and CAP rates go up, what will happen again.

Scott: Then we’re kind of back where we were.

Erik: Right. There back where we were.

Scott: So, I guess, I always like to, especially as we wrap up discussions, look at the future. And when you look at California, Silicon Valley, you guys are doing such great things. You’re working and navigating these kinds of challenges. Where do you think it goes? How does it, maybe, change for the better as we move forward?

Erik: Well, you know, you asked, specifically, from our perspective, how we navigate multifamily development, especially when I just told you the window closed and it’s barely reopen. And the answer to that question is, we are able, as local developers in Silicon Valley, to get land values that make sense for multifamily.

You see a lot of the bigger companies that are trying to enter the market, kind of, overpaying, and you’re wondering how are they accepting such low returns to do theirs? So for us, it’s a unique relationship with property owners that allows us to acquire property for a price that makes sense, so that we can actually do our development projects. Moving forward, we’ll see that multifamily window open again because it has to. We have to create new housing.

There’s no scenario where multifamily isn’t going to work forever in Silicon Valley. And we’re starting to see it reopen right now. And it’ll be a variety of factors, whether it’s rent increases, CAP rates thing, where there are more jobs being created. And boy, that more jobs being created…

Scott: I mean, that’s huge.

Erik: …thing, it’s, like, getting worse for housing. The average worker in Silicon Valley, a tech worker, their salary has gone up 30% in the last 12 months. There’s a direct correlation between salaries and rents. There’s another direct correlation between the price of single-family homes and rents, because what can people afford for their mortgages?

And in Silicon Valley, we’ve seen single-family homes go through the roof. They’re going up faster than they did pre-bubble. I mean, it’s unbelievable how fast they’re going up. So, we have this affordability issue, where people can’t buy houses, so they’re going to be forced to rent. And we’re having their salaries go up significantly. Combine that with the housing crisis and more jobs, and what we’re going to see is rental increases. CBRE and Colliers are both predicting, you know, between 5% and 10% rental increases this year and next year in the Valley.

And because we see that, you know, we’re very confident that our multifamily is going to work.

Scott: Do you think that there are innovations and development, whether… When you’re talking about multifamily unit size, are there creative things you can do with common areas, and really anything else when you’re developing a multifamily property that can maybe address this and make it even better and help with some of that?

Erik: You know, there’s been a lot of groups out there that have tried to, what I would say, like, disrupt the traditional way that you build buildings. And we are constantly on the cutting edge of researching whether or not we should incorporate those new techniques into our buildings, whether it’s modular construction, the new CLT construction types, utilizing different parking structures, or stackers, or puzzles.

What should the parking ratio be? You know, that’s been a really big issue lately. But we try to look at all of those, and we haven’t seen anything that’s really done a whole lot. Although parking stackers have come a long way, to the point where we’re seeing them in a lot of our projects and other folks’ projects. The parking ratios have gone down, which has reduced costs somewhat.

I mean, in the suburban days of multifamily developments, cities would require one to two parking spaces per unit. And that’d be like an average of 1.5. Now we’re seeing stuff as low as, like, 0.5 per unit. Now, we’re not quite there yet at Urban Catalyst, but we are below a one-to-one ratio, which is, you know, very, kind of, call it, cutting edge.

Scott: Sure.

Erik: But we’re finding that’s the true demand from a marketability perspective. So when I think about these new designs, we haven’t pulled the trigger on any modular. We find that it doesn’t save money, and it says it’s going to save time until it runs into a problem, then it won’t save time.

Scott: Right.

Erik: And CLT, we’ve looked at too. It’s an innovative technique and design. It’s somewhat unproven. Until somebody can come along with a better technology to truly disrupt, I don’t think we’re going to be utilizing it. It’s going to be the, you know, do the tried and true methods. And when you look at, you know, talking to a bank, or if you’re financing your project with a third-party equity group, they’re going to want to see proven track record of construction type in order to finance your project.

Scott: Right. That makes sense. But still eyes and ears open, right?

Erik: Always. We would love to find something that really radically changed it. But the only thing that we can see that would really, you know, radically change the market, would be the state of California coming in and, you know, relaxing the regulations associated with the construction of housing. And we’re starting to see that.

They’re coming in with bill after bill after bill. They haven’t quite gotten to the point where it’s going to make a huge difference. Even though they talk about how it’s going to make a huge difference, it’s not making a huge difference yet, but it should in the future.

Scott: Right. And there’s clearly that public pressure.

Erik: There is the public pressure. I mean, I used to work for a company called Zarsion. I was the president of Zarsion America. And at Zarsion America, they build 7,000 units a year in China, which makes them a boutique builder in China. And when you go to China, and you learn about their process. I mean, they’re a communist country, so the government just owns all the land.

The government sells you the land, the government determines the prices of the housing, but they do it in a way, knowing what your margins are, to incentivize people to do it. And so they just build the housing at will and keep that housing at a price that people can afford. And here in the United States, it’s like the exact opposite. We have local land use authority from politicians that, you know, in some cases, they’re really not qualified to be there.

And politicians always want two things. They want to get re-elected to their current position, and they want to get elected to a higher position. And if they approve housing in their district, there will be enough people that are anti-housing that they won’t get re-elected. So we ask these local politicians to walk the political plank. And that just is something that has not been successful for California, why we’re seeing the state taking more aggressive measures, and I anticipate we’ll see them take even more aggressive measures in the next few years.

Scott: It’s going to be interesting to see how it all sort of turns out. Erik, thank you so much for joining me in this discussion. Before I let you go , if folks want to find out more about the great things you guys have going on at Urban Catalyst, where can they do that? Where can they connect?

Erik: Sure. They can visit us at urbancatalyst.com.

Scott: Awesome. Thanks.