California REITs Will Benefit From Relaxed Development Laws

Construction workers build a mixed-use complex with over 700 apartments and 95,000 square feet of commercial space in Los Angeles. (Mario Tama/Getty Images)

To ease California’ housing shortage, Gov. Gavin Newsom enacted two laws Monday to exempt urban housing development from excessive environmental review.

The change could prove a catalyst for new projects by residential real estate investment trusts, says Mizuho analyst Haendel St. Juste. Red tape from the state’s strict 1970 California Environmental Quality Act “had acted as a high barrier and multiyear zoning impediment for new development projects in the state,” he said, in a Tuesday note.

Among the apartment REITs he follows, St. Juste said that Essex Property Trust got over 80% of its net operating income from California in this year’s first quarter. Roughly half of its California projects are in the San Francisco Bay Area, which has the nation’s highest premium on owning versus renting, and one of the highest median incomes.

Newsom insisted that California’s legislature append the two bills to the state’s just-passed budget, calling them the “most consequential housing reform we’ve seen in modern history.”

One of the reform bills will exempt urban apartment projects from lengthy reviews under the California environmental statute. The other exempts other kinds of development, including rail projects, wildfire mitigation, and advanced manufacturing facilities.

It will take a few years for any affects from the bills to appear, says the Mizuho analyst. Their changes don’t take effect until January 2026. Apartment projects take a couple of years to finance and build. By 2028 and 2029, the resulting new supply will arrive on the market.

American housing production has trailed population growth for decades, Piper Sandler’s Alexander Goldfarb wrote in April, but the imbalance in California is one of the nation’s worst. A preamble to one of the two new bills says that the state’s two million unit housing shortage amounts to half the national shortage.

Newsom’s next target for reform could be California’s powerful Coastal Commission, said the Piper analyst. “While we aren’t ready to confuse California with Texas, we note some recent events suggest the pendulum is moving back towards the center,” Goldfarb wrote.

While Essex is the clearest beneficiary of California’s development reforms, Mizuho’s St. Juste points out two other apartment REITs that get 40% of their income from the state. They are Equity Residential and AvalonBay Communities.

St. Juste has a Hold rating on Equity Residential, and Buy ratings on AvalonBay and Essex.

Write to Bill Alpert at william.alpert@barrons.com