Tenderloin Heights

Rents Firming in Spite of a Less Than Rosy Future

by Jim Forbes

If my quarterly surveys are any indication, rents have bottomed out in San Francisco and may even have found a touch of traction. Although not yet shared by the South Bay, San Francisco’s median-priced two-bedroom unit has moved up in each of the last two quarters—first $55 per month at the start of the summer and then a healthier $70 in September. The citywide number now stands at $1,920 per month, up nearly 7 percent since a six-year low of $1,795 on March 31, 2003. San Jose’s market has done the opposite, however, and is down 8 percent since the spring, suggesting that the recovery is confined only to the true economic and cultural center of the Bay Area. (No offense San Jose, but really.)

In economic terms, there’s definite improvement for our city. Lured by bottom basement office rents, employers are returning to town in big blocks. All the major brokerage houses reported positive absorption for the third quarter. Some of the planned relocations, such aschild-wearcompany Gymboree and software maker Macromedia, are nothing to sneeze at. If you estimate one employee for every 250 square feet of office space, these two employer expansion plans alone could result in 800 jobs. While some of those workers may already live here, apparently some live down in San Jose.

But I’m not a big bull on San Francisco rental rates continuing to climb at a 14 percent annual rate. Although again this market appears to work in tandem with the NASDAQ, excessive supply may just establish that disconnect between the fortunes of the high-tech and San Francisco rents. First, condos South of Market are in such over-abundance that I wouldn’t be surprised to see lenders enter the rental market as they foreclose on developers who can’t unload the inventory. Of course, this would be the most extreme consequence of all those new high rises. In the interim, substantial discounts on condos combined with Japanese-style interest rates could end up removing from the rental market those well-heeled tenants who manage to scrape together sufficient down payments to get on the tax rolls.

The supply side of the equation cannot be underestimated, even in San Francisco where demand seems endless. Although the latest figures for housing construction from the city’s planning department are from the year 2000, a quick drive around the city confirms that new housing construction has continued basically unabated. The last big year before the recent boom was 1990, and the oversupply (by San Francisco standards) back then contributed to many of the foreclosures of apartment buildings (both new and old) that occurred in the mid-nineties.

The reason that badly needed new construction can end up in the financial garbage pail is the high cost for entry. Land, construction costs, entitlement periods, set-asides and low-income inclusions all add big time to the cost of a new apartment or condo, making even our astronomic real estate market insufficient to get a decent return. But once the owners accept the poor decisions they’ve made, or lenders clear them out and start anew, more supply becomes available than can be absorbed, and thus the price of real estate drops.

There are other reasons why I am still bearish on near-term rent levels. First, there is the new governor (assuming he actually shows up—I wrote this just after he was elected, and I still don’t know why someone would want to go from movie star to a moving target). The prior administration, with the help of a recalcitrant Republican minority, basically punted the state’s financial problems into the next year by borrowing heavily. Unfortunately, they essentially used up all the bond-style exemptions available to them, leaving this year’s budget decisions truly in the Herculean category. The result could be cuts that I thought were coming last year in state payrolls—ones that will directly impact demand for apartments. In addition, we could see increases in the sales tax, income tax or both, which will also impact consumer’s discretionary funds.

Further, if Arnold makes good on his pledge to restore the Vehicle License Tax offset, it will create a decrease in revenue to the police and fire departments of local governments. Consequently, San Francisco might be compelled to make cuts elsewhere, again taking money out of the hands of potential tenants.

Of course, all this could be mitigated if the economy actually gets roaring again, but I don’t see that there is much Sacramento can do for the state’s economy. Legislators’ hands are tied behind their backs by voter-mandated spending initiatives and a constitutional requirement to balance the budget. About the only possibility I foresee is for business friendly Arnold to use his incredible Totemic charm to get some corporate CEO friends of his (besides Kenneth Lay) to set up shop here, thus creating jobs.

No, the financial growth really has to come to the country as a whole for California to benefit, and here again I’m a bit pessimistic. This is because I think the Bush administration is gambling against the odds with their tax-cut strategy to create jobs. Despite GDP growth, much of it caused by the war in Iraq and longer hours by workers for the same pay, there has not been any increase in jobs. The reality is that people with jobs rent apartments (actually people without jobs also rent apartments, but they can’t pay as much or sometimes not at all.) But the Bush people are hoping (or I guess in their case praying) that the economy will suddenly kick in at all levels and then generate enough tax revenues to pay for all the money they gave away to the rich who have been wisely putting it in the battered stock market.

If this strategy doesn’t work, as it eventually failed to work in the Reagan era, then the one source of energy in this economy—cheap money—will be lost. With this loss, those precious jobs disappear, and as I have said many times before, they contribute to rents. I definitely don’t think more tax cuts and spending increases are warranted. With manufacturing jobs now logically fleeing to cheaper labor pools overseas, a 6 percent unemployment rate may be the natural number, at least until the next generation ofworkersaretaughtnewskills. Meanwhile, with record budget deficits and the oncoming social security obligations of the baby boomers about ready to converge, I think our economy will be better off if we go back to a balanced budget.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. Jim Forbes is president of Urban Properties, a real estate investment and brokerage firm. He can be reached at 415.922.8998 or at his Web site.