Market View
by Jay Greenberg
The first quarter of 2006 has produced steady numbers for the San Francisco apartment market (regarding total number of transactions, dollar volume and continued appreciation) when compared to the very strong numbers from the first quarter of 2005. The rental market continues to show positive signs, with improving rents for the first time this decade. Local economic indicators for population and employment have slipped in the last quarter for the first time in the last two years, but the forecast is for continued slight gains. Most importantly, interest rates are slowly creeping up, but still remain at historically low and attractive levels. The San Francisco apartment market has been escalating for more than a decade, after a brutal period in the early 1990s. As the first quarter ends and we head into the second quarter, the market appears to be "steady as she goes."
The following are 2006 first quarter statistics for the 5-9-unit sector versus the same time period for 2005. The average price per sq. ft. has increased from approximately $270 in 2005 to approximately $300 in 2006. Gross rent multipliers have increased from 16 in 2005 to 17.45 in 2006, and the cost per unit has risen from $242,000 in 2005 to $276,000 in 2006. Dollar volume for the 5-9-unit sector in 2005 was $51 million, versus $65 million in 2006. The number of transactions in 2005 was 33 versus 41 in 2006.
For the 10-plus-unit sector in the same time period, the average price per sq. ft. has increased from approximately $285 in 2005 to approximately $323 in 2006. GRMs have risen from 13.15 in 2005 to 14.31 in 2006, and the cost per unit has decreased from $295,000 in 2005 to $252,000 in 2006. So, the cost per sq. ft. increased, while the cost per unit declined. The decline in the price per unit is not a demonstration of declining values but is an overall reflection of the total unit mix that was transacted between the first quarter of 2005 compared to 2006.
Dollar volume for the 10-plus-unit sector in 2005 was $119 million versus $77 million in 2006. The number of transactions in 2005 was 19 versus 15 in 2006. Overall, the total dollar volume for 5-plus units has decreased approximately 16%, and the number of transactions has increased approximately 7%. I personally do not sense any dramatic changes in the current marketplace. Activity levels on well-priced properties continue to be excellent.
Last summer I started hearing from owners that they were experiencing increased vitality in the rental market. Actual renters started showing up, units began renting quicker and rental rates began to bump up. Improving economic conditions provided apartment owners with an active rental market again after surviving some very lean years. Apartment owners are benefiting from soaring home prices, with affordability currently at less than 10%. In addition, there is minimal competition from new supply, as many developers have shifted their focus to condo projects. Based on recent conversations with some of the larger management companies in San Francisco, it appears the entire city is below a 5% vacancy rate, with many of the more affluent areas of the city, such as Pacific Heights, Russian Hill and the Marina, at 3%.
During this first quarter, I have been able to increase my rents approximately $200 for one-bedroom units north of California Street. The units have also rented within a two-week marketing period. Many owners I have talked to are experiencing the same results. At this same time, we have experienced a slight dip in employment and population for the first time in the last two years. In the last few months it appears that labor force and employment have both dropped approximately 0.5%, as reported by the state's Employment Development Department. The forecast is for continued slight growth through 2006 with the expected creation of 17,000 positions, or approximately a 1% gain.
Investors have been snapping up apartment properties for the last few years at a blistering pace as abundant, low-cost, capital-fueled acquisitions. Conduits, portfolio lenders and the agencies remained interested in the multifamily sector and competed aggressively to gain greater market share. At the end of 2005, certain relationship-type lenders were making 75% loan-to-value loans of $3 million and more on high-quality buildings at 100 basis points to 110 basis points over the 10-year Treasury, with debt service coverage 1.2 times to 1.25 times. On lesser-quality properties, spreads were 105 basis points to 115 basis points. Smaller fixed-rate loans were also being written against several indices of terms ranging from 3 to 10 years. The Federal Reserve has continued with its measured interest rate hikes each quarter and slowly pushed rates above 5% for the first time in nearly four years. The yield on the 10-year Treasury is currently 5.04%, due to indicators that point to an economy that is growing at a steady, healthy pace. The 10-year Treasury is approximately 60 basis points higher than it was at the start of 2006. With oil reaching $75 a barrel and a possible pause from the Fed's rate hikes, many are confident that the 10-year Treasury will remain in the 5% to 5.25% trading range for the remainder of the year. While the recent run up has put pressure on values in other markets and product types, I have yet to see a noticeable effect on multifamily prices in San Francisco. Rates continue to remain at historically low levels and buyers continue to take advantage of widely available and cheap funds.
The San Francisco apartment market has come a long way from the early 1990s, which was a brutal period for real estate in California. Apartment building buyers were nowhere to be found. In 1995, I started seeing slight rental gains for the first time in the decade. The first rental gain that I noticed was that some Russian Hill one-bedroom units were renting at $950, an increase of $100 above market at the time. Shortly after that I saw the units break the $1,000 mark. In 1995, I remember listing a large pride-of-ownership property north of California Street after urging the owners to push the price upward, because their expectation level of the market at the time was low. That property was listed at approximately 10.5 GRM, and $135 per square foot. After a short marketing period there were multiple offers and the property was sold slightly above the asking price. This was the first time I had experienced multiple offers and an overbid in the 1990s.
The market started gaining momentum at this time and buyers started returning to the marketplace. At the same time, the Bay Area exploded as the technology industry expanded and the dot-com craze began. Rents also exploded and by the latter half of the 1990s we saw rental gains as high as 40% in some areas. As rents went higher, values followed. At the end of 1999, the party began to die and everyone stopped giving away free money. Many broke and unemployed people limped out of San Francisco after the bust of our second Gold Rush.
At this time, rents started to plummet and many owners found themselves with huge vacancy rates and no renters. At the same time that rents were dropping, so were interest rates—in some areas as much as 40%. The apartment values continued to rise during this time because of lack of attractive alternatives to the investing public. The stock market was hammered and corporate corruption was big news.
Today the market is on the rise and we are seeing interest rates head up also. We are now beginning to feel the pressure on rents again. Experts have been talking about a correction for years, but it has not happened yet. In my opinion, real estate is going to be popular for quite some time. In good and bad markets there are always opportunities, and this asset blows away any other when you consider all the features and benefits that real estate offers before and after taxes. Leverage, depreciation, appreciation, income, upside, add-value potential and control of your assets are just a few of the features and benefits that many other investment vehicles just don't offer.
Partial List of Sales During the First Quarter:
San Francisco Apartment Sales
| Building | Sales Price | Units | Sq. Ft. |
| 1701 North Point St. | $6,550,000 | 18 | 19,215 |
| 248 Anza St. | $2,501,000 | 10 | 9,198 |
| 425 Warren Dr. | $2,395,000 | 12 | 9,340 |
| 838 Vallejo St. | $2,000,00 0 | 10 | 10,710 |
| 1808 Pacific Ave. | $8,576,400 | 36 | 25,818 |
| 1667 Haight St. | $3,700,000 | 19 | 9,800 |
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine. Jay Greenberg is a real-estate broker with Marcus & Millichap and can be reached at 415-625-2115. Copyright © 2006 by the San Francisco Apartment Magazine. All rights reserved.