Market View
by Jay Greenberg
The apartment sales market has been very fickle in San Francisco this year, but values are holding fairly steady. The rental market continues to be excellent, and it is a good time to consider reinvesting with upgrades to your units. Tenancies-in-common (TICs) and condo conversions continue moving forward and affecting our value indicators. Lastly, uncertainty in world events and interest rates has economists guessing the future.
The following are 2006 year-to-date (through the end of the third quarter) statistics for the 5-9-unit sector versus the same time period for 2005. The average price per sq. ft. has dropped slightly from $306 a foot in 2005 to $304 a foot in 2006. Gross rent multipliers (GRMs) have slipped from 18.92 times gross in 2005 to 18.07 times gross in 2006; the cost per unit has also remained steady at approximately $281,000 in 2005, compared with approximately $280,000 per unit in 2006. Dollar volume for the 5-9-unit sector in 2005 was approximately $184 million versus approximately $113 million in 2006. The number of transactions in 2005 was approximately 116 versus approximately 70 in 2006.
GRM
For the 10-plus-unit sector in the same time period, the average price per sq. ft. has increased from $250 a foot in 2005 to $272 a foot in 2006. GRMs have risen from 13.45 in 2005 to 14.28 in 2006, and the cost per unit has risen from approximately $179,000 per unit in 2005 versus approximately $218,000 per unit in 2006. Dollar volume for this sector in 2005 was approximately $275 million versus approximately $253 million in 2006. The number of transactions in 2005 was approximately 67 versus approximately 60 in 2006. The sources of the numbers reported are the Marcus & Millichap Research Department, the San Francisco Multiple Listing Service and CoStar Comps.
When we look at the value indicators this year compared to 2005, the numbers are very similar. The change in the market is occurring in the number of transactions and dollar volume. All these numbers are down from last year. In summary, prices are holding fairly well, however buyers have more choices and are choosing the best located and priced properties available on the market. The number of price reductions, properties withdrawn from the market and days on the market all increased in 2006 when compared to 2005. There is a lot more inventory available in the 5-9-unit sector. I have had several properties this year that I thought were well priced, but did not sell. That has not happened to me in many years. On the other hand, there has been a shortage of properties for sale in the best locations. When these properties come to the market fairly priced, the activity levels have been excellent, with multiple offers and overbidding. Most buyers are aware of the current state of the market regarding lack of buying competition and are taking advantage of the timing with the ability to negotiate slightly better numbers than last year.
Transactions
In my last article, I reported on one buyer who has completely dominated the 10-plus-unit market in recent years. The buyer had listed a large number of 10-plus-unit apartment buildings for sale. We were all watching to see the effect this would have upon values and the overall market. But, nothing has changed. This dominating force withdrew all the properties that they had for sale and is back to buying larger apartment properties at a similar pace to last year.
As I reported in my previous article, the rental market is hot again and continues to be excellent as we enter into the fourth quarter. We are not expecting this to change until we hit the holiday season, which is always a difficult time for rentals. With the steady rise in interest rates over the last two years, many people have decided that renting is the way to go in San Francisco. Job and population growth in the Bay Area was excellent through the summer months. Approximately 2,600 new entries came into the labor force and approximately 5,400 new jobs were created between August and September of this year. All the recent vacancies that I have filled this summer went to young professionals arriving in San Francisco from out of state to begin new, well-paying professional positions. I believe the prospective tenants in this market will absolutely pay for upgrades and renovations. Renters are looking for sexy units with upgraded kitchens, appliances and bathrooms. I have found that renters prefer quality over quantity. Recent applicants have reported that they were willing to pay more for a smaller renovated two-bedroom unit than for a larger unrenovated three-bedroom unit. The increased rent achieved upon turnover will cover the cost of the renovations after 12-18 months of occupancy, on average. These turnovers were not long-term, low-paying tenants, but recent renters that had been in the unit for less than three years. On average, an unrenovated two-bedroom unit in the northern neighborhoods rented in the low-$2,000 range about three years ago. Today, a similar, but renovated, unit should rent for approximately $3,000 a month. The upgrade is not limited to the improvements inside your unit, but also to the quality tenant profile that will be attracted to your property.
Volume
The sale of TIC units has had a dramatic effect on our market over the past few years and will continue to do so into the future. The buyers of these properties are looking at intrinsic values when buying and are not interested in income-expense numbers, as a typical investor would be. There are excellent profit margins in these projects for qualified TIC developers; however, these deals are not easy money. A lot of time, expense and expertise are needed to successfully complete these projects. The process is not very complicated if you are a debt-free owner of an apartment property and you are willing to act as the bank in the sale of your units.
It appears that sales of TIC units in average locations are tougher these days. The biggest challenge in getting the units sold is the financing. Typically, in average locations, developers arrange group loans, which are harder and more time consuming to coordinate. Many of the applicants simply do not qualify for the loans and do not have the required down payment needed to close the sale. Many TIC developers in average locations are carrying second loans behind the arranged first group loan.
The higher-end locations have also been affected, but on a smaller scale. In the northern neighborhoods, lenders are more willing to make individual loans to TIC buyers. The typical buyer in a higher-end location is making larger down payments and not having problems qualifying for the loans. Because of the higher down payments, typically the TIC developer is not carrying secondary financing. Recently, the largest TIC project with individual financing in San Francisco began marketing its units for sale. This is a 17-unit TIC project in the Marina. The developer arranged individual ten-year bank loans for the sale of the units at below a 7% fixed rate for five years and variable rates for the next five years. The loan can be paid interest only, with an up to 75% loan-to-value rate at a cost of 1 point. The initial marketing effort received a good response and some of the sales should be closed before the publishing of this magazine. These two- and three-bedroom units, which are completely renovated and include parking, are selling in the mid-$600-per-sq.-ft. range. The units range from 1,250 to 1,425 sq. ft.
Interest rates are still the key factor in the game. I recently locked a ten-year fixed-rate loan for a 16-unit San Francisco apartment property at 5.65%. There are still excellent fixed-rate loans available in the market. While the Federal Reserve Bank left interest rates unchanged at the October 25, 2006, policy meeting, questions abound about the months ahead. Growing market hopes for a long-term rate easing were dealt a big blow after Bloomberg News reported in late October that the Fed’s September projections, issued in conjunction with the minutes from the September Federal Open Markets Committee meeting, imply that unless the economy slows more than the Fed now expects, the central bank may have to resume raising interest rates sooner rather than later to control inflation. Economists saw this as a sign that tightening could well be on the horizon for next year. Rates have been bouncing up and down for quite some time and only the future knows where rates will be next year.
| A partial list of recent San Francisco apartment sales: | |||
| Building | Sales Price | Units | Sq. Ft. |
| 426 Broadway St. | $2,300,000 | 13 | 8,156 |
| 1688 Sutter St. | $3,250,000 | 12 | 5,860 |
| 136 Guerrero St. | $2,350,000 | 12 | 7,164 |
| 455 Arlington St. | $1,728,000 | 12 | 7,992 |
| 3151 Franklin St. | $3,500,000 | 11 | 9,135 |
| 1158 Page St. | $2,716,500 | 12 | 9,189 |
| 1007 Haight St. | $3,680,000 | 15 | 16,500 |
| 475 Warren Dr. | $2,250,000 | 12 | 10,594 |
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or SF Apartment Magazine. Jay Greenberg is a real-estate broker with Marcus & Millichap and can be reached at 415-625-2115. Copyright © 2006 by SF Apartment Magazine. All rights reserved.