Market View
by Jay Greenberg
2006 was another steady year for apartment transactions, even though dollar volume and transactions dipped from 2005. We are headed into our thirteenth year of positive or steady growth regarding values. Rent growth will continue in 2007 and will be the driving force for appreciation. Population and job growth continue upward, providing demand for San Francisco apartments. Demand for housing still lags behind supply, with no great change in the foreseeable future. The buying pool has declined; however, experienced long-term investors are still bullish on the rental upside and safety provided by San Francisco apartments. The availability of financing is excellent and rates remain at historically low levels. Tenancies-in-common (TICs) are still selling in the better locations at numbers that will continue to attract developers to quality locations and properties, while influencing value indicators.
The following are 2006 year-end statistics for the 5-9-unit sector versus the same time period for 2005. The average price per sq. ft. has decreased from approximately $303 in 2005 to approximately $271 in 2006. Gross rent multipliers have slipped from approximately 17.64 times gross in 2005 to 17.43 times gross in 2006, and the cost per unit has also slipped from approximately $267,000 in 2005 to approximately $235,000 per unit in 2006.
Dollar volume for the 5-9-unit sector in 2005 was approximately $249 million versus approximately $187 million in 2006. The number of transactions in 2005 was approximately 160 versus approximately 141 in 2006.
For the 10-plus-unit sector in the same time period, the average price per sq. ft. has decreased from approximately $286 in 2005 to approximately $281 in 2006. GRMs have risen from approximately 13.89 in 2005 to approximately 14.21 in 2006, and the cost per unit has dipped from approximately $229,000 in 2005 to approximately $220,000 in 2006.
Dollar volume for the 10-plus-unit sector in 2005 was approximately $369 million versus approximately $285 million in 2006. The number of transactions in 2005 was approximately 99 versus approximately 74 in 2006. The sources for the numbers reported are Marcus & Millichap’s research department, the San Francisco Multiple Listing Service, CoStar Comps and RealQuest.
For me, the most surprising figures are the drops in price per sq. ft. and the price per unit in the 5-9-unit sector. I have not seen many offerings in this category below $300 a sq. ft., and have seen many at over $400 a sq. ft. Obviously, the majority of the offerings are not closing at these asking prices. We have certainly seen increases this year in price reductions, offerings withdrawn from the market and number of days to sell. Overall, I feel the numbers are still excellent given the rise in interest rates, a slowing economy, and uncertainty and chaos in other parts of the world.
Ups and Downs
Rents were the big story of 2006. Rents started escalating early in the year and continued through the end of the year. It appears that we are back to dot-com levels regarding rents. For the first time in years I saw crowds in front of apartment properties while driving home after work. In my opinion, rents have escalated approximately 30% or more in the better locations for renovated units. This is quite a rise after seven years of flat rents. Rents will continue to rise across the property sector, creating additional appreciation as normal turnover occurs in 2007.
Job and population growth continues in and around San Francisco. Year-end data for 2006 is not available yet, however San Francisco’s December 2006 data appears to show job growth of approximately 6,800 new jobs and population growth of approximately 5,800 new residents. Compare this with the 1,155 new apartments scheduled to be completed this year and the imbalance between supply and demand continues its historical path in San Francisco.
The number of transactions was down in both 5-9-unit buildings and 10-plus-unit buildings. I believe there are two reasons for the decline in sales. The first reason has been a lack of quality product available in the market place during 2006. There were a couple of trophy buildings that sold during the year, however there was not much product available on the north side of town. The second reason is that the buying pool for San Francisco apartments is smaller than a few years ago. Generally, we are not seeing the same type of multiple offer scenarios that we had several years ago. Many investors were driven away by escalating prices, rising interest rates and a cooling economy. News of the bubble bursting was widespread and also played on the psyche of would-be investors. But sellers of trophy properties in prime locations didn’t have to worry about any of that. This property type is still attracting multiple offers and overbidding.
San Francisco has always been the land of the brave when it comes to investment properties. The city has continually been one of the nation’s top performers. The market has always provided low returns, big appreciation and perceived inflated prices that cannot go higher. The majority of the buyers in the market today are long-term, experienced operators that are bullish on rents and San Francisco housing. These buyers are sifting through the available properties for sale and finding properties at prices that still make sense to them. Regardless of where the market is at any given time, opportunity always exists. The long-term operators are keenly aware of the past, present and future rent potential that exists in all San Francisco apartments.
Other Market Forces
Interest rates continued to rise throughout 2006 and have created softening in the single-family housing market, helping fuel the rental market. Rates are still at historically low levels and investors continue to take advantage of the low rates and easy availability of money. There is still plenty of fixed-rate debt available in the 3-10-year range. Ten-year fixed conduit loans are available at just below 6% interest. These loans typically have expensive closing costs and penalties for early payoff. There are other bank programs offering shorter-term fixed money in the mid-6% range with smaller closing cost and less restrictive pre-payment penalties. Variable rate loans are in the low 7% range.
When Federal Reserve officials next meet, they will probably leave the overnight lending rate alone and say they are more concerned about inflation than possible economic weakness. The next decision for the Fed will be whether to resume tightening or to remain on hold, given the economy’s apparent resiliency and the upside inflation risks emanating from tight labor markets.
The TIC market continues to be another variable in the pricing levels for San Francisco apartments. Developers are not as concerned about income and expense numbers when buying properties for TIC conversion. Their focus is on price per sq. ft., price per unit and tenant profile. Buildings with good locations, parking, spacious floor plans and other amenities will continue to attract TIC developers. In my last article I reported on the largest TIC project to date with individual financing in place. The 17-unit Francisco Palms project is located in the Marina district and has 10 units sold or currently pending closing. There are 5 more units available and 2 are still not ready for marketing. The units have sold within 2% of the asking prices in approximately 120 days of marketing. The units are selling in the range of approximately $650 to $700 a sq. ft., depending on how many parking spaces buyers want. The individual financing available to the buyers at the Francisco Palms is not widely available in the market place. If this program is successful for lenders and more funds are allocated to this product type, the popularity of these projects will continue to grow and put additional upward pressure on apartment values.
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 ©2007 by SF Apartment Magazine. All rights reserved.