The Sheridan Report
By Matthew C. Sheridan
Over the last few years, as real-estate prices across the country soared, lenders—seizing an opportunity to capitalize on the craze—began to lower their standards and offer home mortgages to borrowers with blemished or limited credit. With increased risk, but potential for greater profit, subprime loans are often consolidated and sold as mortgage-backed securities. Today, with much of the housing market across the nation languishing, many unqualified buyers are beginning to default on their mortgages and lose their homes to foreclosure. The banks and financial institutions that catered to these borrowers—including well-known HSBC Financial and New Century Financial—are now reporting substantial losses.
The alarms bells were loud enough for Freddie Mac to announce tougher subprime lending standards recently, in an effort to reduce the risk of borrowers’ default. The government-sponsored company will now require that borrowers be underwritten at the fully indexed and amortizing rate, as opposed to the initially low “teaser” rates. Freddie Mac will also limit the use of low-documentation products in combination with these loans.
In the Bay Area, creative financing, such as interest-only loans with no money down, have been extremely popular of late and did lead some to reach for more than they should have. “I’ve seen a lot of young professional people stretching themselves thin,” said Steve Peletz of Peletz & Co. Real Estate. “It’s been an inevitable accident waiting to end.” Much of the problems stem from poor or questionable lending practices, he said. “I think for many it won’t be a problem, but for some, it will depend on interest-rate movements.”
Peletz, a real-estate broker who owner-operates apartment buildings in San Francisco and manages them for others, sees the recent slow down in the local housing market as a consequence of incomes failing to keep up with housing prices. “Interest rates were at 40-year lows, and it led to frenetic price appreciation over the ten years leading up to 2006, with a lot of properties doubling or tripling in value,” reported Peletz. “You can’t keep doing that with incomes increasing in the low single digits annually.” The situation does bode well for the rental market though. “Those who can’t afford to buy, presumably will rent—good news for apartment owners.”
Meanwhile, last year’s nationwide foreclosure filings increased 42% from the year prior, reported RealtyTrac, an online marketplace for foreclosure properties. “The increase in the number of properties in foreclosure was driven partly by the general slowing of overall housing sales, and partly by the impact of monthly mortgage payments increasing dramatically for homeowners who held some of the riskier types of adjustable rate and subprime mortgages,” said James J. Saccacio, chief executive officer of RealtyTrac. Detroit, Atlanta and Indianapolis led the nation in foreclosure rates. Foreclosure filings in Detroit represented 4.9% of all households—or one out of every 21 households—4.5 times the national average.
In sunny, coastal California, homeowners faired better last year when it came to hanging on to their investments. San Francisco only had one foreclosure filing for every 279 households (or 0.4%), while Oakland homeowners experienced a 1.4% default rate (or one foreclosure filing per 73 households). As a whole, California had 142,429 foreclosure filings last year, more than double the year prior—one for every 86 households, or 1.2%.
Depreciation
Only once in the last ten years has housing appreciation in San Francisco actually declined, and that was just after the attacks of September 11, 2001. But in the fourth quarter of 2006, home appreciation dipped into negative territory, dropping 1.2% percent from the previous quarter, but still up 2% from a year ago. Nationally, despite the doom and gloom in the press, home prices actually moved up 1.1% in the fourth quarter of 2006 from the previous quarter and rose 5.9% year over year, according to “The House Price Index,” published by the Office of Federal Housing Enterprise Oversight. “The data shows that, on a whole, prices are still rising, albeit at a much slower pace,” reported an optimistic James B. Lockart, director of the OFHEO. “This suggests that house appreciation is, for now, more in line with historic norms.” Readers should note that the OFHEO reported that California saw negative quarterly appreciation rates in 21 of 26 cities for the fourth quarter of 2006.
Vacancy Rates
In the fourth quarter of 2006, the San Francisco Metro Area’s residential vacancy rate stood at 7.1%, down from 7.7% in the previous quarter, but up from 5% a year prior. Supplied by the U.S. Census Bureau, the survey area includes the Oakland Metro Area and has a margin of error of 1.5%. Due to the inclusion of cities such as Fremont in the data, the vacancy rate for San Francisco itself is probably a bit lower. For example, The Mark Company, which specializes in the sale of newly constructed condominiums in San Francisco, just reported last year’s fourth-quarter rental vacancy rate for the city was 4.2%. NAI BT Commercial, meanwhile, split San Francisco’s vacancy rate into two categories. For buildings with 99 units or less, the rate in the fourth quarter was 3%; for 100-plus-unit buildings, that rate stood at 4%.
For 2007, Marcus & Millichap predicts that San Francisco’s vacancy rate will be 3.9% “Apartment investments in San Francisco are buoyed by limited new construction and a low rate of housing affordability,” notes Jeffrey Mishkin, regional manager of Marcus & Millichap’s San Francisco office. “Tenant demand is strong throughout the metro area, but properties in the city’s core are especially popular with renters and investors.” The company’s National Apartment Index—a snapshot analysis that ranks 42 apartment markets based on a series of 12-month forward-looking supply and demand indicators—showed San Francisco jumping ahead eight places recently to rank eighth overall.
Employment
Last month, California’s Employment Development Department issued its annual revision of employment numbers. Despite the seasonal loss of jobs after the holiday season, which resulted in the San Francisco Metro Division shedding 19,600 jobs between December 2006 and January 2007, the data shows year-over-year gain of 26,800 jobs between January 2006 and January 2007, a 2.9% gain. These are phenomenal numbers. According to the EDD, professional and business services led the year-over-year increase by adding 8,300 jobs, with computer systems designs contributing 2,200 of those jobs. The region, which includes Marin, San Mateo and San Francisco counties, also showed strong gains in the leisure and hospitality sector, which advanced 3,900 jobs, year over year. The unemployment rate for San Francisco in January stood at 4.4%, compared to 3.8% for San Mateo County and 3.6% for Marin County.
Rents React
All signs point to an upward pressure on rents. A pullback on the housing market, sustained regional job growth, lower vacancy rates, and a political system that severely restricts both housing development and ownership all contribute to making San Francisco a kettle bursting with potential for rent growth in the year to come.
Rents were up 12% between the fourth quarter of 2005 and the fourth quarter of 2006. According to MetroRent, the average rent for an apartment in San Francisco stood at $2,203. Michelle Horneff-Cohen, president of Property Management Systems, says there is not a lot of turnover in the rental market right now. “Nobody is moving—everybody who decided to move during the ‘dot-bomb’ moved, and the market has flushed itself out,” she comments. When she does have vacancies, the units fill up fast. Rents are not back up to the height of the market citywide, but in Russian Hill, for example, studios are once again renting for $1,300 a month.
Chaos—Near and Far
When former Federal Reserve Bank Chairman Alan Greenspan mentioned the word “recession” in a speech, some did a double take. When the Chinese stock markets dropped almost 9% a few days later, many said it was about time. When the U.S. financial markets did the same the next day, people started to think the worst. When the GDP was revised downward from a predicted 3.5% to 2.2% for the fourth quarter of 2006, the number shocked some, but was right in line with other downward trending data. Despite San Francisco’s job growth and rising rents, our economy is still tied to the rest of the Bay Area, which is tied to California. The state is tied to the U.S. The U.S. is tied to the world. Everything is related.
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or SF Apartment Magazine. “The Sheridan Report” does not make any guarantee, warranty or representation as to the completeness or accuracy of the information contained herein. Matthew C. Sheridan is the editor of SF Apartment Magazine and the East Bay’s Rental Housing magazine.For more information, visit www.sheridanreport.com. Copyright © 2007 by SF Apartment Magazine. All rights reserved.