Up, Up & Away
by Matthew C. Sheridan
It was a shocker—many never even saw it coming. All along, however, the signs were there. A few old sages had some insight, along with folks with serious resources, but most never thought it would actually happen. And the outcome will affect many sectors in our community. The decline in rents is of course what I am talking about. And there is so much in the glorious world that went into it.
Under the stewardship of Mayor Ed Lee, the creation of housing units has been a top priority. The Pipeline Report, a quarterly snapshot of residential and commercial development projects reported by the San Francisco Planning Department, shows a projected 63,600 apartments or condominium units currently being planned for construction. A relatively new slice of housing stock will be units created under the city’s evolving Additional Dwelling Unit ordinance—of which several iterations have been enacted. The sustained support from the Board of Supervisors of this prudent approach to increasing supply has been a refreshing development.
According to SocketSite, some 6,200 units are currently under construction in San Francisco. This new supply is welcomed here and will continue to bring balance to the rental market and put pressure on rents. Yet proposals for new housing projects have slowed considerably lately, dropping to a four-year low this last quarter. We’re seeing developers finally begin to put the brakes on the glorious symphony of cranes and cement trucks that have clogged our skylines and streets over the last five years. A recent survey of apartment developers suggests the market has topped off throughout the state, but especially in San Francisco and Silicon Valley. The latest Allen Matkins/UCLA Anderson Forecast reports that 53% of their Bay Area panel would not begin new multifamily projects in 2017—up from 39% a year ago. Their panel believes rents have reached their zenith and therefore must decline relative to inflation.
Employment Turns Sluggish
As 2016 ended, job growth slowed to a trickle across the state, according to the monthly Employment Development Department report issued in January. Payrolls rose a measly 3,700 over the previous month. In San Francisco, while not as bleak, the numbers point to a sustained trend of a slowing labor market—one that we’re unaccustomed to here and will impact apartment house rents and sales.
The monthly gain for the San Francisco Metro Division was a meager 100 for a total of 1,103,000 jobs. Year-over-year employment growth rose by 1.9% or 20,400 jobs for the region, which includes San Mateo County. The gains were led by construction jobs, which added 3,300 or a 7.5% increase. While San Francisco slows, Silicon Valley continues in overdrive rising by 36,900 jobs or 3.4% year over year. The slowing job numbers were confirmed by the Conference Board Help Wanted OnLine report, which showed that the San Francisco Metropolitan Statistical Area had the largest percent decline in December of all 52 MSAs, declining 5.2% from the previous month; San Jose’s MSA retracted 0.3%. Year-over-year data shows both regions declining almost 10% for total online job listings.
However, the report also points out that the Bay Area remains a favorable market for job seekers, with the ratio of job openings to unemployed workers near parity. This illuminating indicator—the supply/demand rate—shows San Francisco at 0.87 and San Jose 0.76. The jobs are here, but only for the brave ones.
In mid-March, the EDD will release its annual benchmarking of its employment data. The process—in which monthly labor force and payroll estimates are updated and historic numbers are adjusted—always shows mild corrections to its analytics. This year’s update should face close scrutiny as we look for signs of greater weakness in employment or a possible bump—data that should be a real indicator for the rental market.
The New Normal
The secret has been out for some time now, but rents are down and will probably slide further in 2017. The media finally got around to covering this development last year—but expect them to start piling it on as the declines are sustained.
At the close of 2016, asking rents were down roughly 5-8% by some conservative estimates. Axiometrics, a national analytics firm, shows asking rents down year over year in nearly all San Francisco neighborhoods. Zumper, a rental-listing startup, reports asking rents were down by 5.4% at year’s end. Keep in mind, both sources focus heavily on data derived from REIT-owned larger buildings, property-management and leasing-company listings, or tech-savvy owners—frequently leaving independent owners out of their statistics. In fact, the rent losses are probably significantly higher than what they are reporting.
“We’ve seen decreases of 10-20% on medium-size units,” comments J. J. Panzer, president and broker or Real Management Company. He reports there’s a lot of hesitancy by owners to reduce asking rents these days, fearful of being stuck with a lower base rent for the long-term. “There’s a ‘new normal’ out there,” reports Panzer. “Owners have to be competitive to get a good tenant.” He believes that we’re seeing a real change in supply—with a significant number of units being built in San Francisco, which means there’s a lot more places for tenants to choose from.
“Tenants want a deal in today’s market,” remarks James Wavro. He believes most owners have gotten used to the change and have recognized that they can’t be as aggressive with rents as a few years back. Wavro, who runs J. Wavro Associates, is hopeful the market will rebound this spring and attributes some of the added slowdown in rents to anxiety over the recent national election. However, “A lot of people think it just started to get bad,” warns Wavro, who opines it may be another year and a half until we really come out of it.
Building owner and property manager Ryan Steel sees the correction as a slump, not necessarily a long-term trend. “Rents were really high,” says Steel. “The peak wasn’t sustainable.” He points out the correction coincided with job freezes locally in the tech market. He believes that down time on turnovers are the perfect time for owners to upgrade units—renovations like streamlined floor plans and amenities like radiant floor heating.
A few months back, famed real estate economist Ken Rosen delivered a presentation at the UC Berkeley’s Haas School’s Fisher Center of Real Estate Conference. The background was the recent election of Donald Trump to the presidency of the United States, which shocked the world. Mr. Rosen’s talk went through a list of promises that President Trump campaigned on that will affect real estate and the regional Bay Area economy. These included tax cuts, spending increases (especially for the military), regulatory reform, de-globalization, shutting down Obamacare, and deportation of undocumented people.
Rosen cautioned that many of these steps will lead to dramatic change, and it will not be business as usual. He pointed out that the country is at full employment and that military spending increases will lead to huge increases in the deficit. For real estate, he sees higher inflation and higher cap rates. He said that immigration is a good thing for the real estate industry and the U.S. economy. He cautioned that President Trump’s policies will have a greater impact on the Bay Area by restricting the flow of physical goods, people and capital.
He predicted a banking-regulation rollback by the new president. And since the election, Wall Street has gone on a wild ride, pushing past the 20,000 mark for the Dow Jones. Like a kid in a candy store, the markets have gone crazy. Mr. Rosen predicts, “Like a sugar rush, it feels real good, but then we have the correction.” A crash is coming. For the Bay Area, that means slower job growth due to trade restriction and sanctuary city restrictions. He predicted interest rates will move faster than we think—so lock them in now.
The boomtown we’ve experienced over the last seven years appears to be over. These days, folks can catch a San Francisco Muni 1-California bus every three minutes during the height of rush hour and San Francisco’s budget stands at almost $10 billion. Yet, up until last November, when voters approved a budget set aside for tree trimming, the city could not even properly cover the cost of maintaining trees. As rush hour slows, near-empty buses rumble down our streets, a reflection of our local government’s failure to respond to changing technology, habits and time. As San Francisco begins to resist the crackdown on our sanctuary-city policy, look for a reallocation of our precious resources. Those potholes are gonna get bigger.
Special thanks to RealAnswers (formerly RealFacts) who provided this magazine with needed rental data for the last decade. The firm closed its doors recently and we thank them for their years of providing help to the publication.
Matthew C. Sheridan is the publisher of SF Apartment Magazine and a realtor with apt Group, where he helps clients with the acquisition and disposition of apartment buildings in San Francisco. For more information visit aptgroup.com.