San Francisco Apartment Association
SFAA Magazine Archives

February 2003


Guesses for the New Year

by Jim Forbes

If I could make one prediction for 2003, I would forecast that you would not see many predictions about rental housing for 2003. At least there won’t be any that contain a sense of certainty or clarity, or that sound positive. We head into a new year with less going for us than in 2002, and this includes the lack of any consistent indicators. How this will affect rents and real estate prices is anyone’s guess. San Francisco rents may soften a bit more, but probably no more than 5 to 10 percent or so off 2002 levels. Returns on purchases will continue to be at historic lows. Okay, these are only my guesses. But there are several reasons why I think the direction the market will take in 2003 will not be much different from what we saw in 2002.

Rental Market
San Francisco rents are in the midst of the worst downturn in the past 35 years, perhaps since the Depression. From the peak of October 2000, rents have dropped 40 percent. For 2002, the median-priced two-bedroom rent added 6 percent toward that total and is down 13 percent from last January. We have now returned to a level not seen since the summer of 1998, when rents had dropped from $2,000 to $1,850 in a brief reprieve after the torrent of increases in 1997.

With this latest drop, rents have now started to fall in line with the CPI (Consumer Price Index), or at least in terms of their historic relationship to it. Since 1967, the first year for which I have data, annual increases for San Francisco rental rates have averaged 159 percent of the CPI per year. From 1967 to 1995, rents were a total of 152 percent of the CPI, with the peak in 1986 at 169 percent. Beginning with the blistering increases of 1996, rents skyrocketed from 188 percent in 1996 to over 300 percent in 2000. Clearly these figures for four years were out of sync with historic ones. They are now at 198 percent.

To get back in line with the 1995 figures, rents would have to plummet another 20 percent. I don’t see this happening. Thanks to the largest increase in personal income ever recorded (a function of better jobs and replacement of lower income families with higher income ones), the 1996 level of 188 percent is probably the new bottom. This would mean a 5 percent drop from where we are today.

In addition, with the recent 13 percent price drop, San Francisco rents are now in-line with other major metropolitan areas in the state. With 1996 denoting the ground zero point for the four-year boom market, according to statistics maintained by the national real estate apartment firm of Hendricks & Partners, San Francisco rents combined with Marin County’s have climbed 46 percent. Meanwhile rents have also grown 48 percent in West L.A., 45 percent in San Jose and 47 percent in San Diego. (See graph for how we got here.)

Although I am partial to our economy over that of Southern California, theirs is more diverse and thus should be more resilient to our present high-tech slump. Further, I would not be surprised to see rents in Southern California decline somewhat. This might be especially true in L.A. with “for rent” signs everywhere. The average increase in this area has been in excess of 7 percent, which is an aberration there.

There are other reasons why I think rents will be down a bit in 2003. The first reason is that we have some horrendous government budget shortfalls that when bridged will remove billions of dollars from the economy, completely negating any benefit federal tax cuts may have. In San Francisco, our budget problems are acute because the city and county numbers play havoc with our local economy, especially when added to the state’s $34.8 billion shortfall. Government spending, although many of us don’t like it, provides funding that goes into the hands of tenants and prospective tenants, which in turn creates demand for our product.

The second factor is that supply is on the rise. The large-scale building of residential units South of Market, though not as much as in the early 1990s, provides prospects with more options to buy or rent. The consequence is that tenants have greater leverage in negotiating a lower price with potential landlords. I have even read that a large commercial developer in San Jose is ripping down office buildings in order to build residential units on the same site. As San Jose competes with San Francisco both in terms of jobs and housing, even this kind of addition to the supply side of the equation can cause rents to soften.

The third issue is the fluidity of the job market. Although normally I would list this first in terms of its impact on rental demand, I think much of the job loss in San Francisco has already occurred. Most, if not all, of the future lay-offs should occur outside of the city limits. Throughout the Bay Area—in spite of the impact that the market’s fluidity and related layoffs have on overall rental demand—prices and opportunities have probably reached a point where job increases will occur here in town. This is due in large part to companies that may want to relocate at 1998 prices, at least in terms of their own costs for office space and rental rates for their employees. The only factor that could keep the brakes on the relocation of companies back to the city is home prices, which remain astronomical.

A fourth factor is the price of homes. Even though rents have come full circle to July 1998 levels, median home prices have nearly doubled since then. They have increased 72 percent with prices now at $550,000, which creates a significant barrier to renters who wish to permanently exit the rental world. If home prices had also plummeted 40 percent, I would conclude that rents could very well drop another 20 percent, in part because prospective renters would quickly be on the purchase circuit. However, this scenario is far from happening. (For those of you who like statistics, the increase of San Francisco home prices has averaged 255 percent of the CPI since 1982; currently prices stand at 325 percent.)

Sales Market
Compared to home prices, apartment buildings and in fact other income producing real estate are also selling at unprecedented highs vis-à-vis rents. This is partially because there is just too much money out there chasing too few good deals. Maybe the Bush Administration’s proposal to eliminate the taxation of dividends from stocks will do something to suck away some of this cash that is bidding apartment building prices to near below five percent returns. All I can say is if interest rates ever go back to 8 percent (let alone 10 or 12 percent), the housing question could get real ugly.

Meanwhile, buyers continue to evaluate deals based on recent closings, which further perpetuates the insanity. In addition, Sec. 1031-trade buyers who earlier got out high are now resigning themselves to pricier purchases, often made under duress of a high tax bill. Agents working the buy side often won’t even talk to a buyer until the buyer is in the 45-day identification period, because agents know the buyer will need that kind of motivation to actually compete. Meanwhile, the agencies that control the listings such as Marcus & Millichap are having their best years ever.

The opinions expressed in this article are those of the author and do not necessarily reect the viewpoint of the SFAA or the SF Apartment Magazine. Jim Forbes is president of Urban Properties, a real estate investment and brokerage firm. He is the publisher of SF Property rePort. He can be reached at 415-922-8998 or at his Web site. Copyright © 2003 San Francisco Apartment Magazine