Market View

Q1: How Long Will This Fire Burn?

by Jay Greenberg

The first quarter of 2004 has turned out to be the hottest first quarter that I can remember in the past decade. Values continue to rise at a remarkable pace. Interest rates have risen and are expected to continue to move upward.

The first quarter of 2004 has been remarkable in terms of sales activity. The dollar volume in the first quarter of 2004 was approximately triple the average of the previous five first quarters going back to 1999. The number of transactions in the first quarter of 2004 was approximately double the average of the previous five first quarters going back to 1999. Typically the first quarter is the slowest time of year for both dollar volume and number of transactions because of the tax season and lack of inventory. This year was no different regarding the lack of inventory. However, hungry investors seeking properties found their way to buildings that were on the market and even to others not yet on the market.

Values are continuing to rise, fueled by hungry investors and the lack of inventory. Every property that I have listed this year has had multiple offers and overbidding within 10 days of entering the market. The average cost per unit has risen each year in the first quarter since 1999, which many thought was our peak market. While 1999 was the peak for the rental market, it wasn’t for apartment-building values. I recently closed a nice corner marina-style apartment building in the Sunset District at over $330 a square foot, and I have another 12-unit 1950s-style building in the Sunset District set to close next week with a gross rent multiplier (GRM) of over 14. These are very impressive numbers. There seems to be no pricing discrepancy between locations like Pacific Heights and the Marina District compared to the Sunset District and other similar neighborhoods.

Interest rates are on the rise and expected to continue upward. This rise began with an unexpectedly strong employment report in March and April. While the initial excitement over the latest employment reports have subsided, record home sales and strong gross domestic product numbers continue to push rates upward. In a recent statement in preparation for the Federal Open Market Committee Meeting on May 4, Greenspan continued to be vague, saying that the U.S. economy has entered a period of “more vigorous expansion” and though there are “no signs of broad-based inflation pressures, the federal funds rate must rise at some point to prevent pressures on pricing inflation from eventually emerging.” In Non-Fed speak, he is saying, “I’m going to raise short-term rates, I’m just not telling you when.” There is speculation that a rate increase could come as early as this summer, but others feel it will be a post-election adjustment.

The employment report for April exceeded analysts’ expectations; a verification the economy is on the road to recovery. Rates will undoubtedly spike again as they will solidify expectations of strong growth and confirm speculation that payroll trends and economic recovery have sufficient momentum. Along with these trends, there also is the increasing likelihood of movement for the 10-year treasury bonds to the 4.8 percent range by the end of the second quarter with the potential to hit 5 percent by year-end. In the past few months, rates have climbed approximately 100 basis points. Six months ago, I refinanced a 12-unit building at 4.6 percent fixed for five years. Today the same program is at 5.65 percent. Buyers have not been deterred by the rising rates and probably will not be for some time. Money is still cheap. Pricing and values could and should be affected as the rates rise; however, this has not occurred yet.

How long will this fire burn? For years, people have been talking about our bubble bursting, but the bubble continues to grow. Real estate moves in cycles, and typically these cycles last approximately ten years. In my opinion, this current cycle started in 1995 when I first began to see rents increase and confidence return to the sales market. The early part of the 1990s was a brutal period with 20 percent vacancy downtown and real estate owned (REO) apartment buildings selling at GRMs of three and four. We have come a long way since that time.

Partial list of sales for March 2004: San Francisco Apartment Sales (10+ units)
	Sales Price	Units	Sq.Ft.
825 Pine Street	$3,161,000	16	10,950
835 Pine Street	$3,161,000	16	10,950
2140 Pacific Avenue	$10,100,000	24	39,966
2332 Steiner Street	$2,900,000	10	7,500
943 Geary Street	$2,051,000	12	11,600
747 Eddy Street	$1,730,000	16	10,000
1970 Fell Street	$2,450,000	12	10,050
29th Avenue	$1,864,000	12	9,240
1750 Mission Street	$2,600,000	25	11,333

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. Jay Greenberg is a real estate broker with Marcus & Millichap. He can be reached at 415-391-9220 ext. 300. Copyright © 2004.