Market View
by Jay Greenberg
The first quarter of each year is typically slow, but velocity in the market will increase as we move forward through the year. The apartment sales market continues to perform consistently, with steady numbers regarding values and sales. The 10-plus-unit market has been and continues to be dominated by a very small pool of buyers. Appreciation continued for owners as rents have escalated over the past 18 months, and will probably continue as we head into the summer months. Developers are successfully completing tenancy-in-common (TIC) and condo-conversion projects and affecting value indicators. Lastly, interest rates will most likely remain steady for the next few months.
The following are 2007 year-to-date (through the end of the first quarter) statistics for the 5-9-unit sector versus the same time period for 2006. The average price per sq. ft. has increased from approximately $293 in 2006 to approximately $304 in 2007. Gross rent multipliers have slipped from approximately 17.4 times gross in 2006 to 17.12 times gross in 2007, and the cost per unit has increased from approximately $273,000 per unit in 2006 to approximately $280,000 per unit in 2007. It is difficult to believe, even after selling properties at these numbers for several years, that the average GRM is at this level: 17 times plus. Certainly the dynamics of rent control, TICs, absurd housing costs and the desire to own have driven this sector to levels that are hard to imagine.
Dollar volume for the 5-9-unit sector in the first quarter of 2006 was approximately $50 million, versus approximately $44 million for the first quarter of 2007. The number of transactions in 2006 for the same time period was approximately 32 versus approximately 24 in 2007.
For the 10-plus-unit sector in the same time period, the average price per sq. ft. has remained steady at approximately $271 in 2006 and approximately $272 in 2007. GRMs have slipped from approximately 14.46 in 2006 to approximately 14.28 in 2007, and the cost per unit has slipped from approximately $242,000 per unit in 2006 to approximately $218,000 per unit in 2007.
Dollar volume for the 10-plus-unit sector in 2006 for the first quarter
was approximately $40 million and has increased slightly to approximately $44 million in 2007. The number of transactions in 2006 for the same time period was approximately 10 versus approximately 11 in 2007. The source of the numbers reported is from Marcus & Millichap’s Research Department, the San Francisco Multiple Listing Service and CoStar Comps.
All Peaks, No Valleys
Historically, the first quarter is always the slowest quarter regarding apartment sales. Most investors are recovering from the holiday season and preparing taxes. As we progress through the year, momentum typically builds, with the fourth quarter having the most closings. The first quarter also has historically low inventory available. On the flip side, the fourth quarter closings typically produce some more desperate buyers in the marketplace during the first quarter seeking well-priced quality properties, only to find a shortage of inventory.
Since 1995, our sales market has been very steady with a lot of peaks but no valleys. Values have risen steadily over this time, with excellent appreciation that has outperformed almost every other market and product type in the country. We have had some phenomenal years regarding dollar volume and number of transactions, again without the valleys. We have not had years with sharp declines in sales. Dollar volume for 2006 slowly trickled down from the record years we experienced during 2004 and 2005 and is average regarding number of transactions. This performance in the sales market is not consistent with the rental market, which was on a wild upward swing during the same time period.
The 10-plus-unit sector of the market has been dominated for years by many of the same investors. The buying pool for these properties has continued to shrink over the last few years as the usual suspects continue to close the majority of the 10-plus-unit properties. Many other investors talk of wanting to enter the buying market; however, they are unwilling to compete with the active buyers. Meanwhile, with the recent spike in rents, decent operators are seeing the appreciation that has historically made San Francisco apartments one of the “most wanted” on the national real-estate investors’ list. San Francisco apartments over the last decade have always been at or near the top of this national list, however because of the dynamics of the market, we have not seen outsiders impact our market. This is mainly due to our local government, rent control and the lack of larger 100-plus-unit properties. Over the past decade, I have been continually contacted by large national operators hoping to penetrate the market and capitalize on the dynamics of San Francisco apartments. Outside investors are usually looking to acquire a large pool of units in order to justify setting up shop here. To date, I have not seen any of these operators penetrate our market. The San Francisco apartment market is difficult to comprehend for outsiders, and even insiders. Ultimately, our market is all about appreciation. There are not many markets in the United States that can produce a $1,000 or $2,000 monthly increase on a single turnover.
A Fluctuating Market
We saw a flat rental market in 1995 that slowly started gaining momentum. Within a few years, the rental market was hot again. The rental market went from hot to scorching as money was tossed around by everyone from venture capitalists to young dot-commers. But, by the end of the decade, all the rental gains were lost and owners were working harder than ever to find renters for vacancies. Owners had trouble adjusting to the new rental market and many sat on multiple vacancies for months at a time while they denied reality and slowly chased the market down. This down rental market lasted for years as we suffered from the dot-com hangover, stock market losses, corporate corruption, the attacks and aftermath of September 11, 2001, and more. The rental market started showing signs of life in 2004 as owners filled vacancies without rental concessions. Job and population growth was slowly rising each year and the rental market stabilized.
Over the last 18 months, the rental market has become hot again with the dot-com-era gains returning and even surpassing previous levels. Since January 2006, San Francisco has gained approximately 21,000 new workers and approximately 23,000 new jobs. Crowds are back renting units and I personally have not rented a unit in over a year that was ready to be shown. Renters have been snapping up units while they are still being renovated–without finished floors or appliances and with workers still hammering away. In some cases, owners have reported that they were able to double the rent that was achieved approximately three years ago. As we head into the summer months, I expect the rental market to stay hot. Renters are looking for upgrades and willing to pay premium rents for new updated units in most neighborhoods.
The TIC and condo-conversion market has picked up steam again as developers are successfully completing upscale projects. A year ago, this end of the market was virtually untested, and now the results are coming in. The largest individually financed TIC project to date is close to being completely sold out, with sales well above $700 a sq. ft. There are other high-end TIC sales now occurring well above the $1 million dollar pricing level. The success of these projects continues to put pressure on values as developers throw out income and expense numbers when they evaluate potential projects. Developers are willing to pay more for the “right” property than an investor can. Typically, the right property will have location, location, location, and a unit mix consisting of larger units with multiple bathrooms, good closet space, and more than one parking space per unit. Buildings with these combined qualities will sell at premiums above the market as developers and investors evaluate the future potential of these qualities.
Last, the economy remains on an even keel with underlying inflation showing signs of easing and growth not slipping too far. Recent reports indicate that the annual inflation rate remained above the roughly 2% level that the Federal Reserve considers acceptable, virtually ensuring that interest rates will remain unchanged for at least the next few months.
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.