market view
by Jay Greenberg
In this article, the statistics through the second quarter of 2007 regarding dollar volume, number of transactions and value indicators are reported. The apartment sales market has been very strong in 2007, with some interesting phenomena occurring in both the sales and rental markets. Interest rates remain at historically low levels; however there appears to be volatility in the financial markets that is beginning to affect commercial real-estate loans. Hang on as the wild ride continues in the San Francisco apartment market.
The following are 2007 year-to-date (through the end of the second 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 $313 a sq. ft. in 2006 to approximately $327 a sq. ft. in 2007. Gross rent multipliers have slipped from approximately 17.8 times gross in 2006 to 16.77 times gross in 2007, and the cost per unit has increased from approximately $282,000 in 2006 to approximately $296,000 per unit in 2007.
Dollar volume for the 5-9-unit sector (through the end of the second quarter) in 2006 was approximately $103 million versus approximately $130 million in 2007. The number of transactions in 2006 was approximately 65 versus approximately 77 in 2006.
For the 10-plus-unit sector in the same time period, the average price per sq. ft. has increased from approximately $298 a sq. ft. in 2006 to approximately $306 a sq. ft. in 2007. Gross Rent Multipliers have risen from approximately 14.04 in 2006 to approximately 15.94 in 2007, while the cost per unit has decreased from approximately $244,000 per unit in 2006 versus approximately $228,000 per unit in 2007.
Dollar volume for the 10-plus-unit sector in 2006 for the same time period was approximately $306 million versus approximately $382 million in 2007. The number of transactions in 2006 was approximately 52 versus approximately 73 in 2007. The source of the numbers reported is the Marcus & Millichap Research Department, the San Francisco Multiple Listing Service and CoStar Comps.
In the 10-plus-unit sector we have increases in GRMs, cost per sq. ft. and number of transactions. Prices are at all time highs and velocity is excellent. These results are not occurring in many other apartment markets outside of San Francisco. There are some select micro markets that are performing well, however many markets are having difficulty getting transactions completed.
Odd Numbers
We have an interesting phenomenon occurring in the San Francisco market, where the rent and pricing levels are fairly similar in neighborhoods that are distinctly different. I have seen rent per sq. ft. numbers well above $2 a sq. ft. in neighborhoods ranging from Pacific Heights to the Richmond District to the Mission District. These neighborhoods are quite different in characteristics and tenant profile; however they are able to achieve similar rent-per-sq.-ft. numbers as buildings approach fair-market rent levels. On the flip side, I have seen similar buildings in the same neighborhoods with rents in the low $1-per-square-foot rent level.
There are many factors that contribute to these odd numbers. The first is rent control. Some buildings’ rent-per-
square-foot numbers are suppressed by many long-term tenants, while other buildings have been fortunate enough to have high turnover rates in the last few years, pushing rent-per-square-foot numbers to the high end of the market. Another contributing factor is varying size of units. Typically, studios will get the highest rent per sq. ft. and one-bedroom units will get a lower rent-per-sq.-ft. number. Very large units will usually not receive the same high-end rent per sq. ft. as smaller units. The larger units are capable of achieving the high-end rent-per-square-foot levels if upgrades are made to the unit.
The owner/operator of the building is also a factor in the varying rent levels. In many neighborhoods and blocks, the rent levels for comparable units can be drastically different. Some owners have owned and operated their buildings for 25-plus years with low taxes and debt; they are not looking to push up rents and dislike turnover in the units. This type of owner would typically rent the units below market and hope tenants stay put, avoiding turnover. On the other hand, new owners purchasing at today’s pricing levels need to add value and push rents to the high end of the market level in order to stay afloat financially. I believe the top end of the rental market today is slightly above $3.25 per sq. ft. I have rarely come across buildings at $3-per-square-foot rent levels, however I have seen a handful approaching this mark. In order to achieve this level you would need a combination of some of the following factors to occur: complete turnover of the majority of the units in the past 18 months, many upgrades, a prime location, and small units with parking and views.
Another interesting phenomenon is similar pricing levels in different neighborhoods. I am seeing similar GRMs and cost per sq. ft. in many neighborhoods in San Francisco. A recent pride-of-ownership building on the north side of town received multiple offers, and should close at 17-plus GRM and $400-plus per sq. ft. Compare this to a recent sale in the Tenderloin of a building that was not offered on the open market and closed at approximately 15 GRM and also $400-plus per sq. ft. These numbers are not the norm, however, they are occurring in varying neighborhoods.
Interest Rates and Lending
Interest rates remain at historical lows, with fixed-rate money available in the mid 6% range. The Federal Reserve Bank has been standing pat on interest rates for over a year now. After raising the overnight federal fund rate at every policy meeting from June 2004 to June 2006, the central bank’s temporary pause in rate changes has a good chance of lasting until this fall or longer. The Fed gave itself more flexibility to make future cuts by referring to “future policy adjustments” instead of “additional firming.” Fed officials are reluctant to relax monetary policy as long as prices continue to climb above their unofficial target of 2% a year.
Currently, economic signs are highly contradictory. There’s definitely a very odd midcycle slowdown, according to James Paulson, chief investment strategist at Wells Capital Management. Housing and autos make up 9% of the gross domestic product and are down 12% from last year–that’s a huge collapse. But the other 91% of the economy is up over 3.5% over last year. The housing market downturn is more severe than Fed officials had expected, and the auto industry is in dire straits. But the rest of the economy is doing well. Fed policy makers have been puzzled by the “disconnect” between slowing growth and continued high employment. The unanswered question is whether the past year’s meltdown in the housing market, and a decline in cash-out refinancing by homeowners, may yet cripple consumer spending. Many argue that the effect of the housing market fallout has been delayed, but will indeed lead to slower growth and rising unemployment, forcing a Fed return to reducing interest rates by the end of the year.
Loan terms in recent years have been very attractive due to low loan spreads, low Treasury rates and aggressive underwriting parameters. The capital markets have facilitated this by enabling lenders to sell, or securitize, large diversified pools of loans at small profit margins and, thereafter, recirculate the proceeds through additional new originations. However, tight margins on large asset pools mean that lenders have large loss exposure until loans are securitized. Attractive loan terms and readily available capital have resulted in a large volume of loans being originated in the first half of this year that are now coming to the market for securitization. The market has usually been able to absorb a spike in supply without a large decline in prices being paid; however, we have recently experienced a withdrawal of buyers, due primarily to credit concerns.
Recently, concerns over underwriting guidelines in subprime residential loans have resulted in an increased scrutiny of the underwriting practices of commercial real-estate lenders. Rating agencies, which were by many accounts not diligent in their scrutiny of subprime loans, are now aggressively raising concerns regarding the structure and underwriting parameters used by commercial lenders. Buyers of the loans or bond pools have likewise taken a more conservative approach to what they are willing to purchase, or have increased the yield they now require. These factors have resulted in lenders suffering losses on their existing loan pools and, therefore, having to increase spreads on new loans, as well as loans in process. Aggressive loan structures, such as full-term interest only and ultra low-debt coverage ratios, are becoming difficult to obtain. Further complicating the picture has been a rapid increase in the cost of interest rate swaps over the past couple of months (an increase of approximately 20 basis points since May), which has also increased interest rate spreads.
What does it all mean? In the short term, acquisitions or refinancing based upon loan terms and rates from earlier in the year have left many borrowers scrambling. The availability of the aggressive loan structures mentioned had been a major factor in driving the value indicators in our market. Only time will tell what effect these current changes will have on our market. Stay tuned.
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.