market view
Riding Out the Storm
by Jay Greenberg
The sales market for the first quarter of 2009 continues to be sluggish, and closing escrows has become very challenging. The Lembi factor continues to be a major force in our marketplace. All things considered, value indicators held up very well in 2008. The positive aspects of owning San Francisco apartments thankfully still exist for the majority of owners. Most of the rental market remains fairly steady, with a slight dip in rental rates. Lenders are still active in the San Francisco multiresidential market, with tighter underwriting guidelines balanced by attractive rates. We are seeing small increases in labor force numbers combined with small decreases in employment, based on the data available today, which is approximately three months behind.
The following are 2008 year-end statistics for the 5-9-unit sector versus the same time period for 2007. The average price per sq. ft. has increased from approximately $323 a foot in 2007 to approximately $355 a foot in 2008. Gross rent multipliers have decreased from approximately 17.01 times gross in 2007 to 15.90 times gross in 2008, and the cost per unit has increased from approximately $294,000 in 2007 to approximately $341,000 per unit in 2008. Dollar volume for the 5-9-unit sector through the end of 2007 was approximately $243 million versus approximately $166 million in 2008. The number of transactions in 2007 was approximately 141 versus approximately 53 in 2008.
For the 10-plus-unit sector in the same time period, the average price per sq. ft. has remained steady (approximately $314 a foot in 2007 and approximately $315 a foot in 2008). Gross rent multipliers have decreased from approximately 15.95 in 2007 to approximately 14.90 in 2008, and the cost per unit has increased from approximately $233,000 per unit in 2007 to approximately $269,000 per unit in 2008. Dollar volume for the 10-plus-unit sector in 2007 was approximately $667 million versus approximately $353 million in 2008. The number of transactions in 2007 was approximately 129 versus approximately 79 in 2008. The source of the numbers reported is the Marcus & Millichap Research Department, the San Francisco Multiple Listing Service and CoStar Comps.
The Big Picture
There are many big stories going on in our market. One of the biggest stories is the absence of activity. Overall, dollar volume decreased approximately 43% for both reported sectors combined, and the number of transactions decreased by more than 50%. In September 2008, we entered into an extreme market. Escrows are becoming more difficult to close because buyer expectations are growing and economic news continues to deteriorate. Asking prices are looked at as starting points for negotiations and contract prices are considered starting points for renegotiations after inspections. I expect this trend to continue during the first half of 2009 and possibly for the remainder of the year. Many investors are waiting on the sidelines for large price adjustments and the opportunity to purchase lender-owned and distressed buildings. Nobody knows exactly when and how this is going to happen; however, the majority believes it is going to happen sometime in the near future. Time will tell.
The Lembi factor continues to be another big story unfolding in our marketplace. The largest San Francisco apartment owner recently filed a “deed in lieu of foreclosure” for 51 buildings to UBS Investment Bank, in exchange for a release of personal liability. Investment group CIM Group has also recently purchased a loan pool encumbering another 24 buildings owned by the Lembi Group. It appears that the Lembi Group and CIM may be working on a UBS type of arrangement to return the properties in exchange for a release of personal liability. General opinion in the marketplace is that this is just the beginning of a pattern that will repeat itself again in the future.
At press time, UBS was not actively talking with brokerage firms in regard to valuations of the properties, nor are they responding to offers from principals interested in purchasing the properties.
Value indicators held up fairly well considering the national economy, the tremendous deterioration of pricing in many housing markets, and the constant negativity in the media. For both reported sectors combined, cost per sq. ft. numbers rose approximately 5% and cost per unit numbers were up approximately 14%. Gross rent multipliers slipped approximately 7%. Because of our rent controlled market, it is not unusual to see cost per foot and cost per unit values rise while multipliers slip. The majority of the city’s apartment properties will continue to see income grow as we move forward, unless the property is maxed out at market rents. Occasionally, I will see properties at 80% to 90% market rents, but rarely do we find rent controlled buildings that are producing their full potential. As we move forward into the not-so-bright future, we could see the 10-plus-unit sector dominated by lender-owned properties and more significant pricing adjustments. If and when this occurs, we will probably see all value indicators at lower numbers.
In spite of the San Francisco Rent Ordinance, apartments have been a highly sought after investment vehicle for the past couple of decades because of their safety and appreciation potential. Nationally, the apartment sector has been the best performing sector of the investment market over the past 12 months. It is times like these that make many owners thankful that they have a safe place for large amounts of equity without the volatility that is affecting the financial markets. Even though values are dipping and could possibly fall significantly, most apartment owners do not feel panicked because the bills are covered and income is steady.
Housing is not a fad and people will always need a place to live. The majority
of San Francisco residents are renters and this trend is probably not going to change in our lifetimes. The bright side of what is happening today is that most apartment owners made sufficient down payments when purchasing their properties. By doing so, most owners have properties that cover expenses, mortgages and reserves, and produce positive cash flow. By being in this position, most owners have the luxury of not having to sell their properties during down cycles in the market. The majority of owners will ride out this cycle.
The rental market has cooled since last year and rents have dipped slightly in most neighborhoods and price ranges. The one sector that has taken the biggest hit is the high-end luxury market: units that rent at $7,500 a month and above. Many people do not even know that there is a rental market in the $10,000 to $20,000 range. Well, there is, and this sector has taken it on the chin. Leasing agents have told me that even after 30%-plus price reductions for high-end rentals, the phone is still not ringing. The types of jobs that lured this tenant profile in the past do not exist right now.
I recently rented two units in the $2,500 to $3,000 range and had to reduce the rents by $100 to $150. I was very pleased with the activity the units generated and still received calls from many parties that were coming from outside the area. Tenants are certainly pickier these days and have more options. One looker who was coming from out of town told me he had seen approximately 40 apartments. All things considered, (excluding the high-end luxury market) the rental market is still steady and would be considered excellent in most places other than San Francisco. We still have vacancy rates below 5%, with pretty solid rental traffic.
Lenders are continuing to loan on San Francisco apartments. Underwriting has tightened and loan-to-value ratios have decreased. This is putting a strain on pricing because investors are not willing to settle for the same type of returns on big down payments that we had become accustomed to over the past five years. Most of the lending in San Francisco is coming from local and regional banks. Nationally, lending is coming from the local/regional banks, life insurance companies, and Fannie and Freddy.
Rates remain at historically low levels, but not as low as we saw a few years ago. Recent fixed-rate financing in the three-to-ten-year term has been quoted in the low- to high-6% range. Currently, spreads remain elevated and volatile. We do not expect this change in the near future because of weakening fundamentals and heightened concerns over values. There is not enough velocity in the apartment market to really determine where values are currently.
Nationally, employment has been battered. Prior to September 2008, the country was losing approximately 250,000 jobs a month, for the previous six-month period. Since that time we have been losing approximately 600,000 jobs monthly. The city has not had the same kind of job loss that the nation is experiencing. From 2007 to 2008, the labor force increased 2.4% and employment increased by 1.28%. In the final five months of 2008, we saw employment decline four out of the five months. The declines ranged from 0.36% on the high side to 0.02% on the low side. The one positive month was October, which had a gain of 0.19%.
All things considered, local fundamentals held up fairly well in 2008. We are expecting 2009 to be a tough year no matter what your business is. As we all know, there is no quick fix to a broken economy.
The opinions expressed in this article are those of the author, and do not necessarily reflect the viewpoint of the SFAA or the SF Apartment Magazine. Jay Greenberg is a real-estate broker with Marcus & Millichap and can be contacted at 415-625-2115. Copyright © 2009 by Black Point Press. All rights reserved.