market view
Same Old Tune
by Jay Greenberg
In the third quarter of 2008, dollar volume and the number of transactions dropped dramatically, accompanied by rising inventory levels. Several large high-profile portfolios were offered for sale, with disappointing results. As the quarter closed out, our economy received the worst financial news since the Great Depression. Lenders have tightened underwriting and debt-service coverage ratios, resulting in many cancelled transactions. The rental market remained steady through the third quarter, but we seemed to be treading water through the holiday season.
The following are 2008 (through the end of the third quarter) statistics for the 5-9-unit sector versus the same time period for 2007. The average price per square foot has increased from approximately $333 in 2007 to approximately $376 in 2008. Gross rent multipliers have slipped from approximately 17.09 times gross in 2007 to 16.37 times gross in 2008, and the cost per unit has increased from approximately $298,209 in 2007 to approximately $304,715 per unit in 2008.
Dollar volume for the 5-9-unit sector (through the end of the third quarter) in 2007 was approximately $199 million versus approximately $104 million in 2008. The number of transactions in 2007 was approximately 113 versus approximately 57 in 2008.
For the 10-plus-unit sector in the same time period, the average price per square foot has jumped from approximately $316 in 2007 to approximately $347 in 2008. GRMs have slipped from approximately 16.54 in 2007 to approximately 15.54 in 2008, and the cost per unit rose from approximately $234,000 per unit in 2007 to approximately $268,000 per unit in 2008.
Dollar volume for the 10-plus-unit sector in 2007 through the end of the third quarter was approximately $585 million versus approximately $301 million in 2008. The number of transactions in 2007 was approximately 97 versus approximately 40 in 2008. The source of the numbers reported is from the Marcus & Millichap Research Department, the San Francisco Multiple Listing Service and CoStar Comps.
Dollar volume in the 5-9-unit sector and the 10-plus-unit sector combined is down by 49% and the number of transactions is down by 54%. Inventory levels have reached all time highs. There were increases in cost per foot and cost per unit numbers in both of the reported sectors.
There has been a tremendous slowdown in activity. Only the best properties in the best locations have sold. This has created the increase in cost per foot and cost per unit numbers. In a rent controlled market, typically rental income will increase annually for the majority of buildings in our marketplace. Even if GRMs drop, we can still expect cost per foot and cost per unit numbers to increase over time. There are still buyers out there for well-priced properties. In October, my firm listed an 11-unit building in a prime Pacific Heights location at 12.66 GRM. The property received multiple offers above the asking price.
There were two large portfolios offered for sale by the Lembi Group during the second and third quarters that totaled 687 units. These two portfolios were available jointly or separately. The offerings received a decent response by lookers, but the marketing effort produced several offers that were considered weak and unqualified. The portfolios have been withdrawn from the market. The group was also offering another 20-plus apartment properties for sale individually with various agents in San Francisco. At press time, the listings on these offerings had expired and had not been relisted.
Doomed to Repeat It
The current state of the market reminds me of 1992, when we became involved in the Gulf War and California had many military base closings, affecting the state and region. The country was working through the savings and loan fiasco, the largest banking failure in United States history, even larger than the banking failures during the Great Depression. Over 1,000 savings and loans failed, resulting in the bankruptcy of the Federal Saving and Loan Insurance Corporation and a loss of over $150 billion, of which over $120 billion were covered by U.S. taxpayers. Many culprits were blamed for this banking disaster, including junk bonds, greedy and corrupt banking officials, lack of government regulation, and the irresponsible monetary policy at the United States Federal Reserve. Does any of this sound familiar?
In 1992, the market went into a period of inactivity, with very few sales occurring that year. The next couple of years brought declining values and the best buying opportunities that I have seen in the San Francisco apartment market in the past 20 years. The buying did not begin until prices adjusted and bargains became available. During this period, properties in the Tenderloin were selling at four to five times the gross income. In the northern neighborhoods, trophy buildings on top of the best hills were selling well under ten times gross income. Are we headed to these types of numbers? Stick around for the next few years and we will all know the answer.
The month of October gave us the worst economic and financial news that this country has seen in over 70 years, starting with big declines in the stock market and a bailout package for AIG. Next came the big Wall Street bailout and more declines in the stock market. The economic news consisted of bad news followed by more bad news, including a quickly deteriorating labor market and an economy that seems to be falling into a deep recession.
The U.S. Labor Department reported that the nation lost 533,000 jobs in November. This puts the nation’s unemployment rate at 6.7%, the highest since March 1994. Job loss in September and October saw 723,000 lost jobs in those two months. In all, the U.S. economy lost approximately 2 million jobs in the first 10 months of 2008. San Francisco has held up better than most places in the country, adding approximately 2,300 jobs between October 2007 and October 2008.
The real-estate market quickly felt the effects of the news. I was speaking with an escrow coordinator at a large residential brokerage firm in town and she said that over 50% of its pending transactions were cancelled in the month of October. Lenders have tightened up on their underwriting criteria and raised their debt-coverage ratios from a break-even scenario last year to a 1.2 coverage ratio, with some lenders using an even higher ratio. This equates to much lower loan-to-value amounts.
I recently met with an owner who had refinanced a property approximately one year ago. The lender provided $3.5 million at the time. Today, the same lender with the same property and borrower would only loan $2.8 million. This loan is assumable; however the lender would require the principal amount to be paid down to approximately $2.6 million for an assumption because of the reset in the property taxes. One of the transactions I was working on fell apart when the buyer went to lock in the rate and the loan-to-value ratio dropped from 65% percent to 50% percent and the interest rate jumped from 6.5% to 7.1%. There are lenders out there making loans, but financing and pricing are still the biggest obstacles in completing transactions today.
As we made our way through the third quarter, the rental market held up pretty well. But now the market has a different feel to it. There does not seem to be as many calls or renters out there. The holiday season is always slow, but owners reported a slow down prior to the beginning of the holidays. I have not heard of anybody reducing asking rents or making concessions, but activity has slowed down. Many of the leasing agents I spoke with recently expect rents to remain flat for the next year as we progress through the national economic mess that is upon us.
The market has changed and values are going to be declining in the near term, regardless of the reported statistics. What does all this mean for San Francisco apartment owners? Depending on your short to mid-term plans, it means different things. If you are an owner for the next five-plus years, then the focus should be on keeping your best tenants happy and praying for the turnover of your below-market rents. Do not sit on vacant units trying to capture a few extra dollars. If you are planning on selling in the next few years, you will need to be a leader in the market and not a follower. This means pricing your property to sell and not sitting on the market with a heap of properties that are not generating offers. Regardless of your plans, you should tighten your belt because nobody knows how deep the mess is or where the bottom lies.
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 reached at 415-625-2115. Copyright © 2009 by Black Point Press. All rights reserved.