Market View

By Jay Greenberg

The dynamics of the San Francisco apartment sales market has changed quickly since this time last year. The city’s largest landlord and largest buyer in the marketplace for the past five years has sold several high quality properties and currently has more for sale. Value indicators in all categories have continued to escalate while transaction volume continues to decline. The rise in value indicators is a surprise as many ponder the results for the near future. Fundamentals remain sound for San Francisco apartment owners regarding rentals, population and employment. Interest rates remain at historically low levels. All in all, the San Francisco apartment market has held up well during these difficult times.

The following are 2008 year-to-date (through the end of April) statistics for the 5-9-unit sector versus the same time period for 2007. The average price per sq. ft. has increased from approximately $310 in 2007 to approximately $386 in 2008. Gross rent multipliers have increased from approximately 16.82 in 2007 to 17.88 in 2008, and the cost per unit has increased from approximately $283,000 in 2007 to approximately $324,000 in 2008.

Dollar volume for the 5-9-unit sector (through the end of April) in 2007 was approximately $81 million versus approximately $54 million for the same time period in 2008. The number of transactions in 2007 was approximately 46 versus approximately 26 in 2008.

For the 10-plus-unit sector in the same time period, the average price per sq. ft. has increased from approximately $297 a foot in 2007 to approximately $399 a foot in 2008. GRMs have risen from approximately 15.68 in 2007 to approximately 17.01 in 2008, and the cost per unit has increased from approximately $219,000 in 2007 to approximately $366,000 in 2008.

Dollar volume for the 10-plus-unit sector in 2007 for the same time period (through the end of April) was approximately $164 million versus approximately $214 million for the same time period in 2008. The number of transactions in 2007 was approximately 37 versus approximately 14 in 2008. The source of the numbers reported is from Marcus & Millichap Research Department, San Francisco Multiple Listing Service and CoStar Comps.

A Big Player Steps Back
The San Francisco apartment market started to change back in August of last year. This change in the market began with the front-page news of the coming subprime mortgage meltdown. As we continued forward into the year, the subprime news became more alarming and sales, dollar volume, and some value indicators dropped. Meanwhile, many pending transactions were either extended or cancelled. Financing became more difficult to obtain for buyers as lenders began to discover their own exposure to the subprime meltdown.

Around the same time, the city’s largest landlord, The Lembi Group, changed hats and halted a billion-dollar acquisition spree by placing 17 buildings on the market for sale. In a few months, they went from being the largest buyer in the marketplace to the largest seller in the marketplace. Back in 2006, The Lembi Group also offered approximately 17 buildings for sale. After several months of limited activity, all the offerings were withdrawn from the market and the group continued purchasing San Francisco apartment buildings.

Late last year, the group again offered approximately 17 buildings for sale. To date, the group has sold three San Francisco apartment properties for approximately $50 million dollars—a hefty profit for the group. Two of the properties that were sold were not formally on the market. At press time, there did not appear to be any pending transactions for the group. Meanwhile, additional properties have been offered for sale by the group.

In a previous article, I used the analogy of taking Michael Jordan out of a Bulls playoff game and putting him on the other team. The results would be dramatic. The Lembi Group has had a similar effect on the San Francisco apartment market. In 2007, through April 30, the group purchased approximately 32 10-plus-unit apartment buildings. In 2008, through the same time period, the group did not purchase any buildings.

A Closer Look at the Stats
We have seen declining sales volume for the past few years with escalating value indicators. The general opinion in the market place is that prices are too high and some pricing correction is due. Many investors have sat on the sidelines waiting for a pricing correction, thus creating a dwindling buying pool.
The stats above are amazing when you consider the drastic rise in value indicators in a time of so much financial negativity and uncertainty. Real-estate markets in many parts of the country have been devastated, while we have all-time-high value indicators. In the two reported categories combined, we have approximately a 23% increase in price per sq. ft., approximately a 25% increase in price per unit, and approximately a 7% increase in GRMs in one year. In individual categories, we even have some higher increases. The cost per unit increase in the 10-plus-unit category is approximately 41% higher than the same time period last year. Can you imagine?

All increases in the 10-plus-unit category are higher than the 5-9-unit categories. The 5-9-unit category increases are very impressive on their own and demonstrate the overall strength of our market, especially considering the state of the national economy. This sector of the market has a larger percentage of owner-users and speculators looking for TIC conversions than the 10-plus-unit sector. Historically, the 5-9-unit sector has sold at higher value indicators and typically has a larger buying pool than the 10-plus-unit sector. In the 10-plus-unit sector there were a total of 14 sales. Of the 14 sales, 8 were located north of California Street in areas like Pacific Heights, the Marina, Russian Hill, Nob Hill and other
prestigious neighborhoods. These are historically the most sought after neighborhoods by investors and command the highest pricing levels. Another factor to consider is that 3 of the 14 sales make up approximately 80% of the total dollar volume for the category. These three sales have drastically affected the value indicators in this sector, as has the fact that the majority of the sales occurred in the most sought after neighborhoods.

The three largest sales were: 21 units at 2360 Pacific Ave. in Pacific Heights, for $20,500,000, 21.9 GRM, $586 per sq. ft., $976,000 per unit (built in 1929, this is a classic concrete and steel pride-of-ownership San Francisco apartment building with views and parking); 72 units at 1221 Jones St. in Nob Hill for $37,500,000, GRM N/A, $499 per sq. ft., $520,000 per unit (this is a modern mid-rise, built in 1971 with views and parking); 193 units at 355 Berry St. in the South of Market area for $115,000,000, 17.55 GRM, $732 per sq. ft., $595,000 per unit (this is a 2007 nonrent-controlled building.).

None of the sales that occurred were in neighborhoods like the Tenderloin or the Outer Mission District. I have recently closed transactions in both of these neighborhoods that are not included in the stats above because the closing date was after April 30 (the last reporting date for the above stats). The numbers for these sales are under nine times gross, approximately $170-$180 per sq. ft. and under $100,000 per unit. I believe that some pricing adjustment has already occurred in the low- and mid-range levels of the apartment market. In the low- to mid-level 10-plus-unit sector, 15 times gross and $350 and up per sq. ft. is probably not going to sell today. Unless the majority of the comps continue to be pride-of-ownership buildings coming from the best neighborhoods, I believe we will see declining value indicators going forward into 2008. This does not necessarily mean prices are dropping, but that equilibrium is occurring in the marketplace regarding location and quality of properties selling. The total number of transactions for this reporting period is down approximately 43% in the 5-9-unit sector, 72% in the 10-plus-unit sector, and in both sectors combined we have over a 50% decrease.

Meanwhile, fundamentals are sound for San Francisco apartment owners. The rental market is strong in all sectors with gains in population and employment numbers. In the past 12 months (from April 2007 through April 2008), we had a 2.86% increase in the labor force and a 2.39% increase in employment. This is the largest year-over-year change we have seen in the past few years.

In a tightening credit environment, apartments have solidified their position as the favorite product type of most lenders. During the first quarter of 2008, the most notable financing trend was the significant expansion into the multifamily market of government-backed Fannie Mae and Freddie Mac. Responding to the recent
mandate to provide market liquidity, the agency lenders have increased funding volumes dramatically. Fannie Mae and Freddie Mac continue to be the lowest-priced option for non-recourse apartment financing. However, underwriting guidelines tend to be conservative with relatively high origination and legal costs.

These costs make agency loans impractical for some properties and borrowers, especially on smaller deals. For these smaller loans, commercial banks continue to provide consistent financing for San Francisco apartments. Since August 2007, lenders have returned to traditional underwriting techniques resulting in lower loan-to-value ratios across the board. Five-year fixed-rate loans can still be obtained in the low 6% range.

All in all, the San Francisco apartment market has performed extraordinarily well during these uncertain times. So far, it appears our market correction is occurring more in sales volume than in major pricing adjustments. Stay tuned.

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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 © 2008 SF Apartment Magazine. All rights reserved.