market view
The Wild Ride Continues
by Jay Greenberg
The apartment sales market has been very weak in regards to dollar volume and velocity; however, statistics show values are still holding steady. Inventory numbers are at very high levels and may ultimately create a strain on current pricing levels. Some large transactions have already occurred and more are expected as the city’s largest landlord navigates the troubled banking and lending issues that have plagued the national real-estate market. The news for apartment owners/operators remains steady, with positive population and job growth and continuing strength in the rental market.
Hang on as the wild ride continues in the San Francisco apartment market.
The following are 2008 year-to-date (through the end of the second quarter) statistics for the 5-9-unit sector versus the same time period for 2007. The average price per sq. ft. has increased from approximately $327 in 2007 to approximately $421 in 2008. That is an impressive gain of 29% in a slowing market. Gross rent multipliers have slipped from approximately 16.77 times gross in 2007 to 16.49 times gross in 2008, and the cost per unit has increased from approximately $296,000 in 2007 to approximately $310,000 per unit in 2008.
Dollar volume for the 5-9-unit sector (through the end of the second quarter) in 2007 was approximately $147 million versus approximately $103 million in 2008. This is a 30% decrease. The number of transactions has dropped from 89 in 2007 to approximately 45 in 2008, a decrease of approximately 50%.
For the 10-plus-unit sector in the same time period, the average price per sq. ft. has increased from approximately $306 in 2007 to approximately $379 in 2008, an increase of approximately 24%. GRMs have dipped from approximately 15.94 in 2007 to approximately 15.36 in 2008, and the cost per unit has increased from approximately $228,000 in 2007 to approximately $278,000 in 2008.
Dollar volume for the 10-plus-unit sector in 2007 for the same time period (through the end of the second quarter) was approximately $444 million versus approximately $279 million in 2008. This is a decrease of approximately 37%. The number of transactions in 2007 was approximately 74 versus approximately 33 in 2008, a decrease of 55%. The sources of the numbers reported are from the Marcus & Millichap Research Department, the San Francisco Multiple Listing Service and CoStar Comps.
In both sectors (5-9 units and 10-plus units) the velocity has dropped 50% or more. The majority of local investors are not interested in buying at current pricing levels. I believe the transactions that are happening today are driven by the best locations, added value and development opportunities, owner-users and, lastly, by motivated sellers who price to sell and are looking to move large equity gains from marginal neighborhoods to higher quality properties and locations. I believe the motivation by these sellers has come from an anticipation of future negative pricing adjustments. To date, we have not seen any significant pricing adjustments in both the 5-9- and 10-plus-unit sectors for price per sq. ft. and price per unit. However, as stated above, the best locations have driven the majority of our sales this year. There have already been some real pricing adjustments in the B and C locations—approximately 10% to 15%. I believe this trend will continue as we move through the rest of the year.
These are tricky times when it comes to pricing properties. The inventory levels for apartment properties are at the highest levels we have seen in recent years. Many agents are ignoring current market conditions when pricing properties and are sitting on listings generating no activity. Agents and sellers need to really dig into the market data to accurately price properties. On the other hand, well-priced properties are still receiving multiple offers and selling above asking prices. Ultimately, increased supply coupled with decreasing demand could put a drag on pricing levels as we go forward.
A Lembi Liquidation Sale
The Lembi Group has recently listed two pools for sale, totaling 19 properties comprised of 687 units, and has another 20-plus buildings for sale individually with various agents around town. Additionally, the group has reached a tentative agreement with a Real Estate Investment Trust for the sale of 1,500-plus units. A combination of stiffer underwriting guidelines, lack of liquidity in the banking industry and maturing notes has triggered the selling spree by San Francisco’s largest landlord.
The Lembi Group has been a significant leader in the San Francisco apartment market for decades. It has added value to virtually every property it has owned by renovating apartments and common areas, and improving tenant profiles. With these improvements come higher market rents, which in turn have elevated pricing levels for all of San Francisco. The group unfairly received some bad press over the last few years because of a pending suit filed a few years ago by the city attorney and some tenant groups asserting unfair business practices, when, in fact, the group has received awards from the San Francisco Apartment Association for turning disgusting drug and rat-infested buildings into safe, quality housing for all residents. Unfortunately for the city, the politicians got it wrong again and have elected to defend the rats and drug dealers instead of defending the Lembi Group.
Rents May Have Peaked
Overall, fundamentals for apartment owners and operators remain steady. Many insiders feel that apartment rents have peaked. If this is true, I believe most owners are quite content with current rent levels and will not find this news disheartening. My experience has been that the mid-range market ($1,500 to $3,000) is still very healthy with a consistent pool of renters. A client reported that he had two rental units available over the Fourth of July weekend in the $2,800 to $3,400 range. During this holiday weekend, he received over 30 calls for the two units and rented both units that week. The rental agents that I have spoken with echo this sentiment, adding that the market under $2,000 is hyperactive. On the other hand, some sales agents I have spoken with reported that their clients are experiencing a slower rental market. We will all have to stay tuned regarding the direction of our current rental market based on the conflicting opinions I am hearing.
As an agent and owner/operator, I have found that most owners do not rent at absolute top of the market rents and that the majority of owners rent well below market. Many owners renting well below market are just not interested in spending money on upgrades to units and are happy with the rent levels they receive for unrenovated units. Employment numbers seem to still be moving in a positive direction in San Francisco, with a 3.09% increase in the labor force from June 2007 to June 2008. Our research also shows a 2.09% increase in employment for the same time period. For the San Francisco MSA, the increases are slightly lower, but still moving in a positive direction.
Long term, I see a very bright future for apartment rentals in San Francisco. Flight from suburbia has been occurring for some time now. Rentals are the most affordable housing available in the city. San Francisco has always had and will always have a shortage of housing. This factor, coupled with soaring inflation, fuel costs and financial woes around the country, is only going to make our city even more popular. Compared with other great cities, San Francisco rents and prices are relatively cheap. The death of the commute could be near. It certainly does not make sense for families to move to secondary markets if they are going to have to drive to work. Fuel costs are rapidly eating up any savings in housing. Across the country, cities have refurbished urban areas and brought back residents looking for culture, shopping, nightlife and all the rest. San Francisco certainly has all of this, plus excellent professional opportunities.
Unfortunately, the national lending market is in a sad state of affairs. Locally, financing has not been an issue in any of the San Francisco apartment transactions I have been involved with this year. The usual local lenders are still funding purchases in San Francisco for apartment properties, though the underwriting criteria have become more conservative in the past 18 months. Fixed-rate financing in the 6% to 7% range, depending on the length of the fixed period, is still available for typical purchases. On the other hand, we are having a very difficult time obtaining financing on other transactions in secondary markets. In these markets, financing has become the biggest hurdle.
What does the future hold for San Francisco? I believe the number of transactions for the remainder of this year will remain low. With growing inventory, sellers are going to need to be aggressive in their pricing if they want to get noticed. I do expect some additional large portfolio sales to occur. Ultimately, the outside buying community could have the most to say about our near-term pricing levels. Stay tuned.
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 © 2008 by Black Point Press. All rights reserved.