SF Apartment : July 2016

SHERIDAN REPORT

Turning a New Lease

by Matthew Sheridan

You’ve seen the signs. The ones swaying in the wind or plastered to the side of a building: “Apartment for Rent.” Sure, Craigslist still works, but the age-old corner-window signs have been popping up in every neighborhood in town. It’s been the talk of the town for the last nine months: what’s happening with the rental market? 
By mid-October, the slowdown was noticeable by many in the industry. There was no pop with the fall resurgence of rentals typical for that time of year. The new year came and went—no change—and then the spring. Is it happening? Is that correction finally here? To borrow Fred Sanford’s infamous line—yes—“You big dummy!”

It’s Here
The writing has been on the wall for some time. Even over in Oakland, where the fever-pitch rhetoric over housing was at it’s highest this past spring when the city fathers overnight imposed a 90-day rent freeze in the city, for five straight quarters rent growth (asking) had rapidly shrunk from 22.3% to 7.2% year over year.

Meanwhile, here in San Francisco, rent growth (asking) has slowed to a snail’s pace over the past year. “It’s not been a dramatic downturn,” as one seasoned property manager recently put it, but rent growth has stopped completely, and now it’s begun to trend downward. The local media—always remiss in reporting what’s truly happening on the ground when it comes to housing—will, of course, have a slightly different narrative on the subject.

“There’s been a huge slowdown,” reported Stephanie Gordon, president of Gordon Property Management. “Units are renting for a lot less than they were before.” She said a year ago her firm was pretty aggressive in pricing—not outrageously high— just started high. “We’ve been a lot less aggressive in our pricing—you just can’t get those rents.” She sees a lot of inventory out there now, all neighborhoods, all types.

Property owner Mark Henderson noticed a change in the attitude of prospective tenants. “They’re a little more in control, they know they have more choices,” observed Henderson, an SFAA board member. “There’s no need to sign a lease right away.” He concurs that activity is much slower and there’s been a softening in rents.

He described recent showings for a remodeled junior one-bedroom that had been vacated after one year. “We held two open houses, each for an hour and a half, and only two people showed up at each showing—a year ago, we had one showing and ten folks showed, the second open was quickly cancelled.”

Some factors contributing to this correction are simple: more housing, rent concessions, fewer jobs, folks leaving, and the return of Airbnb units to the marketplace.

Airbnb
Let’s start with the latter: Airbnb. This is the least impactful—in my opinion—but nevertheless a recent development. The advent and phenomenal growth of home sharing was a game changer a few years back. Tenants got into it, landlords got into it, your neighbor got into it, even the old leftist on Bernal Hill got into it. For awhile, this corner of the sharing economy operated in a no-man’s land. No doubt thousands of units were pulled off the market that should have been available as traditional rental units. Eventually legislation was enacted to begin to regulate it (landlords with no lease prohibitions against subletting were excluded—of course). After some hiccups, San Francisco is now seriously going after scofflaws and leveling huge fines, while politicians threaten even more regulation.

“We had one client who was making a killing, having converted her backyard into compound sheds with kitchenettes,” reported Eric Baird, managing director at ReLISTO. Everything went well until she got the notice—an oversized yellow sign from the Sherriff posted to the property. “There were lots of landlords who had been Airbnb’ing whole buildings.” Now they’re trying to figure it out, with most doing long-term furnished units, according to Baird.

As tenants and owners come clean (fear of eviction or a huge fine can be a real motivator), I believe these units are retuning to the marketplace, replenishing some of the lost housing supply that “disappeared” over the last four years.

Homelessness and High Rents
According to a recent survey commissioned by the San Francisco Chamber of Commerce, respondents said the top two major issues facing San Francisco today are homelessness/street behavior (51%) and rising rents (44%). The rapid rise of mini tent cities that sprinkled across the city surprised many. Not since Camp Agnos arose around City Hall almost 30 years ago has the city experienced this sort of phenomenon. The cynic in me thinks this was quietly allowed to fester only to be used as a campaign tool later on. Regardless, the tactic okayed by us as a society helped exacerbate the problem. Clearly there’s systemic societal and personal failings at work, but it’s been impossible to ignore the wretched plight of the homeless. These days, it’s depressing to walk or drive through many neighborhoods in San Francisco.

Equally depressing is the out-of-control housing market we’ve experienced over the last four years. When tenants are bunked up, packed into furnished high-end SROs, and paying close to $1,500 each—something is wrong. The toxic ingredients were there: no development, NIMBYism, rent control, water on three sides. Since the trough in the rental market in the third quarter of 2009, asking rents had risen 67%. The market was imbalanced; tenants had reached an inflection point. 
Stephanie Gordon relates a scenario she is seeing a lot of lately: The building is on a dingy block South of Market. Small loft-like studios. Every month tenants break their leases because their jobs ended, and they’re heading elsewhere. “It gets old really fast, you don’t want to live long like that.”

More anecdotal tales are percolating up: tenants fleeing the Bay Area for better jobs, better housing, better commutes, and better quality of life. It’s hard to live here—who would blame them for leaving?

Slower Job Growth Projected
Despite the news of the occasional failed start-up and the incessant stories about unicorns failing to get to an IPO, employment growth in the Bay Area remains robust. The San Francisco Metro Division, which now includes just San Francisco and San Mateo Counties, experienced year-over-year job growth in April of 4.1% or a 42,200-job gain. The unemployment rate stood at 3.1% in San Francisco, while in San Mateo County it was 2.9%. Leading the growth were the professional and business-services sector, which increased by 17,100 jobs year over year, and the construction category, which climbed by 5,700 jobs.

Job growth in Silicon Valley continues at the same impressive pace as San Francisco, growing by 4.1% year over year, adding 42,000 jobs by April 2016. The East Bay experienced job growth at a healthy 2.3%, gaining 25,000 jobs.

Yet, job growth in San Francisco is slowing, and according to Beacon Economics it will continue for the next few years. Beacon, in a recent report on San Francisco, projects annual employment growth levels between 1.5% and 2.0% past 2017. While Moody’s Economy.com predicts a near halt to employment growth in San Francisco by 2020.

The initial signs of a slowdown can be seen in the Help Wanted Online Index published by The Conference Board. Between November 2015 and May of this year, the number of online help wanted ads in San Francisco dropped roughly 10% from 135,000 to 121,800.

All These Units
The real driving force pushing rents down is the construction of thousands of housing units, specifically market-rate. According to the latest report by REIS, San Francisco’s current construction boom for apartment buildings is at its fastest clip since they began tracking these numbers in 1980. They project it will peak this year with 5,000 new rental units. Some 7,200 market-rate units are under construction according to REIS. Park Merced redevelopment should add another 5,700 units and numerous condo projects will come in years ahead.

And it’s not just supply that is helping equalize the market, it’s rental concessions the new developments are deploying to help fill their units. In addition to killer amenities, many are offering enticements like one month’s free rent or free parking to fill their units. “It’s a good time to negotiate,” declared ReLISTO’s Baird. 
Tenants have some flexibility now in demanding requests as a multiyear lease. “There’s going to be some bargains as larger developers seek to quickly rent new units.” But in a year, that could change.

These modern, wonder units come with serious sticker shock on lease renewals a year later, when the tenants discover they’re exempt from rent control and that a sizable increase is on the way. “We’ve had more people looking at units and inquiring if they fall under rent control,” reported one manager who oversees numerous rent-controlled buildings. “I’ve been asked more times in the last six months than the 30 years prior about this.”

As we head into summer, there is some evidence the market is picking up a bit, but most evidence points to a tide that has turned.

Matthew C. Sheridan is the publisher of SF Apartment Magazine and a realtor with ARA Newmark, where he helps clients with the acquisition and disposition of apartment buildings in San Francisco. He can be reached at [email protected].