SF Apartment : June 2016

MARKET VIEW

Trading Spaces

by Jay Greenberg

San Francisco is a tale of two cities regarding the sales and dollar volume for the two apartment sectors—the 5-9-unit sector is at peak volume since the financial crash in 2008, and the 10-plus-unit sector has produced the lowest volume for the same time period.

I will examine a few factors that may be creating this scenario. Regardless of dollar volume, pricing levels are still at all-time highs, but they have plateaued for the time being. There is plenty of pent-up demand for larger properties, particularly 15-plus units. If and when some larger offerings become available, we could see pricing levels go higher in this particular sector. The rental market has flattened so far this year with rents slightly off last year’s levels. For the newly constructed, non-rent controlled properties, rents have dropped more than slightly and many owners/developers are offering rent concessions that were unnecessary a year ago. Interest rates are hovering near all-time lows and employment numbers are a key figure to keep an eye on moving forward.

The following are 2016 first quarter (January–March) statistics for the 5-9-unit and 10-plus-unit sectors versus the same time period for 2012, 2013, 2014, and 2015.

5-9 Units
The average price per square foot has increased from approximately $336 in 2012 to $374 in 2013, $421 in 2014, and $453 in 2015. So far in 2016, the price per square foot has jumped to $545. Gross rent multipliers (GRMs) have steadily increased over the past three years. GRMs were approximately 12.76 times gross for 2012, 13.42 in 2013, 16.37 in 2014, and 17.21 in 2015. The average GRM for 2016 bumped up again to 17.38 times gross. The cost per unit fluctuated over the past five years, reaching a five-year low in 2011. Since then, there have been significant annual jumps. The cost per unit was approximately $292,000 in 2012, $342,000 in 2013, and $400,000 in 2014. The cost per unit dipped slightly to $390,000 in 2015. The average price per unit bounced back in 2016 to $491,000—a new record at 20% higher than last year’s figure.

Dollar volume for the 5-9-unit sector was approximately $45 million in 2012 and 2013. The dollar volume dropped to $38 million in 2014, jumped to $55 million in 2015, and jumped again to $85 million in 2016. The number of transactions was approximately 24 in 2012, 22 in 2013, 16 in 2014, and 21 in 2015. The highest number of transactions occurred in 2016, with 29 sales in the first quarter.

10-Plus Units
For the 10-plus-unit sector in the same time period, the average price per square foot has increased from approximately $227 in 2011 to $271 in 2012 to $372 in 2013 to $421 in 2014 to $464 in 2015. In 2016, the upward trend continues with our new average coming in at $545 per square foot. GRMs hit a five-year low in 2010 and have been trending upward since. This indicator was approximately 11.38 for 2012, 13.86 for 2013, 16.40 in 2014, and 17.67 in 2015. Surprisingly, the 2016 number has dropped to 16.92 times gross. The cost per unit has also been trending upward at approximately $203,000 per unit for 2012, $270,000 for 2013, $334,000 for 2014, and $391,000 in 2015. For 2016, a new record was set with the average price per unit coming in at $427,000.

Dollar volume was approximately $115 million in 2012 and $256 million in 2013. Dollar volume decreased to $150 million in 2014 and to $130,000 in 2015. It reached the lowest level we have seen since the financial meltdown in the summer of 2008 with this year’s figure coming in at $69 million. The number of transactions was approximately 28 in 2012 and 2013, 23 in 2014, and 17 in 2015. This year marks another low since 2008, with 11 transactions.

These numbers are sourced from Jay Greenberg, Trigg Splenda, Alain Pinel Investment Group, San Francisco Multiple Listing Service and Costar Comps.

The Big Picture
The dollar volume and number of transactions above demonstrate a tale of two cities. In the 5-9-unit sector, we had the best first quarter we have seen since the financial crash in the summer of 2008 regarding sales and dollar volume; in the 10-plus sector, we had the lowest levels of sales and dollar volume in the same time period. Why is the 5-9 sector so robust while the 10-plus sector is lagging?

To start, I estimate there are 30% more 5-9-unit buildings than 10-plus-unit buildings in San Francisco, which equates to more upside and potential for turnover and capturing said upside. I also believe it is easier to trade up from 5-9-units than for larger property owners, especially if you want to remain in the San Francisco multiunit market. To further amplify this point, there have been only three sales in 2016 of 15-plus-unit buildings. For those who own a larger property and want to trade up and remain in our marketplace, the pickings are slim. 
This week, while writing this article, 22 new listings have come to the market in the 2-4-unit range. Activity in the 2-4-unit range is even more robust than the 5-9-unit sector and supports the trade-up theory mentioned above. Even with the 
robust 5-9-unit sales and volume, total combined volume for all sales of 5-plus units are at the lowest levels since the market corrected in 2008–2009.

Over the past 12 months, prices have continued upward and all value indicators have risen since 2015, except for GRMs in the 10-plus-unit sector. We are currently at all-time-high pricing levels with interest rates remaining at historical lows. Most industry experts believe we have reached peak pricing levels and that appreciation in the near term will come from turnover and rent roll appreciation. I will add that there is pent-up demand for larger properties of 15-plus units. If and when some larger offerings come to the market, I believe the pent-up demand could drive pricing levels higher for this particular sector of the market.

The rental market has peaked and many owners are reporting that they are having trouble replacing rents that were achieved a year ago. There has not been a substantial drop in market rents, yet there is softening in the market. I estimate rents are down approximately 2% to 4% currently. The ownership pool in San Francisco consists mostly of long-term owners, and the majority of long-term owners do not push for absolute top-dollar rents. The preference of most owners is to have a selection of potential renters to choose from so they can fill their vacancies with the best possible renters.

On a national level, San Francisco dropped from the nation’s second-hottest rental market to number 20 in the first quarter. For the newly constructed, non-rent controlled buildings that have joined our housing stock over the past few years, the story is different: with the cost of entry into this marketplace at a premium, owners of these properties have pushed rents to peak levels with many additional charges on top of the base rent. Tenants in these properties are usually bill-backed for utilities and common-area maintenance charges.

The softening in the rental market is causing many owner/developers to lower rents and offer rent concessions like temporary free parking and a free month of rent. Last year, rent concessions like these were unheard of. Developers in San Francisco are expected to build 5,000 new apartments this year, compared to about 2,500 last year. These development projects could have trouble meeting rent projections in the near term.

The unemployment rate in San Francisco dropped from 4.5% in February 2015 to 3.8% in February 2016. I believe we are going to be in a low-interest-rate environment for quite some time and employment is going to be the key driver in our market in the near term. Stay tuned.

Jay Greenberg is with Alain Pinel Investment Group and can be reached at 415-593-8615.