Sheridan Report

Fight or Flight

written by Matthew C. Sheridan

With the success of telecommuting, will renters flee San Francisco?

By late May, a sharper picture of the enormous impact of the COVID-19 crisis emerged and the damage the pandemic has wreaked upon San Francisco’s economy: massive job losses, shuttered businesses, enormous city budget deficits, and a rental market that is already taking a hit. While Mayor London Breed outlined a detailed phased reopening of specific sectors of commerce—much to the relief of business owners and workers—the modifications to employment, lifestyles and habitation brought about by the virus, as well as the shelter-in-place order, could become permanent.

With the apparent success of telecommuting, many businesses are beginning to question the practicality of remaining in urban core cities like San Francisco in light of high operating cost, expensive housing, long commutes, and blighted neighborhoods impacted by severe homelessness. Twitter recently announced that most of their workforce would be allowed to work from home permanently after the restrictions from the coronavirus are lifted.

As long as there is no vaccine and the virus remains virulent, most residents in the Bay Area will avoid the risk of commuting on BART or Muni. Before the crisis, the transit systems were operating beyond capacity. Train cars were consistently overcrowded, while stations were filthy, and fares were pricey—at least for BART. With its boom and bust history, San Francisco has always seen a resurgence of folks returning or migrating to the city when the housing market corrects and rents fall. Now, with the ramifications of commuting, will the city experience a resurgence of workers who want to live near their jobs and embrace the joys of living in vibrant neighborhoods? Or will employers ramp up their exodus to suburban communities with better schools and quality of life and affordable housing? But with remote work—does it even matter?

Thanks to newly embraced remote-work options, Redfin is predicting a flight from expensive coastal cities of people moving to entirely new cities or even just relocating farther out from metro areas. “Redfin is preparing for a seismic demographic shift toward smaller cities,” stated Redfin CEO Glenn Kelman. “Prior to this pandemic, the housing affordability crisis was already driving people from large cities to small.” The internet-based real estate brokerage firm surveyed users on remote work habits and rising wariness about close quarters. More than 50% of respondents from the San Francisco metro area said that they would consider moving away if they were able to work remotely. The survey revealed some will choose to work virtually from a small town, perhaps where their parents still live. “The whole narrative of the past 200 years, of the young person moving to the big city, may turn a little upside down in the years ahead,” said Mr. Kelman.

Anecdotal evidence already points to this occurring in San Francisco, with many owners reporting vacancies arising from tenants up-and-leaving San Francisco, heading back “home” to ride out the storm and be with family. Many may be gone forever.

Staggering Job Losses
In San Francisco, the severity of the economic impact caused by COVID-19 has been severe; over 100,000 people filed for unemployment over the months of March and April. Prior to March—before the shelter-in-place regulations were imposed—San Francisco’s initial unemployment claims averaged 3,190 per month over the previous year. In March, as the restrictions on movement and commerce were instituted, the numbers of claims exploded to 44,306. By April, new claims for that month alone rose to 57,537. These figures only represent new “initial” filings for benefits. Actual reported job losses were equally devastating.

By late May, California’s Employment Development Department reported that the unemployment rate for the San Francisco Metro Division, which includes San Mateo and San Francisco counties, dramatically increased to 12.1% in April, up from a revised 3.0% in March. California’s overall unemployment rate stood at 16.1% in April.

The San Francisco MD shed 165,800 jobs in April over the previous month—a monumentally historic loss. Industries hardest hit were those deeply entwined with the city’s economy and culture: leisure and hospitality (down 69,600 jobs) and food services and drinking places (down 51,400 jobs)—the two combined categories accounted for about roughly three-fourths of the total job reduction. Trade, transportation and utilities reported a drop of 27,100 jobs, while professional and business services suffered losses as well (down 18,800 jobs), and the construction industry lost 11,900 jobs.

The East Bay has also been rocked by historic job losses, with 169,400 jobs gone by April. The unemployment rate was 14.2%, up from 4.0% in March. San Jose MSA, which also includes San Benito and Santa Clara counties, experienced a loss of 128,600 jobs; unemployment rate stood at 12.0%, up from 3.5% from March. Across the nine-county region of the San Francisco Bay Area, 555,100 resi-dents lost their jobs in April alone and the egion’s jobless rate approached 15%. In California, some 2,344,700 people lost jobs in April—an unprecedented decline that has never been seen in the state’s history.

Renters Market
Rents have always been tied to employment, along with supply and demand. Today’s marketplace reflects this, and the market has now responded to the myriad developments caused by the pandemic. Amenities and location truly matter these days. What’s in? in-unit washer and dryers; smaller units; parking. Out? high-rise living; gritty neighborhoods; multiple bedroom units, funky units.

“Rents have come down,” says Jackie Tom. “I think it is going to stay pretty flat for a long time—I doubt it will bounce back—there are so many unemployed.” Tom’s firm, Rentals in SF, specializes in leasing. She cautioned not to go off pricing found on Craigslist for rentals—it’s not the real world.

Tom has seen rents down as much as 10%, while some rents incur a mild adjustment or stay the same. It all boils down to the quality of the unit. “Anything that’s quirky or dated, like units with external wall-mounted wires and trim painted over 25 times—you’ll see a much bigger rent decrease.”

Everyone Wants a Deal
Tenants already understand it is their market now. “Everyone wants a deal—some kind of promotion,” reports Tom. “They’re expecting a month’s rent free upfront.” Of course, in rent-controlled jurisdictions like San Francisco, it’s never that easy. The Rent Board has previously determined that promotions like an initial month’s free rent impact a unit’s base rent. Essentially, whatever the total rent is for the initial year is averaged out by 12 and that becomes the base rent. Disconnected from reality, the board’s perplexing policy does not adjust for the unprecedented times we’re all living under and offers no leeway for owners.

Resourceful owners and managers have provided new incentives to secure tenants. “We can’t offer a free month rent,” said Salman Shariat, president of Sutro Property Management, acknowledging the limitation of the rent board’s archaic policy. “But most people are not moving in immediately, so we allow a longer hold time, with the lease starting several weeks out.”  His leasing strategy also includes a willingness to negotiate something that is fair for both parties. 

Tom reports including enticements such as free cleaning service or paying for neighborhood parking. “If you don’t give them something,” cautioned Tom, “the tenants will find something else.”

“Four-bedrooms are also tough to rent these days,” reported Shariat. Groups of roommates living together in tight quarters under lock down are finding it hard to agree on much, let alone proper social distancing. Tenants are vacating these units and seeking smaller apartments ideal for one or two occupants.

“Rents for four-bedroom units have come down quite a bit,” Tom adds. “Laundry is more important—folks don’t like sharing—no touching.” With business a tad slow due to the pandemic, one positive development for Jackie is she launched a Facebook group called ”San Francisco Landlords” where owners can share stories and discuss all the zany legislation coming from City Hall. She remains cautions, “Rents may go down—I don’t know if we’ve hit bottom yet.”

Some owners have noticed tenants fleeing the ultra-lux living found in South of Market high-rises for less dense housing in outlying popular neighborhoods. Having been cooped high up inside glass-walled units with the only way out by elevator, tenants are looking for doors that open onto a street or have reasonable walk-ups. Access to a park nearby is a huge plus these days, as well as in-unit washers and dryers.

“SOMA is getting killed,” declared Shariat, who manages a number of class B/C buildings in the neighborhood. “We have a lot of vacancies there,” he reported. “In rough areas, tenants are giving notice and moving to better ones within San Francisco. While he has not witnessed a big drop in rents in the portfolio he manages, he reports that units that have all the “boxes” checked—dishwashers, in-unit laundry—are still garnering interest.

Shariat closely monitors the rental market and has begun to see some lower rents in the city for smaller studio units. “Studios have gotten hit pretty hard,” he reports. “You can find a Pacific Heights studio these days for $1,950, while stuff in the tenderloin is going for $1,550—it’s bad.” He’s reports a sizable number of tenants giving 30-day notices seeking out larger units.

So long ADUs—Hello Parking!
With legitimate concerns revolving around social-distancing protocols and commuting on public transit, one large owner interviewed for this column reported he quietly dropped plans to create additional dwelling units and returned the allocated space back to parking. “We shut them all down,” said the owner, who asked to remain anonymous. He predicts tenants returning to San Francisco from Oakland, seeking close proximity to the action and their jobs.

Apartment Building Sales
As of late May, trading of apartment houses had slowed dramatically, with sales occurring infrequently. Since the SIP order was imposed, only two newly listed buildings were sold; one was nearly vacant. Coupled the regulations and limits on showing a building, lenders have increased rates and imposed tougher underwriting standards. Sizable reserves are now required, and due to the local eviction moratorium, buildings with units that have tenants who are unable to or refuse to pay rent, must have their rent rolls audited and the deferred or lost rent is not factored into the property’s gross rents.

Dot-Com Bust
San Francisco housing has weathered several tumultuous downturns over the last few decades.  The devastating impact caused by 1989’s Loma Prieta earthquake was followed by a recession that left housing in the doldrums for years. The zany build-up of the dot-com era lead to an economic implosion locally that effected rents and prices for some time; only to recover thanks to disastrous sub-prime lending standards that quickly overinflated housing prices and pushed the global economy into the Great Recession. These downturns were caused by financial and economic factors. Today’s crisis was borne out the preventative measures to stop a pandemic. The restrictions, shutdowns and layoffs will hopefully be temporary.

Tim Carrico, a past president of SFAA, remembers the dot.com bust was an all-around disaster in many ways, especially for South of Market commercial buildings. “The idiots offered landlords ridiculous rents, often for space they didn’t even need, but thought they might in the future when the pigs started flying,” reflected Carrico. Many small- and medium-size businesses had to move out—many out of the city—and in a very short time, it all went poof! and the landlords were left with empty buildings. The bust put thousands of web-page designing and tech tenants out of a job, and when they couldn’t afford the rents (which they had bid up on their apartments), they left town.

“That left a lot of empty apartments for residential landlords and a big drop in rent levels for the next few years,” commented Carrico, a broker with Coldwell Banker. “I don’t really remember the slope on apartment-building values, but I did buy an 18-unit Marina-style building in 2000 for 9 times gross and I always thought it might have been the last building sold in San Francisco for under 10 times gross!

“The big message to me from the dot.com disaster, was the powerful effect that employment levels have on rents,” said Carrico. “Rents didn’t start rising again until the jobs started coming back some years later.”

Matthew C. Sheridan is an apartment building specialist with Newmark Knight Frank and is the emeritus editor and publisher of this magazine. He can be reached at 415-273-2179.