It may have the coldest summers in the entire country, but San Francisco’s apartment market is nothing if not hot. Bolstered by a strong employment base rooted in technology, limited supply, long-term stability, and solid fundamentals, the City by the Bay continues to keep multifamily investors active and satisfied.
Indeed, with a large and growing population and significant presence in industries ranging from technology and environment to health, education, and agriculture, the undoubtedly strong San Francisco market will continue to dominate in the years to come.
Jobs, Jobs, Jobs
Like the rest of California, the Bay Area has had to endure massive layoffs in conjunction with the Great Recession. Despite total job losses of more than 43,000 in the past year, according to the California Economic Development Department, major Bay Area cities and submarkets (including San Francisco’s close-in suburbs such as Marin, San Jose, and Oakland) appear to have fared better than other California submarkets, with an average unemployment rate of 10.7 percent versus the statewide average of 12.4 percent. Considering that state and national job losses are moving from the private to the public sector, the Bay Area as a whole seems poised to weather the storm, given the low percentage of government and substantially government-funded education and health services sector jobs that make up the region’s employment population.
Still, job projections are underwhelming, though most economists will agree that the local economy has started to show signs of recovery. In the past six months, Bay Area markets have by and large displayed monthly job growth in the employment services industry (i.e., temporary workers), a leading indicator of the California economy believed to help predict trends in future employment.
With a diverse, highly-skilled workforce, a multitude of leading companies headquartered in the region, and a growing presence in the Green Tech industry, the Bay Area provides a solid economic climate that, despite flat job projections for the remainder of 2010, shows signs of life in a recession.
A Solid Foundation
Thanks to its lifestyle, nightlife, and culture, the Bay Area is still one of the most desirable places to live and work in the state, so the metro benefits from a relatively high occupancy rate. While the recession has resulted in somewhat lower occupancy levels, vacancy rates have already begun to stabilize and are expected to return to between 4 percent and 4.2 percent by the end of 2012, according to New York-based research firm Reis. Today, year-end vacancy rates are projected to be 4.9 percent in San Francisco/West Bay; 4.3 percent in the South Bay; and 5.4 percent in the East Bay.
Meanwhile, rents are also expected to make a comeback. Historically strong rent growth in the Bay Area was marred by rental declines of roughly 4 percent to 7 percent in 2009. Although 2010 saw moderate rent growth, those rates are beginning to show signs of improvement.
By the end of 2010, Bay Area average rents are expected to be $1,826 for San Francisco/ West Bay; $1,503 for the South Bay; and $1,340 for the East Bay. In San Francisco and West Bay, which includes the affluent Marin and San Mateo counties, an already tight and expensive market will likely see rent growth of just below 2 percent from 2011 to 2012, with growth rates expected to increase to 2.6 percent by 2014. On the other end of the spectrum, the East Bay market, which has the most affordable rents in the region, is projected to grow at a faster pace, to more than 4 percent the annual growth rate by 2013.
As rents and vacancies continue to improve, concessions are also projected to decrease. While some properties are still offering as much as one month free rent (8.3 percent off market rent), concessions are becoming increasingly limited and are likely to diminish significantly in 2011.
Thankfully, this picture will continue for a while, as new supply is not expected with construction at a near standstill. Only 2,100 units were delivered to the market in 2009, with a mere 1,400 units projected in 2010, many of which are garden-style properties. This represents a less than 1 percent increase in total inventory since 2008. With high barriers to entry in the Bay Area market, 2011 will see little change, with roughly 1,800 new units slated for delivery. One project on the books is San Leandro Crossings, a mixed-used, multi-phase, transit-oriented development that will include 300 multifamily units slated for delivery in 2012. The property will be developed by Westlake Development Partners and BRIDGE Housing Corp. and will feature a 200-unit mixed-use residential project plus a 100-unit strictly residential project.
Although development activity is expected to increase from 2012 on, forecasts also show positive net absorption, which indicates that demand will still outweigh supply.
From a transactional perspective, the bottom line is that San Francisco is a fundamentally strong market, which explains why it continues to attract investors, despite a sluggish economy. Consider that Class A cap rates, which are sub-5 percent in the City Center and as high as 6 percent in the East Bay, are conducive to trades. Meanwhile, Class B and C cap rates tend to run only 75 to 125 basis points higher than those in Class A.
Sales and acquisitions in the city are really defined by their location—whether they are located in urban San Francisco or the suburbs. The urban San Francisco market is characterized by distressed assets, with the primary catalyst for the surge in transactions being the liquidation of the Lembi Group’s assets. (Once San Francisco’s largest multi-family owner, the firm has foreclosed on 100-plus properties throughout the city since 2009.) In 2010, the urban San Francisco market has experienced increased transaction volume, primarily in the 10-unit-plus sector. In August 2010, UBS sold a 245-unit portfolio of four REO properties in the Downtown/Civic Center neighborhood for $123,000 per unit. While sales of properties with fewer than 10 units are lackluster, the overall market has seen remarkable improvements in sales velocity and transaction volume. Across the Bay in the suburban neighborhoods, institutional assets have seen a significant increase in transaction volume in 2010—albeit for a different reason. While there have been several notable bank-owned properties to trade this year, the increased velocity in Bay Area sales can primarily be attributed to a compression in cap rates. Limited product availability, increased competition to acquire assets, and significantly reduced interest rates have compressed cap rates as much as 100 basis points within the past year. And as the market begins to stabilize, cap rates are projected to fall further and command better pricing for multifamily assets across the region.
Leading the charge into the next few years will be the REITs—companies such as Essex Property Trust, BRE Properties, and Equity Residential—which are motivated by long-term fundamentals of the region. Though they stayed fairly quiet during the recession, they are now eagerly eyeing acquisitions and new development opportunities.
While 2010 has not produced staggering numbers, it is indicative of a recovery and perhaps more importantly, a stabilizing market. Furthermore, tech companies in the Bay Area are hiring, which also bodes well for the capital market environment. And ultimately, this renewed confidence in the region would signify a promising outlook for the Bay Area multifamily market in 2011 and beyond.
Ria Bitong is director of investment analysis for Apartment Realty Advisors (ARA) Pacific.