Apartments Prove Anchor in the Storm

By Sharon Simonson

Investor demand for large, institutional quality apartments in the core Bay Area is outstripping supply, pushing capitalization rates below 6.5 percent from closer to 7 percent less than six months ago.

Stan Jones, a well-known Bay Area multi-family broker for Marcus & Millichap Real Estate Investment Services, and others in the industry say the few, large properties that have come to market in the last several months have drawn multiple offers, despite softening rents and rising vacancies.

“Prices have firmed up, and I do believe it is going to hold,” Jones said. “My read is we had a falling market [at the end of last year] where no one knew where values were, and we potentially overshot the correction. There is still a lot of buyer demand for the right opportunity, and interest rates have stayed very low.”

Jones typically works with large institutional buyers and sellers such as Wall Street investment banks and publicly traded real estate companies such as AvalonBay Communities Inc.

Michael Shields, a managing director for brokerage Sperry Van Ness in Silicon Valley who specializes in serving small investors breaking into the rental market via the smallest properties, says investor interest is strong in that strata of the market as well.

“Properties priced well will sell with multiple offers,” Shields said. “If you look at the MLS (multiple listing service), the number of four-plexes available and the number that have sold or are in contract are increasing in proportion to those offered.”

Still, prices have fallen 20 percent or more from their boom-time peaks, he and other brokers say.

The sector is aided by available financing through federal government agencies Fannie Mae and Freddie Mac. But even some banks and credit unions are willing to lend on Bay Area apartments. That is in stark contrast to offices, where lack of financing has contributed to rapidly falling property values and increased loan defaults and foreclosures.

Apartments are an inherently less risky sector than offices, however, because losing a single tenant, while unwelcome, does not constitute the hit to cash flow that it might in an office building.

Based on information from real estate research firm Reis Inc., the apartment sector typically leads others out of economic downturns, said Kyle McLaughlin, a senior analyst for the company.

The demand for new apartments is driven by new household formation, McLaughlin said in an email message. The rate of new household formation is in turn driven by employment.

“As the employment picture begins to sure up, those who will be hired back are likely in the younger cohort,” he said. More than three-quarters of young people rent, and as they become employed again, they will begin to drive increased rental activity.

Effective rents in San Jose fell 8 percent on a year-over-year basis, according to third-quarter data just released by Reis. They fell 5.3 percent in San Francisco and 3.9 percent in Oakland and the East Bay. Effective rents include the cost to landlords of providing tenant perks to promote leasing, including rent reductions and free rent. All three Bay Area markets had among the worst showings in the year of the 79 major metropolitan markets that Reis tracks. San Jose’s decline was the worst in the nation year-over-year, Reis said.

That said, San Francisco and San Jose also experienced greater rental growth than the nation at large during the boom years from 2004 into 2008, Reis data show. During that time, San Francisco’s effective rents grew nearly 30 percent and San Jose’s expanded by nearly 25 percent. The average effective-rent growth nationally during the years was 17 percent.

“So it is not surprising that these metros (San Francisco and San Jose) are now exhibiting larger than average declines as rents stabilize to a sustainable level for cash-tight tenants,” McLaughlin said.

Vacancy rates in San Jose and San Francisco also remain below 5 percent while Oakland’s is below 6 percent, among the stronger showings in the same 79 metro markets.

So far this year, there have been fewer than 10 large apartment complexes sold in the nine-county Bay Area, Jones said. He estimates another four or five will sell before year end. That compares to 56 in 2007 and 28 last year.

Some publicly traded real estate investment trusts had been pulled to sell properties because the yields on their stocks were higher than those on their apartments, Jones said. But as their stock prices rose in recent months and their yields fell, the pressure abated. AvalonBay, for one, is in escrow to sell a 192-unit Sunnyvale complex and sold a second, 226-unit complex in North San Jose about a month ago, he said. But he does not expect the company to sell more.

No brokers predicted the massive foreclosure rates seen in single-family homes, condos and even duplexes and four-plexes or those predicted for the office sector.

West Coast Commercial Real Estate News