Bay Area rental housing markets girded by employment strength and scarce supply.
THIS ARTICLE WAS PUBLISHED IN THE ‘Q’ – THE REGISTRY’S PRINT PUBLICATION – IN APRIL OF 2016
By Daniel Smith[dropcap]A[/dropcap]nalysts say residential real estate is still as strong an investment in the Bay Area as anywhere in the U.S.—but not in the bigger cities in the Bay Area if you need a quick return. That condition is evidenced by a group of predictions that at first glance might appear contradictory, but in fact are not.
A Cushman & Wakefield report on Bay Area multifamily rentals says rent increases will dip below 10 percent in 2016 after four years in which the average asking price has risen a cumulative 48 percent. The same report pegs capitalization rates in San Francisco for 4Q 2015 at a meager 3.4 percent. Are these really projections about the best rental investment market in the country?[contextly_sidebar id=”fEZ2uwnPBSByvWpUByO9by4fXNeMdyDc”]“If you’re looking for yield, which everyone is…investments are far more lucrative in the Southeast and Midwest,” said Steve Hovland, research services manager for HomeUnion, the Irvine-based firm that recently issued its Bay Area Single-Family Rental Investment Report, citing one such prediction in the report.
“It depends on your investment strategy,” said Paul Zeger, a partner at Polaris Pacific, a leading West Coast sales and marketing firm. Referring to private entrepreneurs, he said of current Bay Area conditions, “It’s harder for them to compete in that market.”
Zeger was comparing individual investors to real estate investment trusts, REITs, which he said are “driving up the price of land [and]… the price of construction” because they can survive with lower immediate capitalization.
“They’re happy to live with much more modest returns than the developers,” he said of one obstacle REITs pose for private investors.
Capitalization rates in 4Q 2015 fell short of 6 percent region-wide except in Solano County, where the came to 6.5 percent, according to the Cushman & Wakefield Multifamily Snapshot for the Bay Area. For single-family rental homes, HomeUnion quotes modest capitalization rates ranging from 2.7 percent in San Francisco to 3.9 percent in Oakland. Nonetheless, analysts say an extreme demand for housing and steady job creation in the Bay Area are the foundation of all positive forecasts for 2016 and beyond.
The Multifamily Investment Forecast for 2016 issued by Marcus & Millichap predicts “continued performance gains for apartments” and ranks San Francisco and San Jose as the best of 46 metros nationwide, with Oakland, Portland and Seattle-Tacoma not far behind. None of the analysts interviewed disagreed with that lofty rating.
“The reason is simple, and that’s the employment base, the best employment base in the country,” said Ric Russell, senior managing director for Cushman & Wakefield in San Francisco.
“It all ties into jobs,” agreed Zeger, stating that 115,000 jobs were created in the Bay Area in 2016, but only 13,000 homes added. While that ratio should be in the neighborhood of 40 percent, he said, “We’re getting less than 10 percent.”
“There’s just no supply to be had,” said Zeger, citing one exception in the region: northern San Jose. Noting that between 10,000 and 15,000 new rentals are expected to come online there in 2016, he said because of that, “They may go up [just] 5 to 10 percent.”
“We see a fairly significant slowing in rents of existing product,” said Russell on his firm’s prediction of single digit increases.
Hovland called the projection “very realistic” and noted, “We’re seeing some softening in various areas.”
Zeger for the most part disagreed, stating, “I think today there’s plenty of room for rent increases because of the demand. You’re not getting enough [new homes] to have a real slowdown in prices.”
The Cushman & Wakefield Snapshot pegs average multifamily rent in the area as $2,085 in the East Bay as a whole and under $2,000 in Contra Costa and all North Bay counties except Marin, the latter which is $2,557. The Peninsula counties are similar to Marin, and San Francisco leads the area by a large margin at $3,616.
Cushman & Wakefield reported Bay Area multifamily vacancies at 4.5 percent in the fourth quarter, up from 4.2 percent the prior quarter. Marcus & Millichap’s Institutional Property Advisors quote a 4.2 percent vacancy rate for apartments nationwide.
Hovland said negative media coverage over evictions in the Bay Area is slowing rent increases for single-family units lately, adding, “As that calms down, rents can be raised again, but you don’t want to be the guy in the newspaper.”
Despite HomeUnion’s assessment that secondary metros elsewhere are more immediately lucrative than the Bay Area, he conceded, “There’s great investments, you just have to go a little farther out: southern San Jose, eastern San Jose. That’s where you’re going to capture the highest yield [locally].”
The Cushman & Wakefield Snapshot contrasts an increase of about 350,000 in the Bay Area population from 2010 to 2014 with the addition of only 40,000 rental units. Despite tracking 24,500 units currently under development and another 70,000 in the proposal phase, it forecasts “roughly five years of development at the current pace before we expect the region’s housing shortage to be tempered.”
“I think it’ll be a challenge for us to achieve that,” Russell conceded, predicting that affordable housing requirements in San Francisco and San Jose will “eliminate some projects…I think it’s going to slow [development] down a bit.”
“All things being equal, that’s a realistic progression,” said Hovland. “I don’t think it’ll take five years.”
“The telltale sign is when you see all these buildings with signs saying, ‘One month free rent,’” said Zeger of any waning in the local housing shortage. “When that turns into two months, that’s when [you know] there’s a problem.”