Investors continue seeking multifamily deals in the region, often finding them in outlier markets and products
The Bay Area multifamily rental market has experienced a sharp decline in leasing supply in the past quarter, emphasized by a high demand for space from tech industries and resulting in low vacancy rates, higher rental rates and accelerated investment activity, according to the Q4 2018 Marcus & Millichap Multifamily Research Market Report on Bay Area Metros.
Unemployment has reached a record low for the Bay Area economy in recent years, and while political factors have played a role in real estate regulation, multi-family properties in the Bay Area will continue to see trends of steady demand and increased investment activity going into 2019, with an emphasis on continued limited leasing supply and investment in suburban cores.
Even though thousands of units will come online in 2019, the Bay Area remains woefully undersupplied, and the ratio of job creation to housing creation is the most lopsided in the nation
“There wasn’t as much new construction product that came online as maybe in previous quarters this year,” said Adam Levin, senior marketing director at Marcus & Millichap. “Overall, it’s still a very supply-constrained marketplace.”
Significant expansions in the tech, semiconductor and biotech industries in Bay Area metropolitan areas such as San Francisco, San Jose and Oakland have helped to drop unemployment rates to levels comparative to the late 1990s. The second quarter ended with an unemployment rate of 2.4 percent in San Francisco, 2.7 percent in San Jose and 3 percent at the end of the third quarter for East Bay/Oakland – meaning that companies are starting to face some trouble in hiring qualified applicants. Influx of jobs is a direct factor on lower vacancy rates, especially when looking to multifamily real estate.
“If you look at Facebook, for example, which is the third largest tech tenant here in [San Francisco], in 2018/2019 they’re taking on significant amounts of more space, and that’s just more people that need to be housed,” said Clinton Textor, first vice president at Marcus & Millichap.
Oakland employers alone created 22,400 new jobs during 2018, and San Francisco companies were not far behind with an additional 21,600 positions contributed, according to Marcus & Millichap Multifamily report, expanding total employment by 1.9 percent year over year. But with a steadily increasing workforce comes the need for more leasing supply.
“Even though thousands of units will come online in 2019, the Bay Area remains woefully undersupplied, and the ratio of job creation to housing creation is the most lopsided in the nation,” said David Nelson, regional manager at Marcus & Millichap.
Though the shortage of leasing space in the Bay Area is becoming increasingly apparent as the year comes to a close, a small number of new units will come online in 2019. Not enough to offset the need, according to Nelson, nor the rental or vacancy rates throughout the marketplace, however. Textor echoed this sentiment.
“If you look at how many units we’re set to deliver, new construction here in San Francisco is woefully inadequate for the demand for apartment product in the city,” he said.
One area with a pattern of consistency is the demographic of buyers in and around the Bay Area, with two of the largest purchasers for rent-controlled spaces being family institutions and private client sectors.
“Apartment yields are still higher than the alternative investments like U.S. Bonds, the S&P 500 dividends, foreign bonds, etc.,” Nelson said.
Though the yield may be higher compared to alternative investments, apartment returns over the past decade have been compressed due to economic factors, primarily the recession. Because of the high demand for leasing supply in the urban Bay Area, investors looking to get the largest yield have been moving further and further away from the urban core, closer to commuter suburbs.
“The East Bay remains very strong,” Levin said. “We’re projecting a lot of rent growth continuing in the East Bay. But with that being said, there’s still always that buyer pool for core Silicon Valley and Peninsula assets. They still remain strong. Cap rate sensitivity is a lot stronger right now. People are looking at where their stabilized cap rate is in comparison to their debt rate constant. They don’t want negative leverage.”
Textor added that Oakland has been an attractive area for investors because of its proximity to San Francisco and a relatively manageable commute. That has resulted in faster pricing growth in the East Bay city than in some parts of San Francisco.
“I think people are looking for better deals than what they can find in San Francisco,” he said.
Rental rates have experienced tremendous growth in the multifamily market in the last quarter, as well. According to Marcus & Millichap’s report, South and Central San Mateo County have led the market with fastest rent growth in 2018, with Class C properties’ monthly effective rents climbing 10.5 percent to $2,304. Class B assets have also exceeded the metro average, rising 5.2 percent to $3,269 per month.
Santa Clara has also experienced a record performance, with Class A rent growth in North Sunnyvale and South Sunnyvale and Cupertino coming in at 8.7 percent higher to an effective rent of $3,350 and 8.5 percent to $3,507, respectively.
“I think people are being smarter about their asking rates,” Levin said. “I think that we’re definitely seeing some levelling on rent levels.”
Nelson added that accelerated growth rates for both Class B and Class C assets and sharp drops in vacancy rates are a direct result of investors moving from the urban core to the commuter suburbs.
“Investors are increasingly looking to Class B and C assets as value-add opportunities that offer a higher yield curve and the potential for increased revenue growth in non-rent controlled markets,” he said.
Politics have also played a role in investment activity. California Proposition 10 aimed to repeal the Costa-Hawkins Act, the state law that restricted the scope of rent-control policies that cities and other local jurisdictions may impose on residential property. Voters overturned the proposition, which boosted the confidence of buyers who were dragging their feet about acquisition in the months leading up to the midterm elections, according to Marcus & Millichap.
Ramon Kochavi, First Vice President and Regional Manager at Marcus & Millichap, agreed that many buyers gravitated away because of Proposition 10 at the beginning quarters of the year.
“There was prominent overhang on our ability to do business,” Kochavi said. “That’s kind of dissipated, but there is the regulatory environment that will always be complicated.”
Heading into 2019, the multifamily leasing market can expect to see a continuation of constricted leasing supply, with suburban areas continuing to heat up as the urban core cools down. The largest remaining project of 2018 will be located in Downtown San Francisco at 150 Van Ness Ave, with a 12-story building that will contain 429 units. About 370 units will come online before the end of the year for the East Bay and Oakland area, as well as an additional 1,025 rentals by end of year in San Jose.
Investors will continue to seek the highest yield, with commuter areas generating more buyer interest, along with a continued increase in rental rates and consistent low levels of vacancy.
“No matter what other trends kick up, I doubt we’ll see anything but strong demand and constrained supply over the next year,” Kochavi said.