The rental market in the Bay Area is one of the strongest in the nation, making the region a target for investors

By Michele Chandler

Unemployment has tumbled into the single-digits to the lowest level in more than 17 years, as the nation’s job market has taken off. At the same time, construction of single-family homes has slowed, under weighty land and construction costs. All that means that apartment rents will continue rising, while sales of multifamily buildings will moderate but still remain strong, according to new reports examining the Bay Area’s rental industry.

In San Francisco, sales of multifamily buildings rose about 10 percent during the past year, according to Marcus & Millichap’s February Multifamily Research Market Report. The study includes investment trends in San Francisco, San Jose and Oakland during the period stretching from February 2017 to February 2018.

“This is a terrific area. I anticipate it staying strong,” said Ramon Kochavi, first vice president and regional manager at Marcus & Millichap.

The rents you’re able to charge for a Class A building, at a minimum, is what you need in order to underwrite the cost of new construction.

Still, throughout the rest of the year, apartment completions in the Bay Area are projected to fall by roughly 3,300 units, the group’s report found. “We have very little land and a very long process to develop the land. That’s an ongoing problem,” Kochavi said.

However, Kochavi added, “you can’t read too much into one year,” because the development cycle for new buildings is so long.

The multifamily industry could also feel fallout should interest rates rise, said Steven Nelson, first vice-president, senior director of the National Multi-Housing Group at Marcus & Millichap. “The slowdown really has to do with everyone being a lot more cognizant that if debt is going to be 4.75 [percent], they can’t very well buy an apartment complex at a 4.75 cap rate.”

In the current economic climate, Nelson said builders are putting up mostly Class A buildings that command higher rents. “The rents you’re able to charge for a Class A building, at a minimum, is what you need in order to underwrite the cost of new construction,” he said.

Right now in San Francisco, the construction of 2,520 apartments is underway, slowing from the 3,925 units that were completed in 2016. Areas with the most activity are concentrated in the South of Market neighborhood and South San Mateo county.

Marcus & Millichap expects the completion of apartments in Oakland will also moderate next year, with 2,460 apartments slated for delivery.

In San Jose, though, construction of new apartments picked up. Builders completed 4,076 apartments last year, surpassing the 3,871 units opened in 2016. Most new units are located in Central San Jose and in the city of Santa Clara. Oakland’s construction activity doubled to 2,780 units completed, primarily downtown.

With supply low in central cities, existing multifamily buildings and new projects in commuter suburbs including Morgan Hill and South San Jose are expected to draw more attention, the group’s research found.

Going forward, the multifamily development industry is keeping an eye on any bump up in interest rates, which slow down sales. The industry is also watching the fate of legislative proposals to repeal the 1995 Costa Hawkins Rental Housing Act, which would pave the way for greater rent controls. “Those are the two factors that are going to most influence sales of multifamily buildings,” Nelson said.

Throughout the Bay Area, apartment vacancy rates remain at or below an average of 4 percent rate in the fourth quarter of 2017. Apartments in Mountain View, Palo Alto and Los Altos saw the region’s highest vacancy rate—5.8 percent. The neighborhood of West San Francisco saw the lowest vacancy rate, 1.9 percent.

Average effective rent in San Francisco rose 6.7 percent to $3,288 per month; this growth was led by 15.5 percent in West San Francisco, where effective rent increased to $3,279 per month. In San Jose, those rents rose nearly 6 percent to $2,680 per month. And, in Oakland, effective rents increased 3.5 percent year over year, reaching $2,259 per month.

The increase in rents and the low vacancy has made the region one of the most desirable multifamily investment locations. In a recent report from Cushman & Wakefield, the top sale price in the North Bay was the $255 million acquisition by The Lighthouse Group of the 284-unit The Cove at Tiburon on Barbaree Way in Tiburon. Cushman & Wakefield’s Northern California Multifamily Monthly Sales update for February 2018 covers Sonoma, Solano, Napa and Marin counties.

The top multifamily sale in Santa Clara county was the $130.5 million Essex Property Trust paid for 350-360 S. Market Street in San Jose, the site of the 360 Residences. Essex bought that 213-unit property from Capri Investment Group.

In San Francisco, the $147.6 million paid by Greystar for the 170-unit Argenta property on Polk Street topped the list compiled by Cushman & Wakefield. Rockpoint Group LLC was the seller in that transaction.

Just one Class A multifamily complex traded hands in San Mateo county during the period, when Greystar paid $107.7 million for the 163-unit Acappella Apartments on National Avenue.

And in Alameda and Contra Costa counties, the largest Class A transaction was the $99.6 million sale of The Mason Flats at Township Square on Lexington Lane in Pleasanton to INVESCO Real Estate. The Resmark Companies sold that property, according to the Cushman & Wakefield report.

Higher yields for apartment buildings in Oakland are siphoning away investors from San Jose and San Francisco, the Marcus & Millichap report said. Nelson said that some Bay Area apartment investors are even heading to Sacramento to buy, drawn by that market’s lower costs for multifamily buildings. The priciest Class A building to change hands in Sacramento last year went for $71 million, which sold in March of 2017, according to Cushman & Wakefield’s report. This was the 213-unit The Foundation property located on 3075 Redding Avenue, which went for $333,333 per unit. The seller was The Opus Group, and the buyer of the property was Scion LLC.

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