Northern Calif. Markets Report Slight Softening After Several Boom Years
Northern Calif. Markets Report Slight Softening After Several Boom Years
Selling prices in the Bay area may have topped out, but limited land and high costs keep market tight
By Teresa O'Dea Hein, Senior Writer
DECEMBER 09, 2005 --Many investors who rode the waves of the swelling northern California real estate market got in when the market was in the depths of the tech implosion and were eventually swept up with rising economic tides. Currents are shifting now in the Bay Area, according to local observers, and the tides are getting swifter, compelling investors to navigate more carefully.
"Whereas condo buyers previously were jumping in with both feet, now they're dipping their toes in to test the water," says Ryan DeMar, a broker with Marcus & Millichap in its Sacramento office. Demar reports that now there's a lot of inventory on the market, with a lot of product not moving.
After several very hot years, northern California real estate experts report that the market has just begun to cool off in the last few months.
Don Little, senior vice president for Opus West Corp., agrees. "I think that everyone who's paying attention expects the exuberance in the market to subside due to rising interest rates and the potential level of future supply. However," Little adds, "some product types and price points are more vulnerable to cooling-off risk than others.
Furthermore, Little notes, "This business is about timing as much as it is about location. You also have to do your homework carefully," he adds, in order to understand local demographic trends.
In particular, he thinks that very high-priced projects might see some price softening.
Sales of higher-end properties are slowing down-"it's just not sustainable," says Caroline Sjostedt, senior vice president/team sales leader for KeyBank Real Estate Capital, Income Property Group, Walnut Creek, Calif., "but whether they'll retract is another question."
San Francisco
The fact that there are a lot more condo projects under construction now than were delivered last year will ultimately lead to softening in the market, says Bruce Dorfman, a principal with Thompson Dorfman, based in Sausalito, Calif. "There is no question that the pipeline is pretty darn full, with a lot more product under construction at a higher cost per square foot."
Absorption had been pretty strong and condo converters continue to go forward, Dorfman adds, but the margins underwriting deals are shrinking. "An additional sign of the softening market," Dorfman says, "is that investors have reduced expectations, looking at lower yields. There also isn't the sense of urgency now that there was over the last 18 months."
Dorfman predicts that if 30-year mortgage rates go up one point, or the market experiences a similar economic shock to its system, "There will be a flurry of activity-it will bring the last salvo of buyers, jumping on the train before it leaves the station."
However, the cloud of rising interest rates is likely, experts predict, to ultimately reveal a silver lining of improvement for the rental market, as more people are forced back into that sector. The affordability index for properties in northern California is especially daunting, given the region's sky-high condo and single-family home prices.
Steve Wilson, senior vice president of development for northern California and the Pacific Northwest for AvalonBay, a REIT with over 9,000 units in the Bay Area, reports, "We're starting to see a trickle of migration back to rentals. We're optimistic that 2006 will give us some pricing power, after concessions disappear. The erosion of concessions started this past Spring-that's where you first start to see the shift in the market."
Wilson expects that rising interest rates and the oversupply of condos will combine to create more opportunities for developers of rental properties. "We may see the pendulum start to swing back to rental communities."
Being on the rental side of the market, Wilson notes, "We've had a tough run since the turn of this century, but we're in this market for the lung run, unlike other developers who pulled up and went to Southern California."
Wilson sees the city of San Francisco as a "great opportunity for rent growth," followed by the East Bay. "Our belief is that the apartment market is improving marginally," Dorfman says. "We're very bullish on the long-term strength of the apartment market because supply's been minimal as converters take supply out of the market."
Furthermore, notes Mark J. Feldman, an associate partner with Hendricks & Partners, northern California managed to generate significant appreciation in real estate even during a post-911 economic downturn in the region, when a significant number of jobs were lost, especially in the technology and tourism sectors. Now, job growth has picked up so Feldman thinks that upswing may help offset the rise in interest rates.
Indicative of the strong demand for condos is the fact that they (either ground-up condo construction or conversion) make up about 40 percent of KeyBank's Bay Area Income Property Group office's current portfolio (based on commitments), Sjostedt reports. Furthermore, approximately 55 percent of the group's loan production this year is in this product type.
As far as the rental apartment goes, Sjostedt believes, "The worst is behind them; the trough has been reached. If people were realistic about rents, occupancies came back last year.
"We are slowly, slowly seeing minor but steady increases in rent since the first of this year. For 2006," she continues, "we're projecting 4-6 percent revenue growth, especially in Silicon Valley.
Projects that make sense to convert to condominiums have done so, Sjostedt says, and ultimately that will create a real up tick in the rental market, as supplies have been reduced.
She's observed that rent concessions are decreasing-"they're not nearly what they had been-though not gone yet." Rental properties, Sjostedt says, had the toughest time in the South Bay, impacted by the tech melt-down in Silicon Valley, and in the city of San Francisco.
Strengthening demand and a limited supply of new product combined to bring down the city's average apartment vacancy rate in the second quarter of 2005 to 4.6 percent, compared to 5.1 percent in the same quarter last year, according to Marcus & Millichap.
Likewise, local rental rates advanced an average of 0.8 percent over the year-ended second quarter, a slight improvement over the 0.3 percent increase over the previous 12-month period.
Marc Perrin, a managing director at Starwood Capital Group, San Francisco, thinks the apartment market in San Francisco is a real opportunity right now, with cap rates so low relative to value. "When this market really does recover, rent growth will be well above average," he predicts. "All the stars are aligned for a really strong recovery, which we're starting to see."
However, going forward, Perrin is wary of the condo market because there's a low of supply due to become available in the next 12 to 48 months.
Jay Greenberg, a senior investment associate based in San Francisco for Marcus & Millichap, says, "Right now, we're seeing a change in the market-the pulse of the marketplace has slowed down at certain price points and in certain neighborhoods as inventory has increased. We're also not seeing as many multiple offers and bids over asking prices."
The market for six-unit and under properties in San Francisco has peaked, Greenberg reports. "That sector is saturated, with a ton of product on the market."
On the other hand, he points out, there's not as much inventory available in properties above six units.
Through the third quarter, Greenberg says that three value indicators all increased in San Fran. These are the cost/square foot, cost/unit and growth rent multiplier (GRM).
"I don't know if we'll continue to see that growth," Greenberg says; "the market may flatten out a bit." Yet, he notes, "there are still buyers out there buying. While there might not be 10 buyers for every property, there are still one or two-and all you need is one."
If you price a property properly, it will sell. This market has been going up for 10 years, and people still see GRMs.
However, properties are sometimes not worth what the owners think they should be, and some brokers price properties on hope instead of reality. I believe there are a lot of over-priced properties on the market," Greenberg concludes.
Greenberg says he's seen multifamily property sales in the City by the Bay break through a number of price ceilings over the last five years, from $200 per foot to over $400-per-foot mark.
With low interest rates, Greenberg notes, "people were buying out of the rental market but now renters are coming back."
The city's tallest residential development got underway in autumn 2005 next to the entrance to the Bay Bridge. One Rincon Hill is designed as a 709-unit luxury condominium complex with two concrete- and glass-towers, one rising 45 stories with the other topping out at 55 stories. Completion is scheduled for December 2007.
Another huge project in the Golden Gate city is Mission Bay, a growth corridor one mile south of the Financial District that has been master planned for 6,000 housing units, along with office space and a university campus.
San Jose (South Bay)
With a growing population that now numbers about 900,000, San Jose was recently named the 10th largest city in the U.S.
The nature of San Jose is changing from a suburban city to an urban one as more condominiums are seen as a way to meet the area's housing needs. As of January 1, San Jose has 36,425 condos, according to the county assessor's office, and more are slated to be built.
With the median cost for a single-family home at a record $714,000, condos provide buyers with an alternative, albeit a pricy one (with the median price at $490,000 in August 2005).
AvalonBay's Wilson believes that San Jose's rental market will continue to lag both San Francisco and the East Bay due to a lack of job growth-"it's a jobless recovery."
Sacramento
The capital city of Sacramento has benefited from in-migration from Bay Area residents, as well as people from Southern California, forced out by those regions' stratospheric selling prices. The four-county Sacramento market, part of the larger Central Valley region, is expected to continue to grow. A recent forecast from experts at the Public Policy Institute of California predicts that population booms are expected to swell the Sacramento area, among other regions, by 45 percent in the next two decades.
"I think downtown Sacramento is going through a rebirth with restaurants and entertainment options," Opus West's Little notes, "as people have a growing appetite for the amenities of downtown living."
Hoping to follow in the footsteps of cities like Seattle, Portland and Denver, Sacramento is trying to revitalize its downtown by encouraging residential development.
To that end, for example, the Sacramento County Board of Supervisors has begun negotiating with D.R. Horton, a leading national homebuilder based in Fort Worth, Tex., to transform the nondescript former Bank of America building into a modern mixed-use high-rise in the next two years.
The proposed 21-story Library Lofts would add nearly 300 loft units along with 30,000 to 45,000 square feet of, office space, five parking levels and 5,000 square feet of streetside retail to the civic corridor. Preliminary designs for the project indicate that it would borrow aspects of the central downtown library next door.
At least 2,500 condominium units are now being planned for downtown and midtown Sacramento. An ambitious plan by shopping center developer John Saca calls for erecting what would be the city's tallest buildings as well as the tallest residential structures on the West Coast. The planned 53-story, two-tower complex would contain 810 condominiums as well as a luxury hotel.
Evidence of the demand for downtown Sacramento apartments is shown by the fact that vacancy rates are among the lowest among the capital region's submarkets. Demand has also been fueled by completion of several major office developments in the last two years that have accounted for about 20,000 new workers.
Since Sacramento didn't suffer job losses like other parts of the Bay Area and has instead seen significant job growth, Sjostedt, who grew up in the area, sees a brighter future for its rental market.
However, she's a little skeptical of the big push in downtown residential development for the city, with many projects on the drawing board. "I don't see a real depth of market for that product type there."
David Harrison, a senior advisor with Sperry Van Ness, Sacramento, agrees that the market has started to shift, with properties staying on the market longer or owners cutting prices or offering financing terms. "Cap rates have stayed a little stagnant, so some owners are testing the waters with a higher initial price."
Even though the market is transitioning, Harrison adds, "converters will pay above-market rates for a building with a (conversion) map on it." And others, he notes, are taking advantage of the relatively low cost of financing to trade up into a bigger property, even if they think prices will decline somewhat in the future on the basis that they'll still be accumulating equity.
Since some markets typically dry up sooner than others, Gary Roller, senior investment associate and a director of Marcus & Millichap's National Multi Housing Group, Sacramento, has found that Fresno tends to be a bellwether in the Central Valley region. "The Fresno market had been aggressive, but when we see a downturn there, it trends to show up in Sacramento nine months to a year later."
The key variable, many observers concur, will be how fast interest rates will move.
Selling prices in the Bay area may have topped out, but limited land and high costs keep market tight
By Teresa O'Dea Hein, Senior Writer
DECEMBER 09, 2005 --
"Whereas condo buyers previously were jumping in with both feet, now they're dipping their toes in to test the water," says Ryan DeMar, a broker with Marcus & Millichap in its Sacramento office. Demar reports that now there's a lot of inventory on the market, with a lot of product not moving.
After several very hot years, northern California real estate experts report that the market has just begun to cool off in the last few months.
Don Little, senior vice president for Opus West Corp., agrees. "I think that everyone who's paying attention expects the exuberance in the market to subside due to rising interest rates and the potential level of future supply. However," Little adds, "some product types and price points are more vulnerable to cooling-off risk than others.
Furthermore, Little notes, "This business is about timing as much as it is about location. You also have to do your homework carefully," he adds, in order to understand local demographic trends.
In particular, he thinks that very high-priced projects might see some price softening.
Sales of higher-end properties are slowing down-"it's just not sustainable," says Caroline Sjostedt, senior vice president/team sales leader for KeyBank Real Estate Capital, Income Property Group, Walnut Creek, Calif., "but whether they'll retract is another question."
San Francisco
The fact that there are a lot more condo projects under construction now than were delivered last year will ultimately lead to softening in the market, says Bruce Dorfman, a principal with Thompson Dorfman, based in Sausalito, Calif. "There is no question that the pipeline is pretty darn full, with a lot more product under construction at a higher cost per square foot."
Absorption had been pretty strong and condo converters continue to go forward, Dorfman adds, but the margins underwriting deals are shrinking. "An additional sign of the softening market," Dorfman says, "is that investors have reduced expectations, looking at lower yields. There also isn't the sense of urgency now that there was over the last 18 months."
Dorfman predicts that if 30-year mortgage rates go up one point, or the market experiences a similar economic shock to its system, "There will be a flurry of activity-it will bring the last salvo of buyers, jumping on the train before it leaves the station."
However, the cloud of rising interest rates is likely, experts predict, to ultimately reveal a silver lining of improvement for the rental market, as more people are forced back into that sector. The affordability index for properties in northern California is especially daunting, given the region's sky-high condo and single-family home prices.
Steve Wilson, senior vice president of development for northern California and the Pacific Northwest for AvalonBay, a REIT with over 9,000 units in the Bay Area, reports, "We're starting to see a trickle of migration back to rentals. We're optimistic that 2006 will give us some pricing power, after concessions disappear. The erosion of concessions started this past Spring-that's where you first start to see the shift in the market."
Wilson expects that rising interest rates and the oversupply of condos will combine to create more opportunities for developers of rental properties. "We may see the pendulum start to swing back to rental communities."
Being on the rental side of the market, Wilson notes, "We've had a tough run since the turn of this century, but we're in this market for the lung run, unlike other developers who pulled up and went to Southern California."
Wilson sees the city of San Francisco as a "great opportunity for rent growth," followed by the East Bay. "Our belief is that the apartment market is improving marginally," Dorfman says. "We're very bullish on the long-term strength of the apartment market because supply's been minimal as converters take supply out of the market."
Furthermore, notes Mark J. Feldman, an associate partner with Hendricks & Partners, northern California managed to generate significant appreciation in real estate even during a post-911 economic downturn in the region, when a significant number of jobs were lost, especially in the technology and tourism sectors. Now, job growth has picked up so Feldman thinks that upswing may help offset the rise in interest rates.
Indicative of the strong demand for condos is the fact that they (either ground-up condo construction or conversion) make up about 40 percent of KeyBank's Bay Area Income Property Group office's current portfolio (based on commitments), Sjostedt reports. Furthermore, approximately 55 percent of the group's loan production this year is in this product type.
As far as the rental apartment goes, Sjostedt believes, "The worst is behind them; the trough has been reached. If people were realistic about rents, occupancies came back last year.
"We are slowly, slowly seeing minor but steady increases in rent since the first of this year. For 2006," she continues, "we're projecting 4-6 percent revenue growth, especially in Silicon Valley.
Projects that make sense to convert to condominiums have done so, Sjostedt says, and ultimately that will create a real up tick in the rental market, as supplies have been reduced.
She's observed that rent concessions are decreasing-"they're not nearly what they had been-though not gone yet." Rental properties, Sjostedt says, had the toughest time in the South Bay, impacted by the tech melt-down in Silicon Valley, and in the city of San Francisco.
Strengthening demand and a limited supply of new product combined to bring down the city's average apartment vacancy rate in the second quarter of 2005 to 4.6 percent, compared to 5.1 percent in the same quarter last year, according to Marcus & Millichap.
Likewise, local rental rates advanced an average of 0.8 percent over the year-ended second quarter, a slight improvement over the 0.3 percent increase over the previous 12-month period.
Marc Perrin, a managing director at Starwood Capital Group, San Francisco, thinks the apartment market in San Francisco is a real opportunity right now, with cap rates so low relative to value. "When this market really does recover, rent growth will be well above average," he predicts. "All the stars are aligned for a really strong recovery, which we're starting to see."
However, going forward, Perrin is wary of the condo market because there's a low of supply due to become available in the next 12 to 48 months.
Jay Greenberg, a senior investment associate based in San Francisco for Marcus & Millichap, says, "Right now, we're seeing a change in the market-the pulse of the marketplace has slowed down at certain price points and in certain neighborhoods as inventory has increased. We're also not seeing as many multiple offers and bids over asking prices."
The market for six-unit and under properties in San Francisco has peaked, Greenberg reports. "That sector is saturated, with a ton of product on the market."
On the other hand, he points out, there's not as much inventory available in properties above six units.
Through the third quarter, Greenberg says that three value indicators all increased in San Fran. These are the cost/square foot, cost/unit and growth rent multiplier (GRM).
"I don't know if we'll continue to see that growth," Greenberg says; "the market may flatten out a bit." Yet, he notes, "there are still buyers out there buying. While there might not be 10 buyers for every property, there are still one or two-and all you need is one."
If you price a property properly, it will sell. This market has been going up for 10 years, and people still see GRMs.
However, properties are sometimes not worth what the owners think they should be, and some brokers price properties on hope instead of reality. I believe there are a lot of over-priced properties on the market," Greenberg concludes.
Greenberg says he's seen multifamily property sales in the City by the Bay break through a number of price ceilings over the last five years, from $200 per foot to over $400-per-foot mark.
With low interest rates, Greenberg notes, "people were buying out of the rental market but now renters are coming back."
The city's tallest residential development got underway in autumn 2005 next to the entrance to the Bay Bridge. One Rincon Hill is designed as a 709-unit luxury condominium complex with two concrete- and glass-towers, one rising 45 stories with the other topping out at 55 stories. Completion is scheduled for December 2007.
Another huge project in the Golden Gate city is Mission Bay, a growth corridor one mile south of the Financial District that has been master planned for 6,000 housing units, along with office space and a university campus.
San Jose (South Bay)
With a growing population that now numbers about 900,000, San Jose was recently named the 10th largest city in the U.S.
The nature of San Jose is changing from a suburban city to an urban one as more condominiums are seen as a way to meet the area's housing needs. As of January 1, San Jose has 36,425 condos, according to the county assessor's office, and more are slated to be built.
With the median cost for a single-family home at a record $714,000, condos provide buyers with an alternative, albeit a pricy one (with the median price at $490,000 in August 2005).
AvalonBay's Wilson believes that San Jose's rental market will continue to lag both San Francisco and the East Bay due to a lack of job growth-"it's a jobless recovery."
Sacramento
The capital city of Sacramento has benefited from in-migration from Bay Area residents, as well as people from Southern California, forced out by those regions' stratospheric selling prices. The four-county Sacramento market, part of the larger Central Valley region, is expected to continue to grow. A recent forecast from experts at the Public Policy Institute of California predicts that population booms are expected to swell the Sacramento area, among other regions, by 45 percent in the next two decades.
"I think downtown Sacramento is going through a rebirth with restaurants and entertainment options," Opus West's Little notes, "as people have a growing appetite for the amenities of downtown living."
Hoping to follow in the footsteps of cities like Seattle, Portland and Denver, Sacramento is trying to revitalize its downtown by encouraging residential development.
To that end, for example, the Sacramento County Board of Supervisors has begun negotiating with D.R. Horton, a leading national homebuilder based in Fort Worth, Tex., to transform the nondescript former Bank of America building into a modern mixed-use high-rise in the next two years.
The proposed 21-story Library Lofts would add nearly 300 loft units along with 30,000 to 45,000 square feet of, office space, five parking levels and 5,000 square feet of streetside retail to the civic corridor. Preliminary designs for the project indicate that it would borrow aspects of the central downtown library next door.
At least 2,500 condominium units are now being planned for downtown and midtown Sacramento. An ambitious plan by shopping center developer John Saca calls for erecting what would be the city's tallest buildings as well as the tallest residential structures on the West Coast. The planned 53-story, two-tower complex would contain 810 condominiums as well as a luxury hotel.
Evidence of the demand for downtown Sacramento apartments is shown by the fact that vacancy rates are among the lowest among the capital region's submarkets. Demand has also been fueled by completion of several major office developments in the last two years that have accounted for about 20,000 new workers.
Since Sacramento didn't suffer job losses like other parts of the Bay Area and has instead seen significant job growth, Sjostedt, who grew up in the area, sees a brighter future for its rental market.
However, she's a little skeptical of the big push in downtown residential development for the city, with many projects on the drawing board. "I don't see a real depth of market for that product type there."
David Harrison, a senior advisor with Sperry Van Ness, Sacramento, agrees that the market has started to shift, with properties staying on the market longer or owners cutting prices or offering financing terms. "Cap rates have stayed a little stagnant, so some owners are testing the waters with a higher initial price."
Even though the market is transitioning, Harrison adds, "converters will pay above-market rates for a building with a (conversion) map on it." And others, he notes, are taking advantage of the relatively low cost of financing to trade up into a bigger property, even if they think prices will decline somewhat in the future on the basis that they'll still be accumulating equity.
Since some markets typically dry up sooner than others, Gary Roller, senior investment associate and a director of Marcus & Millichap's National Multi Housing Group, Sacramento, has found that Fresno tends to be a bellwether in the Central Valley region. "The Fresno market had been aggressive, but when we see a downturn there, it trends to show up in Sacramento nine months to a year later."
The key variable, many observers concur, will be how fast interest rates will move.
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