The 136,143-unit market rate investment grade San Francisco apartment market had the second highest rent gain among the top Reis markets in the second quarter of 2012, with vacancy remaining at a rock bottom level. Investors have noticed, and apartment prices and deal volumes are strong according to Cassidy Turley. “Large portfolio sales helped to boost current totals over last quarter’s already robust totals,” according to this source. Both U.S. Bank and Blackrock sold 16-property portfolios during the quarter, located mostly in the City of San Francisco.
The second quarter 2012 vacancy rate is just 3.1% according to Reis, unchanged for the quarter but down 70 basis points from a year earlier. The second quarter Class A rate is 4.0%, up 10 basis points for the quarter thanks to new supply, but down 60 from a year earlier. With affordable housing scarce, the rate of the Class B/C segment is just 2.2%, down 20 and 100 basis points over three and 12 months.
According to Cassidy Turley, the second quarter vacancy rate is 2.1% for San Francisco/Peninsula apartment properties with 99 units & fewer, and 4.6% for properties with 100 units or more. “The vacancy rate for San Francisco apartments will decline 30 basis points this year to 3.0%, following a 100-basis point drop in 2011,” Marcus & Millichap predicts. “The year-end rate will represent the lowest level since 2001.” While the overall vacancy rate is currently low, it has been lower before. It was below 2.0% for six years during the late 1990s dot.com bubble for example, and has never been above 5.0% in the 30-plus year history of the Reis dataset. Reis predicts the vacancy rate will fall to 2.8% at year-end 2012, level off for a couple of years, then slip to 2.5% toward the end of the five-year forecast period.
SUPPLY AND DEMAND
Just 4,158 units remained vacant at the end of the fourth quarter according to Reis, and at these levels the lack of supply is suppressing demand. Thus the addition of 255 units of new supply in the second quarter merely lifted the lid on net absorption, which came in at 210. Reis predicts 1,414 units of net absorption for 2012, about the same as in 2011.
New supply has been limited here, as high prices and the specter of rent regulations induced developers to build condominiums during the 2000s housing bubble and its bust caused all development to dry up. Thus new supply averaged just 615 units per-year from 2000 to 2010, and then slowed to just 148 in 2011. Reis, however, reports 3,971 apartment units under construction as of the date of this report, with 1,431 of them having broken ground since the start of this year. Four planned projects with 880 units have announced development schedules. Following the completion of 719 units in 2012, therefore, Reis predicts well more than 2,000 will be added in 2013 and 2014. Net absorption, manifesting itself once there are apartments to absorb, is forecast to approximately match this increased development pace, and the somewhat slower pace expected starting in 2015.
Reis reports 205 condominium units completed in the second quarter, leaving more that 2,500 under construction including more than 500 that broke ground in the first half of 2012. “The growing condominium inventory could pose a threat to apartment owners,” according to Marcus & Millichap. “While residents at the upper end of the renter cohort may not have the income to buy homes in the suburbs, the possibility of owning a condo could become an attractive alternative to renting. With 1,100 condos expected to come online this year, and 680 units poised for 2013, the potential competition posed by condominium projects is drawing attention.”
Rents are rising strongly, but not spiking. In the second quarter, according to Reis, the average asking rent increased 1.5% to $1,991 per month, and the average effective rent rose 1.7% to $1,920 per month. The year-over-year gains are 5.5% and 6.3%, respectively, faster than the gains of 4.6% asking and 5.0% effective recorded for all of 2011. Respective gains of 5.4% and 6.3% are forecast for all of 2012. The Class A asking average is up 1.6% for the quarter at $2,384 per month, with the Class B/C asking average up 1.3% to $1,663 per month. The year-over-year gains are 5.5% for Class A and 5.3% for Class B/C.
“Rents in San Francisco have climbed 12.7% over the last twelve months and have increased by about one third in the past three years,” according to Cassidy Turley. “Yet, the market that has posted the strongest recent gains has been San Mateo County. The current average rent here of $2,173 per month is up 15.7% over where it stood a year ago and has jumped 27% in the past two years.” This source puts the asking rent in the San Francisco/Peninsula area at $1,951 per month for properties with 99 or fewer units and $2,460 per month for those with 100 units or more. “This year, asking rents will rise 6.7% to $2,011 per month, while effective rents climb 7.2% to $1,928 per month,” Marcus & Millichap predicts.
The current pace of rent gains as measured by Reis is far less than the wild rent spikes recorded in 1996, 1999, 2000, and 2007, with the effective average rising by more than 10.0% in each of those years. The current 6.3% year-over-year effective rent gain, however, is far more than the 2.7% increase in household average income as estimated by Moody’s Economy.com. The point will be reached, Reis expects, when San Francisco tenants either cannot or will not pay more. Even as the vacancy rate falls, Reis predicts rent gains to gradually slow during the 2013 to 2016 period, to a low of around 2.5% per-year.