“We are in an outright boom; the strongest place in America.” Those were the resounding words spoken by Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the Haas School of Business of the University of California, Berkeley, as he opened the center’s 19th annual conference, Monday, April 28, describing the state of the Bay Area real estate market.
The information presented at the event summarized the state of the national economy, with special emphasis on the regional figures, as well. But it was the assessment of the real estate industry that most of the attendees of the event wanted to hear. Unsurprisingly, the region checked in as healthy as one would expect.
While the nation as a whole is looking to add roughly 2.3 million jobs in 2014, the strongest economy in the entire country, and nearly in the entire world, is the one in the Bay Area, said Rosen. Job growth, spurred by the incredible resurgence of the technology sector in the Bay Area over the last several years, has been driving up the values of real estate assets across the region. But another important aspect of that increase has been the difference between cap rates and 10-year treasuries. “The cap rates are basically at 4.5 to 5.5 percent for most product types, and IRRs that people are pro-forming are in the 6 and 7 percent range. These are very low numbers,” said Rosen. Real estate investors are looking for yields, and real estate is affording the returns that traditional investment vehicles like Treasury bonds are unable to provide today.
“Real estate cap rates are still high relative to 10-year treasuries. … Cap rates look like they’re the lowest they’ve been since 2007. [In] 2007 they were about the same as [10-year] treasuries, so you knew [real estate] was overvalued in 2007. … That isn’t the case now,” Rosen said, explaining that even with depressed cap rates that we are witnessing in our market today, there is still room for profit-making.
This was evident in almost all the figures that he summarized. Transaction volume checked in at the 4th best year ever in 2013, expecting 2014 to even beat that number. Supply is constrained in almost every corner of the industry, vacancy rates are falling in our region, rents are rising, while absorption and leasing continues without abatement. “We are definitely moving in the direction of full recovery [in the Bay Area],” he added.
On a national basis, almost every real estate product type is at a 50-year low in construction. For offices, the suppressed supply has been driven by corporations’ densification of office space. On average, companies are taking 20 percent less space per employee, which leads to slower demand for construction, Rosen said. Packing employees ever so closely to one another has resulted in what seems like slower absorption of commercial real estate, but the real change is in how companies plan for their space.
Housing is another sector that has performed very well, especially rental housing, which Rosen called “the strongest national sector of the real estate market.” Driven by a surge in household formation, the percent of renters has gone up from a low of 31 percent to 35 percent today. Rosen estimates that we will achieve the long-term average of 36 percent in the near term. And while there is a lot of rental housing production at the moment, he sees that slowing down as we move into 2017 and 2018.
“Vacancy rates have plunged. We’re at a 5 percent national vacancy rate for Class A apartments. Class B and C at 8.8 percent. These are very low numbers,” Rosen said.
Record number of people from 18 to 34 years of age are moving out of their parents’ homes, which has been driven by a rapid, 3-percent growth of employment in that demographic cohort. “We are seeing this reflected in rents. Rents are growing about 3 percent a year, which is a fairly strong growth rate,” Rosen added.
“San Francisco leads the way. Rent growth was 12 percent a year. It’s dropped to 7 percent a year, still very strong. We’re basically at full occupancy,” said Rosen.
In the single-family product category, there is some increase in production, but he did not characterize it as a boom; the overall supply is still pretty tight. This is driven primarily by affordability—it is still hard for an average American family to obtain a loan. First-time home buyers, who typically represent 45 to 50 percent of the home-buying market today represent only around 30 percent of the homes sold.
In the retail sector, the only booming area seems to be on the high end. “The internet continues to cannibalize the physical retail. Returns have been very good in retail, but I think they will go back to single digits as we go through the next couple of years,” said Rosen.
In hospitality, occupancy across the nation has been steadily increasing, but San Francisco leads the way in this part of the industry. “In San Francisco this is the highest occupancy we’ve ever had. We are in an outright boom; the strongest place in America. 83 percent occupancy is really, really high for hotels, and RevPAR goes off the charts,” concluded Rosen.
Yet, there are some signs of strain. Citing 2013 as the third largest year in debt origination in history spurred by the ballooning CMBS market and lowered lending standards, Rosen sees danger lurking. He is convinced that we have two to three years left in this cycle, but he also sees some parts of the country, like Washington, DC, already in decline.
For now, however, he believes that times are still good to be a real estate investor.