The housing market in the Bay Area is one of the most dynamic in the world, but it is starting to show signs of maturity. Such was the message presented by a distinguished panel at a residential market update hosted by the San Francisco chapter of the Urban Land Institute at the Omni Hotel in San Francisco on Thursday.
The region, which has seen roughly 60,000 new jobs created in 2013, about a third of that in San Francisco alone, has seen an equally robust increase in property values as well as highway traffic times. But the story everyone came to hear at the second installment of the ULI SF Market Update Series was housing.
The San Francisco Bay Area is one of 6 areas in the nation that Polaris Pacific Principal Paul Zeger characterized as the “hottest markets” in the country with high levels of demand. Seattle, the Bay Area and Los Angeles led the charge on the West Coast, while New York, Washington, DC and Miami were the top three spots to the East. Chicago and Austin also received an honorable mention, although “we are at the leading edge of what’s going on in the country,” said Zeger of the Bay Area.
The main driver of that robust expansion starts with the Silicon Valley, which Zeger credited as the economic engine that drove the entire region. “We’ve got a robust economy, with a big economic engine driving it, and the results that we’re seeing is that the condominium product is selling at record prices, and apartment rental rates are at record prices,” he said.
Estimating demand based on job growth alone, Zeger employed a rough measure of one housing unit per four new jobs that computed a shortage of housing stock to the order of 15,000 units across the region.
But that is just one aspect of the current condition. “The purchasing power of buyers has grown as the interest rates have trickled down,” Zeger noted, “Jobs are great, but tech jobs are really great. They employ highly skilled workers who make big incomes.”
That, along with our natural and political barriers to entry, has helped drive demand for a very small stock of condos to new heights. We are today at approximately two months of inventory, a standard measure used to determine the level of supply, which compared to a healthy six months level is exceedingly low.
As a result, the for-sale market in San Francisco is showing a premium over where prices were in 2006, the last peak. In Silicon Valley those prices are within striking distance of the 2006 peak, roughly 9 percent below, while in the East Bay there is still some room for growth.
One somber data point is that evidence is emerging of a slowdown in the apartment market rent growth. “After two years of double-digit rent growth, in the last quarter of 2013, for the first time in two years, we saw rents flatten out,” Zeger says. This seems like a natural progression of a maturing market, which is also seeing construction costs soaring 20 to 30 percent over the last two years; the likely result of that will be more development activity on the for-sale side, Zeger added.
The panel discussion that followed Zeger’s market overview supported his comments. Moderator Mary Ann King, the Irvine, Calif. -based president of Chicago’s Moran & Company, highlighted a striking product supply figure.
“Consider the last cycle, 2000 to 2012. I would say that delivery has averaged less than 4,000 units per year for the Bay Area overall. If you look at 2013, and what is projected to be delivered in 2014 and 2015, you would say that deliveries have increased close to 9,500 units per year for each of the three years between 2013 and 2015,” King says. This surge will result in nearly a 10 percent increase of the overall market stock. That is an unheard of figure in this market, she added.
Yet, with the size of Silicon Valley, the rising tide has not been lifting all the proverbial boats. Brendan Hayes, vice president of development for the western region of Fairfield Residential says, “We’re looking at something in the neighborhood of a $700 rent premium to be near stuff.”
The “stuff” Hayes referenced in some cases is transit, in others retail and other amenities. For Fairfield, the focus has been retail. “We like the locations that retailers like,” he says.
Sares Regis Group of Northern California has had a slightly different focus, according to Drew Hudacek, its chief investment officer. “After the years of uncomfortableness, as I’ll call them, in 2008 and 2009, we’ve really made a concerted effort to stay as close to our office as possible, and we’ve always been in the San Mateo/Foster City area,” he says. This focus on Peninsula development has pushed the company to consider investing more broadly in amenities, a strategy that today is paying off handsomely. That focus, along with a professional population that is leaving San Francisco, has helped Sares Regis become more bullish on the geography in the middle of it all.
“With pricing where it is both on the for-sale side and for-rent side, a brand new apartment, even if it costs $3,000 or $4,000 a month, is a very attractive option if it gets a young family into a great school district,” Hudacek says.
Eric Tao, the president of AGI Capital Group in San Francisco also added that knowing the customer is extremely important. He referenced lessons learned when developing SoMa Grand in 2007, an “affordable luxury” development in San Francisco’s mid-Market neighborhood. Early potential buyers had a hard time envisioning themselves living in that neighborhood in 2008.
Adding the right kind of amenities and providing a diverse setting is what matters most in San Francisco today. In some cases that includes technology. “With Google’s recent purchase of Nest, providing internet-based ways to manage your utility use, your energy use, your living use…we will have smart multi-family buildings, where not only can you control the overall building, but individuals can participate to manage the usage of utilities and living.”
Yet, the maturity of the market was visible to the panel, as well. “In order to build a viable apartment project in San Francisco, it’s still $100,000 to $120,000 a door for the entitled site,” says Tao. He added that there are a lot of condo players in the market bidding those numbers up. A recent sale to KB Homes in San Franciscobrokered by King’s company, Moran & Company, brought that figure up to $470,000 per door.
But more alarming is the recent trend of un-entitled land sales. “We’re seeing for-sale and for-rent developers, we’re seeing public homebuilding companies buying un-entitled dirt, closing at $120/$130 per square foot,” says Hudacek. Quoting Charles “Chop” Keenan of Kennan Land Company, a legendary developer of the region, Hudacek said that one should never buy un-entitled land in California. It was a warning sign that made him wonder if the market is headed for a cliff.