2016 San Francisco Mid Year Apartment Market Report by RMCsf

Real Management Company 2016 San Francisco Rental Market Mid-Year Briefing

Will there be a course correction in 2016/2017?

Owners who benefited from the strong 2014/15 market might forget how over-the-top it was in terms of rents so they might read more into a declining market than is necessary and possibly overcorrect. I’m offering this informal briefing resulting from the combined observations of our own customer data set as well as from local industry and news reporting. Halfway through 2016 we are seeing a slightly negative trend in the San Francisco rental market. Our clients’ rental units are mid-tier, predominantly well-maintained, older properties offering fewer luxury amenities. For example, many of these older units come with older appliances, Formica countertops and Linoleum flooring rather than brand new appliances and high-end finishes such as granite countertops and tile floors. Our clients’ units in Rent-Controlled buildings and non-Rent Controlled condo units and single-family homes are still renting well but we are not seeing the same rent growth from year to year. In a few cases, we are seeing rents decrease for the first time since 2011. The reasons for these changes may include:

  • A softening of the SF technology job sector
  • An increase in housing supply in some parts of the City
  • Consumer Pricing Exhaustion, the general feeling that tenants are finally becoming overwhelmed by the high prices in the market and, as a result, moving out of the City.

Following the money– understanding the trend of new rental candidates?

In reviewing rental applications for tenants moving into vacant units we are seeing fewer newly minted bachelor’s degree or higher degree candidates going straight from graduation into high paying jobs (jobs paying $100,000 or more per year). We are not seeing as many corporate offer letters as in the past. Now most of the applicants we’re seeing have an established working history and are being transferred within large companies or are taking new jobs at different companies. These prospective tenants have verifiable income, landlord histories, and, for the most part, strong credit histories. Several years ago we saw far more new rental applications from recent graduates whose proof of income consisted of an offer letter for a first job and their only rental history was their parents’ house and/or campus housing. It’s unclear how to interpret this hiring shift, but one idea suggested is that tech companies are holding off new hiring in order to drive short-term profits. 

This is a big shift from the free-wheeling hiring days of just two years ago. According to a December 3, 2015 Bloomberg article by reporters Jing Cao and Lizette Chapman, “Silicon Valley is starting to rewrite its own rules for success. Instead of emphasizing growth at all costs, technology investors are now telling startups to cut back on their spending, leading to hiring freezes, office closures, and job cuts.” This policy seems supported by our direct observation with a few of our Relocation Agents reporting that new hires are down this year–especially at Apple.

Another influencer of the changing market in SF is the completion and availability of well over 4,000 new units in SF. Since the economy turned around after the 2008-2009 crash, developers have completed much needed new housing stock with the greatest number opening in SOMA. In April of this year, a Craig’s List survey conducted by fellow SFAA and PPMA member James Wavro counted approximately 2,200 housing “offerings” promoted on Craig’s List in April of 2015. This year’s survey showed that the number of offerings on Craig’s List had more than doubled to 4,500 overall posts.

New buildings like NEMA (754 rental apartments at 10th and Market), Jasper (320 rental apartments at 1st and Harrison), and Trinity Place (over 2,000 units at 8th and Market) are now on line and renting, available for the first time to meet the greater demand we’ve seen consistently for the last two or three years. Today’s tenants are more easily able to leverage one landlord or property manager off another: if you don’t offer a competitive rent when you renew the lease for a new-ish luxury condo your tenant will rent a place in a newer building with better amenities across the street, call a mover, and be gone in 30 days. We’ve seen prices in SOMA stagnate or decrease by up to 10% year-over-year as a result of these factors.

Where will pricing pressures affect landlords the most?

In the short-term, I anticipate that rents for high-end luxury units in newer building will trend downward. Mid-level properties will face this pressure as well but the negative affects won’t likely be felt for a few years. According to a July 16th 2015 CurbedSF article entitled “SF Is Set to Add More Than 3,600 Housing Units Each Year Through 2022,” San Francisco has approved 38,066 new residential units for future development. This type of development will continue to place downward pressure on rents as inventory increases on other comparable units.

Will the Mayor’s plan calling for new below-market-rate (BMR and Affordable) units drive prices down further?

Some landlords may wonder if the increase in affordable housing, should it take place, would reduce the rents they could get in their fair market value apartments. I don’t believe there’s any evidence that this will be a threat to our clients because the income requirement for these BMR units is so low that most of our clients’ tenants would not qualify. Even if some of our clients’ tenants did leave their market-rate, rental apartments to move into newly-constructed BMR and designated “affordable” units it’s most likely that the departing tenants would already benefit from below-market rents due to Rent Control. As a result our clients could actually see an increase in their rent rolls as a result of long-term low-income tenants departing to live in newly constructed BMR and affordable units.

According to SF Mayor Ed Lee’s 2014 announcement of his goal to increase housing in the City the San Francisco Chronicle reported that 10,000 units of his 30,000 unit goal were planned to be made permanently below market rate. To the extent that more units are made available at below market rate those affordable units are not competitive to the units of San Francisco’s open market. Since most of the new units are upmarket or luxury units, these will be the first class of properties to feel a downward effect on pricing. History shows that downward pricing effects take longer to reach older mid-tier properties and can take between 5 to 10 years to realize.

Should we worry about “The Flight Out of San Francisco?”

We are more frequently hearing in the press about the exodus of San Francisco tenants who are choosing to leave San Francisco in favor of Oakland. In this section I wanted to share our observations regarding tenants leaving San Francisco. 

Residents leaving San Francisco are not just moving to Oakland, they are moving in droves to Washington State as well. According to a May 2016 article from Hearst Media’s SeattlePi, California drivers acquiring Washington driver’s licenses increased to over 37,624 people in 2015 making California the largest state of migration to Washington in the US, with more than 16,000 more migrants than second place Oregon. While we don’t have solid data yet to compare, when it comes to people moving to Oakland, lower rents, less traffic and more ample parking are most frequently cited as reasons to move.

How 30 Day Notices helped us understand some underlying economics

We developed our general impressions of tenants leaving SF from their 30 day notices to vacate. We have seen some of the effects of two years of dramatically increasing housing prices. Tenants who experience dissolution of relationships find themselves unable to live by themselves and afford the rent on a single income. Sometimes these tenants are willing to go back to a “roommate situation,” sharing a two, three, or even four-plus bedroom apartment with multiple unrelated adults. Many times these tenants find themselves leaving SF to move back “home” and live with family or just moving farther from SF to afford the rent. However, Rents in places outside SF seem to be catching up in their own ways. Most rents in areas near BART stations in the East Bay are lower than SF but still historically high. Friends who invest in the peninsula cities like San Mateo, Burlingame, Redwood City, and Palo Alto say that competition to purchase apartment buildings there is as strong as they’ve ever seen as a result of the high rents increasing building owners’ returns on their investments. Not to mention the fact that these municipalities don’t have Rent Control, at least like it exists in SF, Oakland, and Berkeley, so it’s easier to reposition a new property and increase cash flow in a shorter comparable period of time.

Looking ahead to the next six months

In looking ahead at the rest of this year and into next year I anticipate that we’re going to see a continued softening in the job market and in rent growth. We may even see a small decrease in overall rents in SF but I don’t anticipate that it’ll be dramatic for well-maintained, older properties. I don’t see the kind of decreases we saw in 2008-2009 or during the dot com bust in the early 2000s but we could be in for a small correction and a period of some stagnation in rents.

As more new apartments become available the demand for higher end units in older Rent Controlled apartments in good neighborhoods will likely decline. As a result, as the tenants in these older apartments experience shifting life circumstances, such as wanting to live on their own instead of living with roommates, wanting to move in with a partner, getting married, or having kids, they could find themselves tempted to move into new buildings like the ones I described to take advantage of the great amenities, fantastic views, etc. As their old apartments turn over these units will decrease a bit in price and become more accessible for other people, perhaps those who lived in smaller, lower-quality units or in less desirable neighborhoods. The great news for owners of Rent Controlled buildings is that they’ll still see increases in their rent rolls periodically as their long-term below-market tenants vacate voluntarily. Even if market rate decreases by 10% you’ll still be ahead by fixing up and leasing a unit that was previously at half of market rate because of Rent Control. It could take five or ten years or more for the effect of all of these new high-end units to spread throughout the market and decrease prices overall but it will happen.

Conclusion: Be well capitalized and don’t over leverage

My tip for clients who own rental units and buildings in SF is to make sure you’re well capitalized going into the next few years. Don’t over-leverage your building, keep at least 35% equity, maybe even closer to 40-45% on hand to make sure you’re going to be able to weather a decrease in rents in your highest-paying units. You’ll probably continue to get a turnover in a long-term below-market unit every so often and that’ll allow you to bring a rent that is 50% or less of fair market to a higher level, but you may also see that super top-end rent you got earlier this year fail to get that same rate next year. Your tenant may approach you and threaten to leave if you don’t reduce their rent after the lease is up. You may have tenants break their leases because they lose their jobs and, as a result, lose on vacancy time and even find yourself unable to get the rent you got just six or nine months ago.

If you’re buying a building today don’t expect to continue to get the same prices on apartments forever. Prepare as if all of your top-end rents will lose 10-20% over the next 12-24 months because it could happen. Make sure you’re still going to be making enough money to pay your bills and still generate positive returns on your investment. Don’t expect to be satisfied by simply breaking even while you wait for the market to recover.

In conclusion, I want you to know that this correction is coming so this is your “heads up.” Don’t be caught off-guard by this scenario and take solace in the fact that we are nowhere near able to build enough housing to ruin your investment and that demand will stay strong because San Francisco remains one of the most attractive places to live on Earth.

J.J. Panzer, CCRM
President, Broker
Real Management Company
(415) 230-8888