WESTERN SNAPSHOT, FEBRUARY 2010

East S.F. Bay Multifamily Market

Oakland apartment investments face significant challenges in 2010 as deeply discounted home prices have narrowed the housing affordability gap dramatically, luring renters into for-sale residences. Northeastern Contra Costa County, which includes the communities of Antioch, Pittsburg, Oakley and Brentwood, remains disproportionately affected by the housing downturn and shadow rentals, leading to large increases in apartment vacancy. The Fremont/Newark/Union City submarket has outperformed the metro since the onset of the recession, registering relatively minimal vacancy rises, but the looming NUMMI plant closure will drag on renter demand this year. GM pulled out of the plant in 2009, and Toyota will cease operations there in the first quarter, leading to the direct loss of 4,700 jobs and potential layoffs among supporting businesses. There is positive news in the submarket, however, as a factory for solar-panel maker Solyndra is under way, and the company signed a lease in late 2009 for a 500,000-square-foot building in Fremont that was previously occupied by Hewlett-Packard Co.

Fundamentals will continue to decline slightly in 2010, but are expected to pick up by 2011. Following a 3.1 percent decline in 2009, employment in the Oakland/East Bay area is forecast to dip 0.2 percent this year with the loss of 1,500 jobs. Multifamily completions will total 760 units in 2010, down from 1,250 rentals last year and more than 50 percent below the 10-year average. Vacancy is forecast to rise 20 basis points to 7.2 percent as reduced construction helps to offset the effects of weak housing market conditions and additional job losses. Vacancy spiked 170 basis points in 2009. Asking rents are expected to slip 3.1 percent to $1,241 per month in 2010 while effective rents decline 4.3 percent to $1,145 per month.

Sales velocity in the Oakland apartment market is anticipated to accelerate in 2010 as investors continue to move off of the sidelines, drawn by the most attractive pricing in years. Cap rates average in the low-7 percent range, though lesser-quality assets in tertiary locations can trade up to 200 basis points higher. Given the limited amount of apartment delinquency relative to the metro’s size, distress is not expected to impact prices significantly. To date, most of the distress has occurred among management-intensive properties in lower-income areas such as eastern Oakland; few high-quality assets in desirable submarkets are considered troubled. Taking note of this trend, local, private investors have returned to the investment market, overlooking expectations for near-term weakness in fundamentals to focus on the likelihood of a relatively swift recovery starting in 2011.

Jerry C. Smith is the regional manager in the Oakland office of Marcus & Millichap Real Estate Investment Services.

West & South S.F. Bay

1. MARKET MOVES

San Francisco/Peninsula/Silicon Valley apartment rental rates have declined nearly 12 percent, and vacancy has swelled 120 basis points since the market’s peak during third quarter 2008. Local multifamily professionals are looking ahead with guarded optimism that asset operations will finally stabilize and nominal growth can be realized by the year’s end. However, challenging current conditions and tempered prospects within the rental market have not stymied renewed investment demand and strong pricing metrics for well-located, well-maintained properties.

Buyers view the local apartment market as an attractive long-term home for capital when considered in the context of current alternative investment options. As such, numerous qualified buyers have returned to the marketplace and are bidding up the handful of assets offered for sale. In fourth quarter 2009, the 192-unit Avalon at Parkside, located in Sunnyvale, was acquired by Acacia Capital Corp. for $43.8 million. More than 30 offers were received and the deal’s initial capitalization rate was 6.25 percent. The overwhelming response to this offering illustrates that, once again, premium assets are being targeted by investors. Unfortunately, despite the demand for intrinsically stable properties, the transactional market for these deals remains relatively stagnant. Most owners seem uninterested in selling today because they believe that either their property is worth an even higher price or they a lack suitable investment option for their own prospective sale proceeds.

2. MARKET MEASURE

The San Francisco/Peninsula/Silicon Valley markets continue to shed jobs. In 2009, the number of individuals employed in the area shrunk by 6 percent and the local unemployment rate reached 10.8 percent. Nearly 18,000 additional jobs were eliminated in the fourth quarter alone. It has long been understood that there is a positive correlation between the employment market’s vitality and the apartment rental market’s performance. Therefore, as long as the area continues to suffer job losses, the apartment market will likely face additional erosion of its tenant base and, in turn, its operations and corresponding property values.

Many industry analysts believe that 2010 will mark the bottom of the regional apartment market and the beginning of its recovery. However, this rebound will not start in earnest until jobs are added to the local economy. Looking ahead, it will be critically important for apartment investors to follow the local job reports. Once jobs are added again to the regional economy, apartment operations should begin to stabilize. At that point, we expect an up-tick in general sales market activity as apartment owners and investors will be able to make informed decisions relating to the future performance of properties.

3. MARK OF A MARKET

The San Francisco/Peninsula/Silicon Valley apartment markets fundamentally benefit from the area’s geography, in combination, with its technological and intellectual assets. The natural features of the area have provided a well-defined and restrictive footprint for real estate development. Consequently, apartment owners are generally insulated from the development of additional, competitive housing stock. Most recently, this reality has been particularly beneficial to San Francisco/Peninsula/Silicon Valley apartment owners because they have not had to battle for prospective tenants with a shadow rental market comprised of unsold single-family homes. Owners of apartment buildings throughout California’s Central Valley, as well as secondary and tertiary Bay area locations, have seen challenging rental markets further exasperated by a glut of vacant homes converted into rental housing.

Meanwhile, the area’s standing as an internationally significant commercial hub makes it a desirable long-term bet for investors. It is the epicenter of the nation’s bio- and high-technology industries. Additionally, the San Francisco/Peninsula/Silicon Valley markets are home to the most highly educated and efficient workforce in the country. With its high concentration of Fortune 500 companies and venture capital-funded enterprises, the area maintains a diversified employment base that is both stable and innovative. As a result, local apartment properties and owners enjoy long-term income growth as workers seek housing options that are located in close proximity to these lucrative employment centers.

Ric Russell is managing partner and Scott MacDonald is director of brokerage operations at BT Commercial in San Francisco.

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