WESTERN SNAPSHOT, SEPTEMBER 2008

San Jose, California Multifamily Market

Seligman

Renter demand in San Jose is expected to sustain healthy apartment market fundamentals this year, despite cooling economic conditions due to the collapse of the credit markets. Low home affordability and the metro’s key high-tech sector have upheld solid renter demand among young professionals, insulating against any considerable threat stemming from the ongoing losses incurred in the financial services sector during the last 12 months.

On the supply side, lengthy entitlement processes and high construction expenses create significant barriers to entry, limiting new additions to rental stock. Instead, builders have been focusing on condo construction as a more cost-effective approach to developing residential space, as there are more than 2,000 condo units slated for delivery in 2008.

By the numbers, the nationwide economic downturn will likely hamper local corporate expansion this year, as payrolls are forecast to edge up 0.2 percent — an addition of 2,000 positions, though down from the 14,000 jobs created in 2007. Developers are forecast to bring 865 units online in 2008, all of which are slated for completion in the second half of the year. Last year, builders added 668 units to total inventory. Despite elevated completions this year, low affordability will boost renter demand and result in vacancy shedding 20 basis points to an extremely tight 3.7 percent. Asking rents, originally forecast to increase 3.8 percent, have exceeded expectations in a number of submarkets so far this year.

Single-family permits totaled 485 annualized units through the second quarter, down a significant 77 percent from 1 year ago, as the softening residential market has created heightened developer caution. Multifamily permit activity has also slowed considerably, dropping 53 percent during the last 12 months to 1,800 annualized units. The median single-family home price has softened 5 percent during the last year to $790,000. Despite slightly easing home values, the median household income is less than half the amount required to qualify for a median-priced single-family home. The monthly mortgage payment, using traditional financing for a median-priced home in the metro area, is $2,100 more than the average monthly Class A asking rent. Although home values have dipped in recent quarters, low affordability should keep homeownership out of reach for a considerable number of renters, boosting apartment demand.

Transaction velocity has slowed 26 percent during the most recent 12-month period, as tighter underwriting standards have presented a challenge for some buyers who have higher loan-to-value requirements. Although trading has decelerated during the last year, the median sales price has appreciated 10 percent to $167,500 per unit, reflective of investors’ flight-to-safety sentiment for top-tier space. Cap rates for apartment properties have averaged in the mid- to high-4 percent spectrum in the past year, roughly 10 basis points higher than the preceding 12-month period. From the beginning of 2008, yields have averaged in the low-5 percent range, which indicates that cap rates could edge higher by year’s end. While apartment investment activity is expected to continue at a more reserved pace this year, largely due to more stringent lending standards, cash heavy institutions will likely sustain a solid presence in the market. A flight-to-safety sentiment will persist, as buyers target well-operated assets in densely populated areas.

Healthy fundamentals will maintain investor interest through year’s end, though, as the market transitions to more sustainable operating levels. Motivated sellers may find that adjustments in expectations may be required in order to stimulate sales activity. Buyers seeking stable investments will likely continue to target well-operated assets in Mountain View and Sunnyvale, where renter demand stemming from young high-tech workers remains steady. Meanwhile, opportunistic investors may seek properties in or near the downtown core of San Jose, where developers are moving forward with revitalization plans in an effort to attract large employers and more residents. Oracle’s acquisition of BEA Systems halted the latter’s relocation to the long-vacant Sobrato building in downtown San Jose, a move that was key to the district’s renewal as a high-tech hub and now is viewed as a setback for the planned revival.

Steven Seligman is the vice president and regional manager of the Palo Alto office of Marcus & Millichap Real Estate Investment Services.

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