It will take some time for apartment buyers and sellers to transition into the 2023 market, according to multifamily agents. Uncertainty over interest rates and tech layoffs as well as ongoing quality-of-life concerns seem likely to keep many of the big players on the sidelines in the first half of the year.
“No seller wants to be the person who undersold and no buyer wants to be the person that overpaid,” said Ramon Kochavi of brokerage Marcus & Millichap. “Nobody wants to go first.”
Wait-and-see strategy
In many ways, this is the same wait-and-see story that has played out in San Francisco’s residential market this winter. But because the closing timelines on apartment buildings are often longer than for residential properties, even buildings that sold late last fall aren’t real comps for the current market, agents said, and instead represent a sunnier spring sales season when substantial rent increases in the city contributed to a frenzy of buying before the ramp up in interest rates slowed the market.
The city’s apartment market had been recovering from the depths of the pandemic before interest rate increases put a damper on sales, agents say. San Francisco saw $2.5 billion in sales with about 280 San Francisco apartment transactions by the third quarter of 2022, according to Marcus & Millichap data. That’s higher than the $1.75 billion and 234 transactions in 2021, but below 2019’s record $3.1 billion with 450 apartment transactions. The price per unit was close to $420,000 in 2022, with some trophy buildings going for more than $700,000 per unit, up from $400,000 per unit in 2021 and lower than the $450,000 average in 2019.
Buyers and sellers should expect a “pricing discovery” period during the first half of the year, Kochavi said, as new sales take months to close and reflect the reality of the market. Interest rates are double where they stood a year ago and rents appear to have plateaued, seriously impacting cash flow for apartment investors.
This transition period of six months to a year happens every time the market has a major shift, said Mark Bonn of Compass. Buyers — and especially sellers — need time to reset their expectations.
“We’re in that period of time now where interest rates have gone up, the economics of the deal have changed, but sellers still want the prices we’ve been getting for, really, the past 10 years,” he said.
‘Pickier’ buyers
Anyone who can help it will keep their properties off the market during this transition period, agents say, but the three Ds — death, divorce and dissolution of partnerships — mean that some sales will take place and set the new terms for the year.
“Some do sell and the new comps are established and then people start to accept the fact that values are lower and are willing to listen to reason a little,” Bonn said, adding that for the time being most sellers are holding firm on their prices or taking their buildings off the market.
He and business partner Mirella Webb have suggested seller financing as an option for landlords who are “still hanging on to their price” and own their building outright, which is the case for many long-term owners, though none have taken them up on the suggestion so far.
Without price reductions or other buyer incentives, transactions could come to a late-2020-style standstill, Bonn said, with the city’s big institutional buyers especially impacted by the uncertainty around interest rates.
“Veritas is being pickier. Ballast is pickier,” Bonn said. “They’re being a lot more careful in how they evaluate properties. It’s not the crazy time where they would buy anything over 12 units.”
Webb said there’s a chance for mom-and-pop buyers “here and there” after years of domination by a few key players.
Sandy Skeie of Marcus & Millichap said he has heard from mid-size buyers who own five to eight properties and may see an opportunity to add to their portfolios in the downturn.
“Everybody wants to do some business, but they need to have some signs to justify it,” he said.
Agents said that buildings in the city’s northern half were far more desirable than those to the south, outside of a few hot spots such as Noe Valley or NoPa. Vacancies in northern neighborhoods such as Pacific Heights and the Marina are down and rents are approaching or have surpassed pre-pandemic levels, according to Zumper data.
Overall, the city’s rents are up only 6 percent in the last year, compared to 30 to 40 percent in some Peninsula communities. Zumper’s Crystal Chen said via email that San Francisco is still the most expensive market in the Bay Area with rents close to $3,000 for a median-priced one-bedroom apartment.
One-of-a-kind tech worker
Renters may be looking for deals in the suburbs, she said, which is also closer to where “the first big tech companies that had mandatory return-to-office policies, like Google and Meta, have a bigger presence.” She expects rents in the city to grow “steadily” after the slow winter season, but not come back to pre-pandemic levels this year.
Bonn and Webb had concerns that tech layoffs could impact even that modest rental recovery, especially if they grow more widespread.
“There’s only one kind of worker right now who can afford $3,500 for a one-bedroom and that’s a tech worker,” Bonn said, adding that rents would only drop so far before those who have been priced out of the city would rush in to lock in rent-controlled rates. “We’re never going to see blood in the streets of San Francisco, but rents will come down.”
There may not be blood in the streets, but some agents expressed anxiety about the continued quality-of-life issues on the sidewalks that they believe is keeping the city from fully recovering from the pandemic. Kovachi said people feel a lack of security, especially when they are downtown, in part because the area has felt desolate with offices only half-filled on the best of days, with even less foot traffic on Fridays and Mondays.
Vanguard’s Allison Chapleau said that open drug use and homeless encampments were the biggest problems facing the city’s apartment market today, in part because they are such difficult issues to solve.
“I don’t know what the solution is, but I think San Francisco has special problems,” she said. “We’re not just talking about interest rates this year. I think we’re talking about drugs. It’s like, who’s going to turn off the party on the streets of San Francisco?”
She said owners can do a lot of things to increase interest in their buildings even as sales slow, including addressing deferred maintenance, upgrading units upon turnover or lowering prices. But they can’t control tent encampments outside their buildings’ doors, she said, which often take months if not years to be cleared by the city and then tend to pop up again just a few feet down the block.
“Owners feel hopeless about having these issues solved,” she said.
Neighborhoods that make tenants feel safer have maintained their value better than those that don’t, she said. She recalled talking to one female tenant who could pay $1,850 for a studio in what she deemed a safer area versus $1,250 in one where she had more security concerns. In the end she decided that, “it’s not worth my life to save $500 a month,” Chapleau said.
“It’s not all interest rates and income. It’s just not,” she said. “Real estate values are really connected to quality of life. If we can work on that, we’ve got a lot of room to go up.”
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