Western Real Estate Business

SEP 2018

Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.

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M A R K E T H I G H L I G H T: N O R T H E R N C A L I F O R N I A 46 • September 2018 • Western Real Estate Business www.REBusinessOnline.com INVESTORS SEE BENEFITS IN SAN FRANCISCO'S MULTIFAMILY MARKET, BUT SEE CAUTIONS, TOO The Northern California multifam- ily market hit its peak in 2016 when it saw total market transaction volume exceed $8 billion. Since then, we have seen a decline in that number, while metrics such as average capitalization rates and price per square foot have continued to perform well year-over- year. Strong economic fundamentals such as low unemployment and a supply-constrained housing market continue to benefit pricing. However, the pressures of rising interest rates, continued softening of rents and the statewide political climate have creat- ed some investment anxiety over the past eight months. The yield on 10-Year U.S. Treasuries has increased more than 60 basis points over the course of the past year, with all-in mortgage rates moving commen- surately. Average full-leverage, 10-year, fixed-rate debt on stabilized product is currently pricing near 5 percent. It is almost certain the Fed will in- crease rates in September, and poten- tially again in December. As of mid- 2018, we have seen a tepid 3.1 percent year-over-year rise in rents, a notable decline from the double-digit growth enjoyed most years since 2012. The current political atmosphere in California has caused some investor chill as the market awaits the outcome of Proposition 10, the Costa-Hawkins rent control repeal measure, and weighs the ramifications of a potential partial repeal of Proposition 13 in 2020. A proposed partial repeal would significantly increase property taxes on commercial properties and trigger a reassessment of property values ev- ery three years. Economic fundamen- tals in the San Francisco Bay Area are stronger than ever, and demand for well-located product is unyielding. With one of the most educated pop- ulations in the nation, 46 percent of adults over the age of 25 hold a bache- lor's degree or higher in the San Fran- cisco Bay Area. This has equated to an unemployment rate of near 3 percent, compared to the 4 percent national av- erage. Fueled by industry sectors with high productivity gains, such as tech- nology, healthcare and professional services, the region continues to ex- perience some of the strongest job growth in the nation. The demand for skilled labor will be a substantial fac- tor in the 5 percent to 10 percent Bay Area population growth predicted from 2017 to 2022. These inputs con- tinue to drive high demand for hous- ing in the Bay Area. Despite significant delivery of new multifamily units in recent years, the Bay Area remains a supply con- strained housing market. While there are notable challenges to investing in the Bay Area, there is still significant capital sitting on the sidelines, ready to invest in well-positioned, value- add product. Kalah Espinoza Vice President of Capital Markets, Multifamily, Colliers International – San Francisco TRANSIT OPTIONS LURE OFFICE PLAYERS IN, AROUND SAN FRANCISCO The economic expansion continues across the U.S., becoming the second longest since World War II. With tech companies driving this cycle, it is no surprise the Bay Area – deemed the "tech capital of the world" — would be front and center. From the more traditional tech companies across Sil- icon Valley to life sciences along the Peninsula to start-ups in San Fran- cisco, the entire region has expanded exponentially since early 2010. There have been ebbs and flows to the boom, including difficulty in ven- ture capital financing during 2016 for some start-ups that were spending a bit too fast and furious, but that issue has mostly receded with "big tech" now leading the charge in absorbing large blocks of space. In San Francisco proper, any of- fice building under construction or completed over the past 18 months has leased. This has led to a dearth of space today and likely into the early 2020s. Constrained supply has led to record-high asking and effective rents, instigating a move from San Francisco by a number of non-profits and professional services firms to other office locations in the Bay Area — generally the East Bay (Oakland). While tech start-ups and big tech are not immune to higher rents, it has proven necessary for them to main- tain a significant presence here be- cause of the deep talent base, among other factors. Exacerbating the sup- ply issue is the lack of new office deliveries until at least 2022. This is due to a variety of factors, including Proposition M, limiting the square footage allocated per year to office development, plus the slow process of upzoning Central SoMa, which will allow for large office projects to proceed though still capped under Prop. M. San Francisco's ongoing tightness may create more opportunity for the East Bay, particularly the Oakland CBD, to syphon some activity thanks to about 2 million square feet of new projects potentially delivering over the next few years. Housing is also booming in and around Oakland. With two BART stations in the CBD within a 15 minute ride of Downtown San Francisco, the area has already begun to reel in numerous nonprofit and professional services tenants. It should only be a matter of time be- fore a major tech company signs a big deal in this market. Meanwhile, activity has hardly come to a stand-still along the Pen- insula. Life sciences rules the roost with tenants of all sizes grabbing space where they can. Many older of- fice buildings are being converted or torn down and replaced with life sci- ence-capable properties heavy with lab space. Much of the activity has taken place in South San Francisco, although there are patches of activ- ity further south. As in the East Bay with BART, any project within walk- ing or biking distance to Caltrain has shown superior performance, espe- cially if it's in a mixed-use area with abundant amenities nearby. In Silicon Valley, the big tech play- ers are generally taking down large blocks of space upon new construc- tion delivery. As the more suburban cities across the valley continue to thrive, downtown San Jose has begun to rise as a key focal destination. This area serves as the South Bay's prima- ry transit hub, with Amtrak, Caltrain, VTA and, in the early part of the next decade, BART all offering connectiv- ity here. Downtown will likely see several major office developments, including mixed-use, in coming years throughout its core, close to Diridon Station and near the future BART sta- tion on Santa Clara Street to accom- modate tech demand. Downtown's office base is expected to grow by 50 percent to 75 percent in the next 10 years, as many enterprise tenants have had their interest piqued by the transit and housing options here. There are billions of dollars chasing property in downtown, which will hopefully result in a renaissance for the entire city of San Jose. No expansion is without issue, and the Bay Area's robust expansion has certainly brought upon areas of con- cern. The biggest area is the steep cost of living, primarily housing costs. While the region has begun to build significant new housing stock, it still has a lot of catching up to do — not to mention much of the new hous- ing is on the upper end of the scale. Traffic and transit have also suffered, although funding in these areas is climbing. If progress can be made on these twin burdens, the boom (albeit with some bumps in the road) may have a clearer path to continue. Robert Sammons Senior Director of Northern California Research, Cushman & Wakefield Erik Hallgrimson Executive Managing Director, Cushman & Wakefield Bay Area Population Densities

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