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Market Perspective: It’s all about rents!

March 20, 2015

In today’s Santa Clara and San Mateo County apartment markets, owners are dancing to the same tune: rents, rents, rents! And by rents, I mean rising rents that, according to market data, have clocked double-digit growth for the last four years with no sign of slowing down.

Spurred on by booming job growth in the Bay Area’s high-tech industry, workers continue to migrate to Silicon Valley, which now reaches well up onto the Peninsula in San Mateo County. With them comes an unending demand for housing, specifically – apartments – and occupancy rates that are all but super-glued at or above 96%. Of course, rents vary based on the type of unit, and even more so by the type of building (Class A, B or C). Since the majority of our inventory is of the Class C type (older buildings with limited amenities), our survey focuses on these rental rates. (Contact me for rates for the other class types.) The average rent for a one-bedroom unit in Santa Clara County (in Silicon Valley) is $2,133, and for a two-bedroom unit the average rent is $2,273. San Mateo County chimes in at $2,110 for a one-bedroom unit and $2,483 for a two-bedroom unit. These rents are the culmination of an average annual growth rate above 10%, causing renters to cry foul and politicians to scream rent control. But is this caused by owners raising rents to gauge renters, or is it the simple law of supply and demand?

As an owner myself, I hear my tenants scream every year I raise rents, and yet my rents are still

10% to 15% below market. Indeed, an owner I know just raised rents in her 100+ unit complex an average of $500 per unit. As you might expect, the tenants cried foul – until they decided to look at available apartments. More than 95% stayed.

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Combine this with a series of facts that are affecting the rental housing market: 1) Single-family housing prices (and down payments) are at an all-time high, 2) Many of the new units constructed in the last few years are Class A properties and have been readily absorbed, 3) New construction of master planned communities is down, and 4) Many homeowners displaced from the recession are still renting. The factors in this supply-and-demand equation result in significant profits for multifamily owners, which are long overdue after The Great Recession. Indeed, because of these rising rents, many are reluctant to now sell, despite extremely high demand from both local, national and international investors. The desire among these investor groups to get in on the Santa Clara County/San Mateo County multifamily product type is fueled by high income buildings, low interest rates and a robust long-term employment outlook for the high-tech industry.

This demand for buildings has resulted in all-time high prices that are generating sales of even Class C buildings in the sub-4% CAP rate range in both Santa Clara and San Mateo Counties. Looking back just four years ago, local values were sitting at a near low point in the cycle. We’d turned the corner toward recovery and deal volume had enjoyed its first kick-start, but pricing for multifamily units had reset to 2005 levels. What a difference four years – and a 40%+ spike in rental rates – can make! Today, average values for the same asset class have increased to approximately $260,000 per unit in Santa Clara County and more than $300,000 per unit in San Mateo County.

This upswing is so astronomical that owners from San Mateo to Palo Alto to San Jose are reluctant to sell. As a result, we’ve seen a big drop in the number of properties on the market, and an increase in the number of buyers asking brokers to find them deals by making unsolicited offers on off-market properties. Indeed, owners of 20+ unit buildings tell me they have received 3 to 4 offers each year. Some owners are taking these offers and cashing out. Some are opting for a 1031 exchange in the hopes they can move up the ladder in property size. Others are moving their capital out of the area into either triple-net, leased investments with higher CAP rates or into larger multifamily properties in different cities. The key to success with this strategy is to work with a broker that has ready, willing and able buyers who are willing to pay a premium to purchase a property. There are many pitfalls to accepting unsolicited offers: from buyers offering too little to lenders unfamiliar with the market or the property and torpedoing a deal. So choose your representation wisely.

For those considering a sale, we are without doubt in a high-value market. My crystal ball cracked from overuse, so whether prices will increase further is hard to say. What is clear is that property values and per-unit values are at an all-time high, CAP rates are at an all-time low, buyers in the market are still fueled by low interest rates, and sheer demand among both small and large investors remains strong. This mix has generated multiple offers on all of my deals, and final sale prices that are always at least at list – and these days, often significantly above what my sellers are asking.

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