Demand is Up. Supply is Down.

May 25, 2018

I’ll be honest. This multifamily cycle continues to surprise seasoned investors and brokers, including me! After years of exceptionally bullish performance, Silicon Valley rents are still strong, money is still available and local sales are still hot. And despite more than 10,000 apartment units that have either recently come online or are currently in the construction phase, demand and occupancy is still strong.

Rent growth at the end of the first quarter represented a 3.2 percent year-over-year increase, fueled in large part by the Silicon Valley’s strong economy. According to a recent article, local unemployment sits at just 2.5 percent and total venture capital investment in the market has hit $24.9 billion and continues to climb.

Exponential demand has pushed average Santa Clara County rents to between $1,600 and $2,300 per month, and San Mateo County rents to between $1,800 and $3,100 per month. It also keeps Santa Clara and San Mateo counties on the list of most expensive rental markets in the country. Still, apartments are often the only alternative in cities like San Jose, which has just topped the U.S. for the highest average single-family home price (at $1.1 million) and highest down payment (at $240,000).

New apartment construction has helped somewhat stabilize rents, however that stabilization may have more to do with owners offering incentives to get a complex leased-up and less indicative of a long-term softening.

From a sales perspective, the market is delivering prices that continue to astound. A few years ago, San Jose was garnering $225,000 to $300,000 per unit for a modest Class C property with good rents. Today, those same units are selling for $250,000 to $350,000, to both new and established investors.

In San Jose’s Class A and B sectors, properties are selling not just to large and institutional investors who already have a presence in the area, but to those wishing to establish a foothold in one of the hottest markets in the nation. They see the Bay Area’s strong job growth, high employment, high single-family housing purchase requirements and limited housing inventory as a boon to multifamily building operators.

The one damper to San Jose’s market, however, is the recently enacted stricter rent control and tenant protection regulations for Class C properties. The regulations have caused many San Jose apartment building owners to sell just to get out from under these stringent new requirements to which owners must adhere.

As a result, in San Jose, buildings are strictly valued on CAP rates based on current income, making pro forma purchases a thing of the past. Now, a buyer will only do this if a building’s occupancy is low, allowing them to reposition and lease-up with new residents at a higher market rate.

It’s especially hard to be bearish when both local and national economists predict continued prosperity for the Bay Area, and especially Silicon Valley and the Peninsula. Driven by high-tech companies such as FANG (Facebook, Apple, Netflix and Google) and despite the dire reports of Millennials supposedly moving out of the area, Bay Area high-tech continues to draw in thousands of new workers eager to fill a plethora of employment opportunities. Indeed, anyone who has lived in the area for more than 10 years has noticed the increase in traffic.

The hot job market is the main reason rents are high and buildings are selling. So much so, in fact, that San Jose, San Francisco and Oakland have been ranked a TOP SELL MARKET in Ten-X’s recent U.S. Apartment Outlook Report. If you aren’t keeping up with economist’s predictions and Bay Area multifamily news, contact me to subscribe to my monthly e-newsletter. In it, I compile the most recent and relevant reports from economists and local and multifamily publications. We are fortunate to be investors in the hottest housing market in the nation, and we must stay informed to make wise purchase and sale decisions.