That One Constant…A Changing Market

September 30, 2019

I’ve been saying for more than a year that this extended multifamily cycle continues to amaze me with its bullish rents, occupancy and sales volume. But I can now say that we’re seeing signs of that one constant…a changing market.

The temperature of our market has, in fact, cooled. In Silicon Valley, there has been an approximate 50 percent drop off in multifamily property sales and, as the Fed continues to lower interest rates, some view current economic changes as a harbinger of a downcycle. In the local market, I contribute this thinking to a few primary trends:

  1. Buyer Burnout… The Silicon Valley multifamily market has been hot for so long that some deals seem to be happening on auto pilot, without regard to compressing CAP rates. But some investors seem to be reaching a sort of buyer burnout, recognizing that while long-term fundamentals for Silicon Valley remain strong, the investment pricing here is out of whack. If this continues, I expect more and more investors might stay on the fence, opting to hold off on acquisitions in Santa Clara County until they can establish better clarity on the future.
  1. Waning International Capital… There is no doubt that international investment activity has trickled. Whether that is due to political factors in places like China, a shifting American economic outlook or both, the international dollars that were flowing into single family and small multifamily properties in Silicon Valley have definitely pulled back.
  1. Value-Add Opportunities are Dwindling… Early in this cycle, Silicon Valley was flush with multifamily properties ripe for repositioning and renovation. The same cannot be said today. When value-add properties do come to market in metro San Jose, they arrive with a premium price tag. If a property was built pre-2005 and falls under local rent control regulations, it also comes with the expectation of a lower cash flow potential.
  1. Speaking of Rent Control… California’s just-passed, statewide rent control is about to shift investment fundamentals across the Golden State. The new bill, known as AB-1482, caps the annual rent increase for California multifamily properties built prior to 1995 at 5 percent, plus the rate of inflation. In San Jose, dramatic rent control changes have already made it challenging for owners to make a property cash flow. Particularly in smaller Class B and C assets, it’s harder than ever to fund critical property renovations and provide an owner with a sustainable return on investment. That has some buyers saying they’ll look elsewhere, like Campbell, Sunnyvale or Mountain View, where prices are still attractive – though they are also now rising at a faster pace due to increased demand. We will see if the new statewide rent control rules create these types of changes in other municipalities as well.

Despite all of these factors, demand for Silicon Valley multifamily investments remains strong. Local vacancy rate sits at 4.3 percent for Class A properties and closer to 3 percent for Class B and C properties. This is in spite of almost 7,800 new rental units introduced to the market in the past two years, driven primarily by demand created through exponential, largely high-tech, local job growth. And while we are no longer reporting the highest rent growth in the country, our local rental rates are still rising – a cumulative 7 percent over the last six quarters.

That makes now still a very good time to sell, particularly for those who don’t have the resources or desire to wait out the multi-year slowdown or recession that is likely on the horizon. Those who do list should be prepared for pricing that is not quite at the peak we experienced in 2018, but still represent a market that is extremely well valued.