For three decades, San Jose and the greater Silicon Valley have been among the fastest growing areas in the western United States. While the market no doubt suffered through a not-so-pretty dot-com bust in 2001, that era is past. Taking its place is an economy that is once again deep into a cyclical rise based less on boom fundamentals and more on steady, sustainable growth.
These fundamentals are putting San Jose on a back-to-basics approach for making money in multifamily real estate: Operate your property well, seek maximum efficiency and minimum downtime, and base your outlook less on the steep appreciation rates of San Jose's recent past and more on the steady, significant rent growth predicted for the future.
THE FUNDAMENTALS Among the greatest benefits a multifamily investor may reap from San Jose are its extremely high cost of home ownership, its extremely low inventory of developable land for new multifamily units, and solid gains in the employment sector. Together, these factors keep the market operating with a vacancy rate of just 3.7 percent, down from 4.1 percent last year, and with a chronic shortage of affordable housing.
While San Jose's rent-controlled properties allow no more than an 8 percent annual increase, the significant inventory not held to this restriction has experienced rent growth of as much as 11.5 percent from this time last year. That's among the fastest rent growth in the western United States and the nation. It's also significantly higher than the declining rents that San Jose was experiencing in the years following the dot-com bust, when literally tens of thousands of high-tech, white-collar workers left the area in search of employment. Before the bust, the Silicon Valley was red-hot, and savvy investors were buying properties and enjoying the rise in rents, cash flow and appreciation. After the bust, occupancy, rents and cash flow dropped almost simultaneously.
Only in the last 18 months has San Jose begun seeing recovery, including a rise in average rent to $1,482 per unit. This places San Jose as the second most expensive place to rent an apartment in the West (Los Angeles/Orange County earns the No. 1 spot) and even beats out its neighbor to the north, San Francisco. Compared to the median price for an average home—which sits in the $650,000 range as San Jose is also one of the most expensive housing markets in the country—that puts the cost of owning at 2.8 times the cost of renting in the Class A category. In 2000, this ratio in San Jose was at just 1.5.
Adding to the mix is San Jose's local employment growth. While commercial real estate research firm REIS says that growth is still 180,000 jobs shy of a peak in 2000, the job market is warming up with a 1.2 percent growth in the past 12 months, with greater gains predicted for the future. The job market is particularly picking up in the higher-salaried technology sector, enhancing the local renter pool with more high-paid professional workers.
THE PLAYERS As much as developers would like to charge in and build, alleviating the surging demand for affordable housing in this increasingly densely populated area, they remain shackled by an extreme shortage of land and by physical boundaries that include the San Francisco Bay in the middle of the market and tight building restrictions in the surrounding hillsides. They are equally constrained by the resulting high land prices, which in a recent development opportunity reached to $22 million for 5 acres in downtown San Jose and ultimately debunked a potential new multifamily property.
The South Bay has only 13 multifamily properties, totaling just 2,049 units, currently under construction. In San Jose, only about 1,000 new units are expected to deliver this year, following only about 630 new units delivered last year. Additionally, the condo market—after converting nearly 1,000 units itself in 2005 and further tightening the apartment market—has dried up. With this said, the only place for San Jose to go may be up, both in price and construction.
On the investment front, San Jose's fundamentals have traditionally served local developers and tuned-in regional developers, but with the market becoming increasingly favorable for long-term investment, San Jose has become increasingly popular among REITs and other large equity investment institutions.
According to New York-based research firm Real Capital Analytics, 47 percent of all transactions for San Jose garden-style properties—which are the dominant type of property in the area—are going to institutional investors and REITs while the remaining 53 percent of sales are to private individuals. In the western United States, barely one-quarter of these properties are being sold to institutional investors (including REITs), while more than 75 percent are being traded by individual investors.
At present, Class A San Jose multifamily properties are selling at a median price of $215,500 per unit and a median cap rate of 4.7 percent. The market among larger investors is so desirable that many REIT-worthy deals of around 100-plus units are rarely even brought to market. Instead, they are trading principal-to-principal in off-market deals. They also are being traded under fierce competition among investors who may have missed the last run-up in San Jose and are determined not to miss it this time around. One such deal, a 311-unit Archstone Community property in the South Bay town of Cupertino, recently sold for a premium without technically going to market. It hit a near-unheard-of price per unit of $282,958 and a cap rate of just 4.3 percent.
THE OPPORTUNITY Though larger properties are in high demand, there has been somewhat of an adjustment in the sub-100 unit market. This market, driven by mid- to small-size investors, is greatly affected by interest rates, and as interest rates have climbed, there has been a downward pressure on prices. Although this price pressure has had a positive impact on cap rates, many sellers are still reluctant to reset their prices, so these properties tend to stay on the market for longer periods of time or are pulled off altogether as sellers give up in frustration. This, coupled with a realization among buyers that they, too, might have missed the recent boom market, has caused the volume of transactions in the mid-size property category to level off.
If there is one thing the smaller investor might glean from large investor activity, it may be that the best move in San Jose lies in making money through long-term plays. In other words, buy a property, improve its operational efficiencies, and increase rents in an effort to grow cap rate and cash flow. On this front, the small investor, just like the institutional investor, could gain greatly from the changing demographic of San Jose renters and the recent influx of immigration, both of which have created demand for small apartment product and allowed properties of four to 20 units to hold their value.
Value-added opportunities from both large and small properties have generated a lot of interest as well. A lot of this activity is occurring among properties that are the result of the 1960s San Jose apartment boom, when smaller properties of four to 40 units were built en masse. With land in such short supply, many investors are turning to these units to refurbish or redevelop as multifamily product and not condominiums. Refurbished units in this class are selling at prices between $150,000 to $185,000 per unit and renting at rates that range from $1,400 to $1,800 per month, depending on size and location.
THE FUTURE As it enters yet another upswing, the San Jose multifamily market represents strong opportunity. Home ownership is expensive, rental demand is high and there is limited new construction competition to speak of. The employment sector is not only solid, but a source of new frontiers for exploration. One of the most significant of these may be San Jose's ability to turn its collective intelligence, capital and resources toward solving one of the most pressing problems today—earth-friendly energy. The market is doing this with a combination of computer processing power and solar energy, or the combination of silicon and solar, to improve on and initiate technologies that create massive amounts of clean energy. In the process, the Silicon Valley may someday become Solar Valley and, combined with opportunities in software, biotechnology, medical devices, telecommunications, and other existing technology applications, could serve as a forerunner in rebuking the concept that technology is moving solely in the offshore direction.
These trends in the job sector are further supported by a continuing influx of venture capital. Of a nationwide pool of $5.7 billion in venture capital funds, the Silicon Valley captured approximately $2 billion, representing an 8.5 percent increase in local venture capital funding from 2005 to 2006. An estimated 37 percent of this goes to local companies, which in turn generate approximately 16,000 new jobs annually.
When it comes to the link between economic potential and the need to invest now in San Jose commercial real estate, the REITs see it, the developers see it and the large institutions see it. If more individual investors also leave the sidelines and begin to operate with an eye toward investing, improving and holding their multifamily portfolio, San Jose has great potential for returning the favor with significant, stable, long-term growth.
FAST FACTS Considering San Jose? Here's what you need to know:
- Population: 953,679
- Occupancy: 96.3%
- Median Age: 35 years
- Median Household Income: $71,765
- Average Rent: $1,482
Unemployment: 4.8% NOTABLE: San Jose boasts the highest disposable household income of anywhere in the country. Home to the largest Vietnamese community outside of Vietnam. Has 25 companies with 1,000 employees or more, including the headquarters of Adobe Systems, Cisco, Novellus Systems, and eBay, as well as major facilities for Hewlett-Packard, IBM, Hitachi, Agilent Technologies, and Lockheed Martin.
MFE DOZEN:Asheville, N.C. (January) Southern charm wins big
Chicago (February) Good news for the Windy City
Atlanta (March) Peachy deals crop up
Denver (April) Multifamily goes mile-high
Washington, D.C. (May) Capital efforts pay off
San Jose (June) Golden opportunities abound
Minneapolis (July) New constructions in the Twin Cities
New Orleans (August) The Big Easy rebuilds
Providence (September) Promising developments in the Northeast
Dallas (October) Herding up new projects
Indianapolis (November) The heartland keeps ticking
Manhattan (December) The market that never sleeps
Swing Vote
Can housing sway elections?
As the presidential race hits full swing, an endless line of talking points begin to echo from the podium: the Iraq war, Social Security, health care, and education. Recently, it seems, another issue affecting the American public has made it to center stage: affordable housing.
According to a recent Zogby poll of 1,205 people nationwide, almost 70 percent of Americans would be more inclined to vote for a candidate who had a clear plan for affordable housing. Commissioned by a coalition of public, private, and nonprofit advocacy groups, the poll also revealed that nine out of 10 Americans consider affordable housing a high-priority issue. This is a major increase from the November 2003 National Low Income Housing Coalition survey, in which only 10 percent of its respondents ranked affordable housing as a top concern.
“This issue seems to be creeping up the income scale and spreading throughout the constituency,” says Conrad Egan, president and CEO of the National Housing Conference, one of the survey's commissioners. He points to static incomes and doubled housing costs as motivating factors.
Tom Bozzuto, CEO of The Bozzuto Group, agrees: “The American public will widely support a plan that addresses the increasing urgency of this problem.”
Malorie R. Medellin is a freelance writer in Hobart, Ind.
Source: http://www.nahro.org/pressroom/2007/zogby.pdf
Renter's Market
Employment figures aren't bad, but they could be better.
Employment numbers released by the U.S. Labor Department on May 4 point to a slow but steady labor market that multifamily pundits say is all well and good but could use some slight improvement to help guarantee both short- and long-term industry health. While the nation added only 88,000 new jobs in April—the fewest since November 2004—unemployment still continued to hover around a five-year low of 4.5 percent (unemployment in March reached 4.4 percent). The stability in employment numbers, however cool, likely point to a economy on a modest track to recovery.
“As long as the economy continues to generate a moderate or better amount of jobs, it looks the apartment market will continue to see the kind of demand it needs to do well,” says NMHC chief economist Mark Obrinsky. “Things have really turned around from the situation four years ago, when everything seemed to be going the wrong way. Now, things seem to be going the right way,” Obrinsky says, adding a cautionary note that the first quarter gross domestic product was just 1.3 percent. “I'm not predicting a recession, but it makes us more vulnerable. If by chance the economy does shift into recession, it is going to change the outlook.”
Still, macroeconomics continue to favor a rental market that struggled against for-sale residential for years. “The perfect storm from 2001 to 2005, where interest rates drove people to homeownership and the demographics were also not renter-friendly, is over,” says Chris Finlay, managing principal for capital markets and operations at Mission Residential.