The Expert: Bay Area Fundamentals Begin to Erode

The San Francisco Bay Area’s apartment market, which for some time seemed impervious to the economic downturn, has finally started to soften. In the first quarter of 2009, apartment vacancy rates rose to 5 percent from 4.2 percent, the largest increase since the dot-com bubble burst in 2001 as rates rose 71 percent. However, the Bay Area’s apartment vacancy rate still falls well below the national rate of 7.2 percent.Part of the decline in fundamentals links directly to the sudden and severe falloff in employment. As of March 2009, California’s unemployment rate reached a historical high of 11.2 percent, and the Bay Area’s rate jumped to 9.3 percent, a 29-year high. Before this recession ends, the area’s unemployment rate could hit the highest level since the government started tracking it in the 1970s.Not surprisingly, asking rental rates are showing signs of weakness, down an average of 1.6 percent for the first quarter. Rather than waiting for tenants to approach them, many owners have initiated tenant-retention programs and proactively lowered asking and effective rents to minimize further occupancy deterioration.Despite these proactive measures, some Silicon Valley property managers are recording an increase in tenant notices of 15 percent or more since February. Many of these buildings have had strong historical occupancy and lengthy waiting lists. Many tenants are simply moving in with family members or consolidating their living space.The conversion of failed condominium projects into apartment buildings has also spurred this decline in fundamentals. This has, at least temporarily, increased vacancy as more apartment units come online. And it has caused price competition in an already soft market as developers rush to stabilize their assets.The good news is that the limited supply of developable land in the Bay Area, coupled with the political constraints on development and lack of available equity and construction financing, will continue to constrain new supply delivery of market-rate apartments. The Bay Area is projected to experience 0.4 percent growth of inventory over the next three years.While San Francisco Bay Area fundamentals will continue to soften in the near term, we anticipate a rebound sometime in 2010 as the stimulus package begins to take hold and the glut of single-family homes and broken condos are absorbed.Keith Misner is executive managing director & head of Cushman & Wakefield Inc.’s apartment brokerage services group. Jason Parr, director for the group, and Seth Siegel, senior director, are based in San Francisco.