Rental Market and Sale Market

(March/2010) … For the past few years this column has been following the apartment market on its way down. Although it did not collapse like the 1 to 4 unit market, nonetheless it has been grinding down to a near standstill.

A recent column noted that the worst of the rental market decline may be behind us and that cap rates on apartment building sales have been heading up, which pushes prices down. We may be approaching a point in time where there is a convergence between the rental market and the sale market and when that convergence occurs, that will be the bottom of the apartment market and the time to start buying.

Apartment buyers have been either on the sidelines or buying other things like the trendy 1 to 4 unit foreclosures. Some apartment buyers are on the sidelines because they do not have the money, others are waiting because the rental market is bad and prices of apartments have not come down enough for them to jump back in. They are taking the wait and see approach. Sellers are taking the same approach. For those owners who do not have to sell they will just wait it out, however, some owners have to sell or really want to. At some point those sellers will put their properties on the market and be willing to meet the market, selling at the best price possible, but still selling. Those sellers are going to set the market and most likely at higher cap rates as buyers demand higher rates of return.

Higher cap rates mean lower prices

Higher cap rates mean lower prices. The Oakland apartment witnessed that very thing recently when a 37-unit building on Richmond Blvd. near the new Kaiser Hospital development at Broadway and Macarthur Blvd. sold for $3,980,000. A year earlier that owner had listed it at $4.8 million and was able to get it into escrow only to have it fall out because the buyer could not get a large enough loan. The price was lowered to $4.7 million then to $4.3 million and then $4.1 million before eventually selling. The cap rate had gone from the high 5’s to 7%. That seller, who had purchased it at the top of the market, ended up losing money. But he sold. He may have reset the market in the process. Bank foreclosures are affecting the market, too, but because there is not a lot of bank foreclosing going on in the larger apartment segment, those that are hitting the market are mostly in challenged areas and in one form of distress or another.

Buyers will return to the marketplace

Eventually higher rates of return should mean that more and more buyers will return to the marketplace. That will probably not happen until apartment operators feel better about the rental market and if you have been following this column for the past several years you know that the rental market is tied to the jobs market and jobs are still in short supply. However, you also know that the job growth graph that the RHANAC market conditions committee uses has turned the corner and job growth on both sides of the Bay has been going up, although it is still in negative territory.

Historically speaking that means that the worst of the rental market is behind us and if the job growth graph continues going up that means that stabilizing rents and vacancies might not be that far away. Once owners realize that the rental market is beginning to turn around it will not be long before they realize that rents will start going back up soon. At that point there will be convergence.