Despite Challenges, San Francisco Ideal Place For Residential Investment, Says Expert

With developers about to deliver thousands of housing units this year in San Francisco, the city risks a short-term oversupply of housing. It will not last long. A lack of available land, high costs of construction and affordability requirements will all make residential housing difficult to build in the coming years. One expert said despite these many challenges, San Francisco will remain a stronghold for developers and investors.

Polaris Pacific partner Paul Zeger (above) said San Francisco is still an ideal place because everyone wants to live here. There is strong demand from college graduates and young people who want to live in San Francisco as well as other groups of financially sound people.

“Mature people want to be a part of the intellectual trust and foreign buyers who are home collectors and own in London, Sydney and Asia all want to be a part of San Francisco,” Zeger said. “They can afford to pay for expensive housing, which pushes pricing up.”

The Bay Area's economy is the last to fall off and the first to come back because of the tech industry, which also makes San Francisco a desirable place for developers and investors, he said.

Developers and investors face difficulties like finding suitable land, navigating through the planning and entitlement process, and securing financing.

“To do a deal in San Francisco, you have to be optimistic of the future to make the economics work out,” Zeger said. “Financial sources are the final check that are willing to accept a certain level of optimism.”

The lack of available land may have a big impact on the San Francisco residential market. Developments in Dogpatch are picking up, as are The Shipyard and Candlestick with developers continuing to eye places down the peninsula toward the San Francisco Airport. Even though there has been a shift toward the East Bay, it does not work for everybody, Zeger said. A lot of people still work in the peninsula and prefer to live nearby and are pushing down toward Palo Alto.

Zeger said affordability requirements have not been helping developers build more housing, and they only help a small group of people.

The same amount of money used to provide discounted housing for a handful of people could be used to build more housing and help a greater amount of people, he said. To provide discounted housing, the cost is often shifted toward market-rate housing.

“Housing is such a big issue. You can’t solve it on the back of market-rate buyers,” Zeger said. “What really has to happen is the affordability requirement needs to be spread out to the entire population, including the people who bring jobs here.”

A Shift Toward Condos Expected

With the high cost of construction, softening rents and compressed cap rates, Zeger said he expects developers to move from delivering a heavy concentration of rentals toward building more condos. The last 10,000 units delivered included 8,500 rentals and 1,500 condos. He expects more of a 50/50 ratio going forward. Last year, 2,730 apartments were completed compared to 1,276 condos, according to a Polaris Pacific report.

Polaris Pacific data from the last quarter revealed some of the steam is being let out of the market, but overall home sales remain strong. During March 2015, median home prices surpassed $1M and have started to come down. During the last quarter, median price decreased 2.5% compared to the prior year. There were 712 resales last quarter, a 3% decrease year-over-year.

All-cash buyers represented 24.9% of sales last quarter, a decline from 31.5% during the same period in the previous year. Investor buyers represented 18.2% of transactions during Q4 2016 compared to 25.3% of transactions during Q4 2015. Months of remaining inventory were between three and four months last year. Comparatively, average months of remaining inventory in 2010 was about seven months.

High-end residential has gone up in the last two or three years and there is continued growth. Demand remains strong. The need for entry-level housing remains unsatisfied because construction costs are so high. More ultra-luxury housing is in the works since many of these have a better chance of penciling. Developers are planning to build high-rise view-oriented condo/hotel combos with the expectation of high prices, Zeger said.

Overall, the general prognosis of the market is good with some short-term blips expected, Zeger said. He said now is a good time to lock in rates because once the market moves back up, buyers would still pay the lower rates.

Find out more at our San Francisco Residential Investment & Development Forum on March 14 at the Fairmont Hotel.