As Costs And Local Headwinds Mount, San Francisco's Multifamily Starts Plummet 62%

While 2019 represents a bounceback year for housing completions in San Francisco, this year's number of groundbreakings tells a much different story.

Through the first three quarters, construction starts on market-rate multifamily units are down 62% to 1,281 from 3,406 at the same point in 2018, according to CoStar. CoStar's data excludes student and senior housing.

Developers cite costs and city requirements, among other factors, as the biggest culprits, with only the most ideally located projects able to overcome those barriers, according to Strada Investment Group Vice President William Goodman. 

"Anything that's not in an A+ location or doesn't have long-term, patient capital is going to struggle," Goodman said. 

Construction costs in San Francisco (and all around the Bay Area) have soared throughout much of the decade, but only more recently has residential rent growth not kept up. For instance, S.F., seeing cost inflation of 5% in 2018, just passed New York City as the world's most expensive place to build, according to Turner & Townsend. 

At the same time, rent growth has slowed. In September, San Francisco one-bedroom and two-bedroom apartments saw 2.7% and 1% decreases in year-over-year rents, respectively, according to Zumper. 

For Strada, the beneficiary of both patient capital partners and an attractive project location near Market Street and Van Ness Avenue, its 420-unit 1629 Market St. project will begin construction early next year, according to Goodman.

The development received $130M in equity funding from Stockbridge Capital Group earlier this year, and in September, Strada and the California State Teachers' Retirement System, or CalSTRS, announced a $300M "build to core" fund for multifamily development, especially in the Bay Area.

Nevertheless, other projects and developers haven't been as lucky. Cost escalation has leveled off a little, to 3% to 5% instead of the 6% to 8% of a few years ago, Goodman says. But financing can still be hard to come by.

Developer Build Inc. received approval for its One Oak project at 1500-1540 Market St. — just a block from Strada's — in 2017, but the company doesn't know when it will break ground on the 40-story, 304-unit development, Build partner and co-founder Lou Vasquez told Bisnow. 

"It's been heavy sledding, and with costs where they are it's difficult to make the deal pencil," Vasquez said. "We've been out looking for equity partners, but there's not enough. 

Only exacerbating the labor shortage faced by the city's residential builders is the abundance of office development happening throughout the Bay Area, said Vasquez, adding that tech giants like Google and their partners have the power to not require the return typically demanded by multifamily investors. 

Though Google has yet to actually begin its Diridon Station megaproject in San Jose, which will have up to 7.5M SF of office, among other uses, its and other tech companies' rapid expansions have affected developers' ability to get multifamily projects financed, according to Vasquez.

"If any of those guys need a million SF of TIs for office, they don't really care how much it costs," he said. 

Google, Apple and Facebook, which all have over $50B in cash reserves, have each announced billion-dollar pledges this year to help mitigate the Bay Area's housing crisis. But they've come in for withering criticism from both local politicians and stakeholders, who say the tech giants have been nearly silent on housing policy.

Aside from construction costs, city fees and other rules, like inclusionary housing requirements increasing each year, have also stymied residential development in S.F., developers claim.

Proposition C originally more than doubled the city's affordable housing requirement, from 12% to 25%, before a revised version lowered it to 18% in 2017 with increases on an annual basis. That steadily increasing threshold, which will rise to 20.5% for projects of 25 or more units next year, is hampering housing output, along with other impact fees costing developers upward of $160K per unit, Vasquez said. 

"None of the developers I know are quite able to get things to pencil nowadays," Emerald Fund founder and Chairman Oz Erickson said at a Bisnow multifamily event last week. "This is the last year of big deliveries for San Francisco. Everybody rushed in to beat the affordable housing requirements.

"Next year, the number of deliveries is substantially below that, maybe 3,000 units. And after that it falls off the cliff," he said.

As of earlier this year, San Francisco had 9,717 net units under construction, according to the city's pipeline report. But like Erickson, other observers worry about what is to come beyond this year and next. 

"We've got a full supply pipeline," CoStar Bay Area Director of Market Analytics Jesse Gundersheim said. "But when it empties out we're going to see a pretty sharp drop-off in the inventory growth levels in 2022."

Developers have some recourse around cost headwinds, like the California State Density Bonus Law, which allows for a 35% increase in density in exchange for satisfying affordability requirements that much of S.F. already requires, Goodman points out. But that doesn't change the math substantially.

"If we're not at a tipping point, we're getting very close to that point now," Goodman said.