Real Estate

REAL ESTATE MARKET: 2023 UPDATE AND ANALYSIS

BY GRANT CHAPPELL

On the heels of a soggy start to the year and the highest Sierra snowpack in 28 years, the Real Estate market’s sluggish momentum and waning demand as we ease into the spring season is cause for concern. The Federal Reserve’s interest rate hikes commencing in March 2022 put a damper that has many buyers on pause and sellers grappling with whether to sell in this environment or hold off. At the time of submission of this article, the Fed raised another 0.25 percent with hints at additional increases to come as inflation remains high, despite a solid jobs report in January. “Too little, too late” comes to mind when looking back at the spring 2020 Fed decision to lower rates to zero.

Locally, the ongoing eviction moratorium, property tax hikes, and increased costs to operate properties further undermines buyer’s willingness to step into the arena. As the data shows, sales are down and prices have softened more heavily in Oakland than Berkeley and Alameda. Ten-thirty-one buyers make a larger percentage of the buyer pool these days as groups backed by institutional capital partners are pulling back on new purchases given the higher cost of debt and low Cap Rates (high prices) available for on-market properties.

With the new year comes new opportunities and challenges, especially after a turbulent election season and further fallout in the tech and crypto industries. The Federal Reserve’s aggressive moves toward inflation saw the largest weekly increase in mortgage rates since 1987 in June 2022. That trend continued throughout the year, but it takes time to impact the market given a typical 60- to 90-day rate lock on investment property financing. For example, deals we closed in Q2 with a five-year fixed rate of 3.5 percent had jumped to 5.5 percent with the same lender by Q4, which dramatically reduced loan dollars and widened the gap between buyer and seller price expectations.

The ongoing eviction moratorium is the elephant in the room in Alameda county, especially in Oakland and Berkeley. Even Los Angeles passed a “just cause” ordinance designed to protect renters post-COVID, as their eviction moratorium was expiring soon. Investors we engage with would prefer a surrounding non-rent controlled city in Alameda County or are pursuing opportunities in surrounding Bay Area counties/Sacramento. Berkeley’s student housing demand has helped prop up property values and rental rates in the vicinity of campus, but the city also has several thousand units in the development pipeline that could put downward pressure on rents and property values once those projects come online.

With near weekly headlines in the news about layoffs from the largest and mid-sized tech firms, fear percolated that apartment demand would be negatively impacted. While shocking to hear of tech layoffs nearly three years into COVID, other media reports that a majority of the large tech firms still retain more employees than pre-COVID levels. COVID workfrom-home policies allocated investor capital to companies and services that support remote work/learning. Tech companies also expanded head counts in other states, partially explaining why Oakland dropped out of the top 10 most expensive rental markets in the country.

Companies’ work-from-home policies appear to be shifting. Though not widely reported at the time of submission of this article, some reporting in the Biz Times and other media suggests a dramatic change to require at minimum, two to four days back in the office. As we recall the prior tech bubble of the early 2000s, apartment and office rents took years to recover, though apartment rents remain buoyant. According to a recent Cushman and Wakefield Office Report, San Francisco and Oakland office markets are two of the least occupied in the country with vacancy rates north of 20 percent.

According to Zumper’s most recent rental report, all three major Bay Area markets (Oakland, San Jose and San Francisco) are still in positive territory for year-over-year rent growth, but only San Jose is positive month to month. Oakland now ranks as 11th priciest market nationally, falling out of the top 10 to cities such as Jersey City, Miami, San Diego, DC, and Arlington, Va. We reported in late 2019 and early 2020 that Oakland had moved as high as fifth most expensive market in the nation, up there with NYC, Boston, SF, and San Jose.

We often hear fears about new supply negatively impacting rents on rent-controlled properties but have yet to see it in our rent figures. It’s worth noting that downtown Oakland added 6,500 units from 2015 to 2021, a nearly 50 percent increase in supply. After SB-330’s 2019 passage, an influx of proposed projects near public transit came online, as it allowed for greater density in exchange for more affordable units. The Brooklyn Basin Development is expected to add 3,100 Units over the next 10 years, so it’s logical to expect rents on existing rent-controlled buildings to decrease down the road.

Danny Winkler’s excellent article in the January issue hit on several key issues negatively impacting small property owners: tax and compliance outcomes can materially impact the bottom line . He also mentioned higher interest rates pushing Cap Rates higher and dragging values down with it and ultimately creating an environment in which deeper-pocketed, larger investors would be able to snap up properties. While that seemed evident in the second half of last year, we see evidence that groups with larger/institutional equity partners are scaling back on purchases and offering well below Cap Rate/pricing targets of Q1 and Q2 2022.

2-4 UNITS

As the data shows, both sales volume and average prices have cooled considerably since Q2 2022. In Oakland average prices on the sale of two- to four-unit properties dropped below $1,000,000 for the first time since Q1 2021. Sales in Oakland also dropped by nearly 40 percent from 132 deals in Q4 2021 to 75 in Q4 2022.

Alameda and Berkeley have also witnessed a similar drop in sales volume compared to Oakland, though average transaction prices remain consistent through 2021 and 2022. Average sales prices in Berkeley and Alameda perform at similar levels consistent with 2021 pricing, though overall sales volume is down more than 50 percent in each city compared to Q4 2021.

5+ UNITS

Oakland sales dropped to their lowest levels since the beginning of the pandemic when just $40,000,000 sold in Q2 2020. With $62,000,000 in sales volume in Q4 22, Oakland is down 50 percent year to year, yet only 10 percent lower than the prior quarter. Oakland also posted its strongest quarter in Q2 22 $177,000,000 in sales, though a significant portion of that volume was part of a $70,000,000 portfolio sale of 13 properties in Oakland and Berkeley. Regardless, the drop in sales volume is staggering and reflects the higher interest rate environment that reduces the buyer’s purchasing power.

Berkeley actually saw a slight increase in sales with $35M in Q4 compared to $28M in Q3, though sales volume is down 50 percent compared to Q4 21. Student housing is a bright spot in Alameda county as UC Berkeley plans to increase enrollment from ~40K students to ~45K by 2030 (according the UC Office of the President 2030 growth plan), yet also has a mandate to hit housing targets as required under a new state law, SB 330. Consequently, there are now thousands of units in the development pipeline in Berkeley since the law allows for greater density in exchange for providing more “affordable units” in new projects.

Alameda city sales totaled $9.5M in Q4, a modest decrease from $11.1M in Q3, yet higher than the $7M that traded hands in Q4 21. Given the lower overall housing stock in Alameda compared to Oakland and Berkeley, it’s historically been a slower market. We handled two sales in Alameda last year and found buyers who wanted to own, or already owned, property in Alameda and find it a more pleasant city to own property, even though rents are not as strong as Oakland and Berkeley.

In summary, the sales trends show reductions in volume and average prices that mostly reflect the goals of the Fed, which are to tame inflation and slow the economy down without damaging the established relationships within markets. With more layoffs announced in tech, fear about the strength of the Bay Area real estate market persists given the heavy reliance on the tech sector and whether more companies will create jobs out of state. As the Fed takes an extended break from policy changes, our outlook is opportunistic caution: keep some powder dry for obvious buying opportunities and be ready for additional headwinds as the ripple effects of tighter credit markets set in.