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ApartmentResearch

M A R K E T R E P O RT
San Jose Metro Area Fourth Quarter 2011

South Bay Landlords Raising Rents at Rapid Clip


As South Bay property operations lean in favor of landlords, marketwide rents will appreciate markedly over the remainder of this year and into 2012. Leasing activity continues to swell in step with rising employment, but more specifically from the inmigration of newly employed tech workers, which has steadily bolstered net absorption over the past two years. This surge in renter demand growth has been accompanied by few stock additions, compressing the metros vacancy rate to a decade low this year. As a result of this tight supply/demand balance, owners are chipping away at concessions and raising rents at a pace nearing those logged ahead of the downturn. In Mountain View and Cupertino, for instance, Class A rents have spiked more than 5 percent year to date, a trend that will likely go uninterrupted into early 2012 as renter demand tied to technology persists. Absorption at the lower end of the spectrum is also on the rise, though Class B/C rent inflation has yet to match robust hikes recorded by the top tier. Extremely tight operating conditions have led some builders to push projects through the pipeline, but with home prices to remain out of reach for many households, new units delivered beyond 2011 will face short lease-up times. Bullish investor demand for properties will compel private-equity buyers to move down the quality scale, driving up sales activity in the process as more mid- and lower-tier assets clear the market. This shift began to take shape over the past year, catalyzed by low interest rates and the onset of a new rent growth cycle. The number of assets changing hands comprised of fewer than 10 units, for instance, accelerated 70 percent over the last year. Nonetheless, location remains a key determinant, and recent closings remain tightly centered around major employment centers. In general, smaller but well-located mid-tier properties are trading at cap rates averaging in the low-6-percent range, while mid- to low-end assets in blue-collar areas sell at yields between 6.0 percent and 7.0 percent. At the upper end of the spectrum, best-in-class properties command cap rates in the high-4-percent to low-5-percent range.

2011 Annual Apartment Forecast


3.0% increase in total employment

Employment: San Jose metro employers will increase staff counts by 26,000 positions in 2011, a 3 percent expansion, which will outpace the addition of 11,600 jobs last year.

480 units will be completed

Construction: During 2011, developers are scheduled to complete 480 market-rate apartment units, outpacing the completion of 270 units in 2010. Despite the ramp up in deliveries, total stock additions this year will remain more than 25 percent below the five-year annual average.

80 basis point decrease in vacancy

Vacancy: South Bay apartment operations will steadily strengthen through 2011 due to outsized home prices and renewed job creation. As such, vacancy will fall 80 basis points this year to 3 percent, following a 130-basis-point drop logged in 2010.

5.4% increase in asking rents

Rents: Asking rents will climb 5.4 percent to $1,525 per month in 2011, while effective rents grow 6.3 percent to $1,434 per month. Last year, asking rents gained 3.3 percent, and effective rents pushed up 3.4 percent.

Economy

Employment Trends
6%
Year-over-Year Change Metro Area United States

Employers in the South Bay marketplace expanded payrolls by 26,800 positions during Vacancy Rate Trends the third quarter, a 3.1 percent increase, marking the 12 months ending in Metro Area Californias largest absolute gain. During the preceding year, local employment levels 10% United grew by 9,700 jobs. States
8%

3%
Vacancy Rate

0% -3% 6% -6% 3% 07 0%

Employment Trends
Metro Area United States

Job creation in the metros key manufacturing sector accelerated 4.2 percent year year, or by 6,400 positions, bringing the segments total employment levels to within 5.3 percentRate Trends highs. During the first nine months of 2010, the Vacancy of pre-recession 4% manufacturing Metro Area sector logged a gain of 4,500 spots. 10% over 6%
United States

Number of Units (thousands) Number of Units (thousands) ExistingUnits (thousands) Existing Home Price (Y-O-Y Existing Home Price (Y-O-Y Chg.) Median Year-over-Year Change Year-over-Year Change Median Number of Home Price (Y-O-Y Chg.) Median Chg.)

* Forecast Sources: Marcus & Millichap Research Services, BLS, Economy.com

-3% 6% 40% -6% 3% 07 20% 0% 0%

Employment Trends Home Price Trends


Metro Area Metro Area United States United States

Vacancy Rate

08

09

10

11*

Only three employment sectors have posted year-to-date losses, including leisure and 07 08 09 10 11* hospitality, financial services and other services, resulting in an aggregate decrease of * Forecast Sources: Marcus & Millichap Research Services, Reis 3,100 workers. 6%
2% 8%
4%

10% 12%

Vacancy Rate Trends Rent employers Outlook: San JoseTrends will increase staff counts by 26,000 positions in 2011, Metro Area Asking Rent United States a 3 percent expansion, which will outpace the addition of 11,600 jobs last year. Effective Rent
08 09 10 11*

08

09

10

11*

* Forecast Sources: Marcus & Millichap Research Services, BLS, Economy.com

Vacancy Change Year-over-Year Rate Median Price per Unit (thousands) Price per Unit (thousands) Price per Unit (thousands) Median Year-over-Year Change Year-over-Year Change Median

* Forecast Sources: Marcus & Millichap Research Services, Reis


6% 0%

Housing and Demographics

2% 8% 6% 07

-3% -20% 40% -6% -40% 20%07 07 0%

Home Price Trends


Metro Area United States

* Forecast * Trailing Marcus & Millichap Sources: 12-Month Period Research Services, BLS, Economy.com Sources: Marcus & Millichap Research Services, Economy.com, NAR

08 08

09 09

10 10

11* 11*

* Forecast * Forecast Sources: Marcus & Millichap Research Services, Reis Sources: Marcus & Millichap Research Services, Reis

2% -12% 6% 07 07

During the year ending in the third quarter, single-family developers secured permits for 900 units, which is nearly identical to the number of permits pulled one year Rent Trends 4% earlier. Multifamily Rent -6% Asking permit issuance, meanwhile, increased twofold in that time to 12% approximately Effective units. 2,850 Rent
08 09 During the third quarter, the 10 median11* price for a single-family home in South Bay was $584,900, 3.1 percent lower than 12 months earlier. The median household in0% come ticked up 2 percent year over year on renewed job growth to $89,300 annually. Rent Trends SalesTrends
Asking Rent

08

09

10

11*

-20% 40% 4 -40% 20% 07 3 0% 2

Home Price Trends Construction Trends


Metro Completions Apartment Area United Permits Multifamily States

$200

08

09

10

11*

Effective Rent In the third quarter, average Class A asking rents were $1,339 per month less than the -12% average monthly mortgage payment, using traditional lending terms. 6%

-6% 12%

* Trailing 12-Month Period Sources: Marcus & Millichap Research Services, Economy.com, NAR

* Forecast Sources: Marcus & Millichap Research Services, Reis

07 $165 0% $130

08

09

10

11*

-20% 1 4 -40% 0 3 07 2

Construction Trends
Apartment Completions Multifamily Permits

$95 $200

Outlook: Although falling home values will enable some residents to leap into ownership, home prices remain out of reach for a sizable share of local residents, a reality Sales Trends that will continue to provide a layer of renter demand. -6%
10 10 11* 11*

* Trailing 12-Month Period * Forecast Sources: Marcus & Millichap Research Services, Economy.com, NAR Sources: Marcus & Millichap Research Services, U.S. Census Bureau

07

08 08

09 09

10 10

11* 11*

* Forecast * Trailing 12-Month Period Sources: Marcus & Millichap Research Services, CoStar Group, Inc., RCA Sources: Marcus & Millichap Research Services, Reis

-12% $60 Construction09 08 08 $16507 07 09

Over the past 12 months, apartment builders completed one market-rate complex accounting for 108 units, down from the addition of 513 units one year earlier. $130

Construction Trends
1 4 0 3 2 1 0 07
Apartment Completions Multifamily Permits

08

09

10

11*

* Forecast Sources: Marcus & Millichap Research Services, U.S. Census Bureau

Fairfield Cerano apartments in Milpitas; final build out on the develop08 10 11* ment is scheduled for09 fourth quarter. the * Trailing 12-Month Period
Sources: Marcus & Millichap Research Services, CoStar Group, Inc., RCA

There are 1,216 rental units under construction across South Bay, which represents $95 $200 percent of existing stock. The largest project slated for delivery this year is the 1.1 374-unit $60 $165 07
$130

Sales Trends

The markets planning pipeline in the third quarter consisted of 6,675 units. During that time, however, less than 10 percent of the units under consideration contained $95 established start dates.
$60 07 08 09 10 Outlook: During 2011, developers11* scheduled to complete 480 market-rate are apartment units, outpacing the completion of 270 units in 2010. Despite the ramp up in deliveries, total stock additions this year will remain more than 25 percent below the five-year annual average.

07

08

09

10

11*

* Forecast Sources: Marcus & Millichap Research Services, U.S. Census Bureau

* Trailing 12-Month Period Sources: Marcus & Millichap Research Services, CoStar Group, Inc., RCA

page 2

Marcus & Millichap

Apartment Research Report

Vacancy

Year-over-Year Change

Limited stock additions, coupled with re-employed residents entering the rental market, pushed the metros vacancy down 80 basisEmployment Trends 3.1 perpoints year over year to Metro Area 6% cent in the third quarter. During the corresponding period 12 months prior, vacancy United States fell 110 basis points.
3%
Vacancy Rate

Vacancy Rate Trends


10% 8% 6% 4% 10% 2% 8% 07 6% 4% 12% 10% 2% 6% 8% 07 0% 6%
Metro Area United States

Top-tier renter demand continues to strengthen at a rapid clip. During the past year, 0% vacancy in the Class A sector decreased 60 basis points to 3.3 percent, which is 160 basis points less than the segments five-year annual average. Over the preceding 12 Employment Trends months, vacancy fell 150 basis points. -3% Metro Area 6%
United States Number of Units (thousands) Chg.) Median Year-over-Year Change Year-over-Year Change Existing Home Price (Y-O-Y Chg.) Number of Units (thousands) Existing Home PriceMedian Existing Home Price (Y-O-Y Chg.) Number of Units (thousands) Median (Y-O-Y

Vacancy Rate Trends


Metro Area United States

20% 07 3% 0% 0%

08

09

10

11*

Year-over-Year Change Vacancy Rate

Home Price Trends EmploymentTrends Outlook: South Bay apartment operations will strengthen through 2011 due to -3% Metro Area Metro Area 40% 6% United States outsized home prices and renewed job creation. As such, United States fall 80 basis vacancy will points this year to 3 percent, following a 130-basis-point drop logged in 2010. -6%
* Forecast Sources: Marcus & Millichap Research Services, BLS, Economy.com

Vacancy Rate

-6% Class B/C vacancy averaged 2.9 percent in the third quarter, down 100 basis points 3% 07 08 09 10 11* * Forecast from the prior period, led by broad-based payroll& expansion and minimal supplySources: Marcus Millichap Research Services, BLS, Economy.com side threats. 0%

08

09

10

11*

* Forecast Sources: Marcus & Millichap Research Services, Reis

Rent Rate Trends Vacancy Trends


Asking Rent Metro Area Effective States United Rent

08

09

10

11*

Rents

* Forecast Sources: Marcus & Millichap Research Services, Reis

Asking rents reached $1,506 per month in the third quarter, a year-over-year increase Home Price Trends -20% -3% of 5.1 percent, while effective rents rose 5.5 percent to $1,409 per month. In the preMetro Area 40% United States ceding year, asking rents ticked up 1.2 percent as effective rents slipped 0.1 percent. Top-tier asking rents grew 5.6 percent over the last Period to $1,722 per month, while * *Trailing 12-Month year Forecast Sources: Marcus & Millichap Research Services, Economy.com, NAR Sources: Marcus & Millichap Research Services, BLS, Economy.com the Class B/C market resulted in a 4.5 percent hike to $1,266 per month. 0%
-40% -6% 20% 07 08 08 09 09 10 10 11* 11*

-6% 4% 12%

Rent Trends
Asking Rent Effective Rent

Median Median Median Price per Unit (thousands) Price per Unit (thousands) Price per Unit (thousands) Year-over-Year Change Year-over-Year Change

-12% 2% 6% 07 07 0%

08 08

09 09

10 10

11* 11*

* * Forecast Forecast Sources: Marcus && Millichap Research Services, Reis Sources: Marcus Millichap Research Services, Reis

Construction Trends Home Price Trends Leasing incentives averaged 22 days of free rent in the Apartment Completions from 25 third quarter, down -20% Metro Area 40% Multifamily Permits United States days of free rent one year earlier. As operating4 conditions tightened, revenues rose 6.4 percent over the past year, outpacing the 1.1 percent gain recorded during the prior -40% 3 20% 07 08 09 10 11* 12-month period. * Trailing 12-Month Period
Sources: Marcus & Millichap Research Services, Economy.com, NAR

-6% 12% $200

Sales Trends Rent Trends


Asking Rent Effective Rent

-12% 6% $16507 0% $130

08

09

10

11*

Outlook: Asking rents will climb 5.4 percent to $1,525 per month in 2011, while Construction Trends effective rents grow 6.3 percent to $1,434 per month. Last year, asking rents gained 1 -20% Apartment Completions 4 3.3 percent, and effective rents pushed up 3.4 percent. Multifamily Permits
* Forecast * Trailing 12-Month Period Sources: Marcus & Millichap Research Services, U.S. Census Bureau Sources: Marcus & Millichap Research Services, Economy.com, NAR

2 0%

* Forecast Sources: Marcus & Millichap Research Services, Reis

$95 -6% $200

Sales Trends

Sales Trends**

0 -40% 3 07 07

08 08

09 09

10 10

11* 11*

Apartment transaction velocity in the South2Bay marketplace accelerated nearly 60 percent over the most recent 12 months, following a 2 percent ease one year earlier. Construction Trends During that time, trading activity was led by a resurgence of closings for properties 1 Apartment Completions 4 Multifamily Permits priced below $5 million.
3 07 08 09 10 11* The median price for properties sold in* the past year fell 9 percent to $150,300 per Forecast Sources: unit, driven by the mix of properties trading,Marcus & Millichap Research descended the Bureau as more investors Services, U.S. Census qual2 ity scale. At the upper end of the spectrum, assets traded above $10 million changed hands with a median price of $212,400 per unit. 1 0

* *Trailing 12-Month Period Forecast Sources: Marcus & & Millichap Research Services, Reis Group, Inc., RCA Sources: Marcus Millichap Research Services, CoStar

$60 -12% $165 07 07 $130 $95 $200 $60 $165 $130 $95 $60

08 08

09 09

10 10

11* 11*

Sales Trends

07

08

09

10

11*

* Trailing 12-Month Period Sources: Marcus & Millichap Research Services, CoStar Group, Inc., RCA

Cap rates for Class A assets in sought-after areas will average in the high-4-percent 0 07 08 09 to low-5-percent range. Well-located mid-tier assets will generate offers in 10 highthe 11* * Forecast Sources: Marcus Millichap Research Services, U.S. Census Bureau 5-percent to low-6-percent range, while lower-tier& deals in blue-collar areas solicit offers between 6.0 percent and 7.0 percent. Outlook: As demand for assets in better locations outstrips the availability of supply, some buyers will gradually consider areas currently overlooked, an occurrence that will likely take hold to some extent in 2012.
u

07

08

09

10

11*

* Trailing 12-Month Period Sources: Marcus & Millichap Research Services, CoStar Group, Inc., RCA

** Data reflect a full 12-month period, calculated on a trailing 12-month basis by quarter.

Marcus & Millichap

Apartment Research Report

page 3

Capital Markets
By WILLIAM E. HUGHES, Senior Vice President, Marcus & Millichap Capital Corporation

Visit www.NationalMultiHousingGroup.com or call:

Increased Fed intervention, such as Operation Twist, should keep interest rates relatively low through the end of the year. As of late-October, the yield on the 10-year Treasury was hovering around 2.3 percent, approximately 175 basis points below the 10-year average. Apartment mortgage originations more than doubled in the first half of 2011 when compared with the same period last year, driven largely by agency lenders Fannie Mae and Freddie Mac, life insurance companies and local/regional banks. While agency originations increased over past year, the re-emergence of life companies and banks caused their market share to drop from 62 percent in 2010 to 44 percent in the first half. Lenders view apartments as preferred assets and are moving down the quality chain to finance Class B properties in strong locations, encouraged by healthy occupancy gains and firming values. Nonetheless, financing lower-tier properties in secondary and tertiary markets remains a challenge. Portfolio lenders generally originate new loans at 55 percent to 75 percent LTVs, while agency lenders provide up to 80 percent leverage on high-quality assets in core metros. All-in rates for $3 million-plus mortgages start around 3.75 percent for a five-year term, with seven-year loans pricing in the low- to mid-4-percent range, and 10-year notes averaging 4.5 percent to 5.0 percent. All-in rates for smaller loans are typically 10 to 25 basis points higher.

John Sebree National Director National Multi Housing Group Tel: (925) 953-1700 john.sebree@marcusmillichap.com

Submarket Overview

Googles recent lease execution of 700,000 square feet in Sunnyvale adds to the collection of tech firms that have secured space in the area, which includes Motorola, HP and Microsoft. Expansions among these tech companies bodes well for local operators, as residents seek housing near work. In Mountain View, Symantec has signed a large lease, which can accommodate up to 1,000 workers. The company expects to move employees into the building over the next two years, which will likely aid apartment absorption trends near the campus in the process. At 289 units, the Mountain View/Los Altos submarket accounts for the most planned projects with established start, which are slated to break ground in the next nine months. In all, more than 3,900 units are under consideration in the Northeast San Jose submarket, or 20 percent of the areas existing stock.

Prepared and edited by Michael L. Brown Research Analyst Research Services For information on national apartment trends, contact John Chang Vice President, Research Services Tel: (602) 687-6700 ext. 6803 john.chang@marcusmillichap.com Palo Alto Office: Steven Seligman Regional Manager sseligman@marcusmillichap.com 2626 Hanover Street Palo Alto, California 94304 Tel: (650) 391-1700 Fax: (650) 391-1710 Price: $150 Marcus & Millichap 2010 www.MarcusMillichap.com

Submarket Vacancy Ranking


Rank
1 2 3 4 5 6 7 8 9

Submarket
Campbell/Los Gatos Sunnyvale East San Jose Cupertino/Saratoga Northeast San Jose South San Jose Mountain View/Los Altos Santa Clara West San Jose

Vacancy Rate
1.9% 2.4% 3.0% 3.0% 3.1% 3.1% 3.4% 3.7% 3.8%

Y-O-Y Basis Point Change


-100 -50 -140 -90 -90 -100 -60 -120 -20

Effective Rents
$1,252 $1,427 $1,275 $1,687 $1,496 $1,126 $1,627 $1,427 $1,244

Y-O-Y % Change
4.0% 6.0% 4.8% 4.6% 5.7% 4.0% 8.4% 4.5% 5.0%

The information contained in this report was obtained from sources deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no representation, warranty or guarantee, express or implied, may be made as to the accuracy or reliability of the information contained herein. Note: Metro-level employment growth is calculated using seasonally adjusted quarterly averages. Sales data includes transactions valued at $500,000 and greater unless otherwise noted. Sources: Marcus & Millichap Research Services, Bureau of Labor Statistics, CoStar Group, Inc., Economy.com, National Association of Realtors, Real Capital Analytics, Reis, TWR/Dodge Pipeline, U.S. Census Bureau.

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