With rents softening and construction costs skyrocketing, 2017 will be a tough year for multifamily. Many projects are no longer able to pencil and developers are thinking about the next cycle. Developers, investors, brokers, designers and consultants gathered at Hines’ 101 California Street in San Francisco last month to discuss the state of the multifamily segment and what to expect this year.
MBH Architects studio director David Delasantos and Bisnow event moderator along with Emerald Fund principal Marc Babsin, AGI Avant CEO Eric Tao and Polaris Pacific partner Paul Zeger, told a crowd of 400 the biggest challenges in multifamily are rising construction costs, softening rents and increasing fees.
Rising Construction Costs
Tao said construction costs have increased significantly (in the double digits) over the last five years. He said with construction costs outpacing rents, his firm has had to make units as small as possible to get projects to pencil. They are now at a point where units can’t get any smaller.
“We’re projecting out rents will go up 3% per year over the next three years. If construction costs flatten, that 12% growth will make up the disparity,” Tao said. “If we underwrite long-term rent growth at 3%, we will build.”
Zeger said the increased cost of construction is not just material costs, but labor costs, which are catching up after years of tough construction conditions.
The market will start shifting from apartments to condos since it will soon make more economic sense, according to Zeger. Over the last few years, of the 10,000 units delivered, 8,500 were rentals. Construction is expected to slow.
The condo pipeline remains a little tricky. There are a lot of high-end products because the costs make sense, but there is a growing undersupply of lower-end products, Zeger said.
Babsin said there is a lease-up battle with so many apartment projects delivering. In 2015, when Emerald Fund delivered 100 Van Ness, 10 leases were signed per week with no concessions offered. Leasing up its Civic Center project was much more difficult with only four hard-fought leases signed each week and concessions of four weeks or more offered. With another 3,500 units expected to deliver this year, Babsin said he expects another ramp-up of concessions.
Babsin said renters are concerned about long-term affordability in San Francisco and think there is not enough supply, and many are still balking at $3,500 for a one-bedroom. He said much more housing needs to be built. If you are a developer who originally penciled in rapid rent growth and delivering this year, you might be a bit more nervous about the amount of supply.
Both Tao and Babsin said the recent affordability requirement is making it more difficult for anything to pencil right now.
“Developers always say when there is a new fee or increase, we can’t afford it. It kills deals. This time we really mean it,” Babsin said.
He said with increased construction costs, the 25% affordability requirement and all of the various additional fees, if rent does not go up, projects just do not work anymore. He said Emerald is looking at the next cycle because things are not working right now.
Tao said another challenge is the need for infrastructure. Developments in Treasure Island, Hunter’s Point and elsewhere need money for funding streets, roads and utilities.