Builders Trade Luxury Condos for No-Frills Rentals

by J.K. Dineen on July 1, 2009

The following was first published in the SF Business Times on June 26th.

San Francisco residential builders are getting back to basics. Gone are the lap pools, spas and 50th-floor penthouses. Gone are the walnut cabinets, marble bathrooms and built-in wine coolers. Instead, developers with the intestinal fortitude to build in this market are focused on rental housing. They are looking at units that are market-rate yet affordable by design. And some are seeking help in the form of federal stimulus money or Federal Housing Administration-backed loans.

“The frills are coming out,” said Tim Colan, executive director of the Housing Action Coalition, who advocates for housing in the city. “No concierge, no fitness room, and much smaller units. These are the coping mechanisms for the new era we’re in.”

The New Reality

For now, the high-rise condo tower is a broken business model in the city. Even with the price of land down more than 50 percent, it still costs at least $750 a square foot to build a steel-frame tower. A tower with 1,000-square-foot two bedrooms would have to average $750,000 a unit to break even. To achieve the 20 percent return most investors seek would require average prices to hit $900,000 — a difficult sell in this market. And that’s assuming developers could get financing, which they can’t.

Instead, the condo market slowdown has forced housing developers to focus on three things: rental housing, cheaper midrise construction and innovative, new financing.

For example, Portland-Pacific LLC won approval for a 113-unit apartment project at 430 Main St. in Rincon Hill, a 75-foot building the developer is positioning as an affordable alternative to some of the neighborhood’s deluxe towers. Portland-Pacific has applied for a Federal Housing Administration-backed loan under Section 220, a program that guarantees loans on rental projects in urban redevelopment areas. At 333 Harrison St., the Emerald Fund is also seeking an FHA-backed loan as well as $2 million in stimulus money for a 308-unit apartment complex at 333 Harrison.

And finally at Trinity Place, self-made builder Angelo Sangiacomo has taken another approach: He is bankrolling the first phase of his 1,900-apartment complex himself, a $175 million investment that will add 440 studio apartments to Mid-Market when it opens later this year.

“The rental market is excellent … We are doing very well with our rentals,” said Sangiacomo.

Sangiacomo’s willingness to build through the longest recession since World War II illustrates another trend. During 2006 and 2007, San Francisco became a magnet for out-of-town developers seeking entrance into a market with some of the highest high-end housing outside of Manhattan. All of these developers — Fifield, Turnberry, Peebles Corp., Crescent Heights and others — have sold their land, attempted to sell, or indefinitely delayed development. Instead, the market has returned to San Francisco-based builders, like Sangiacomo and Oz Erickson’s Emerald Fund, and Joe Cassidy, who is planning to start excavation on 113 units in the Castro. Sangiacomo said he likes the efficiency of focusing on one market.

“A lot of developers have property all over the world,” said Sangiacomo. “I like to walk to my investments.”

HUD Financing

Doug Shoemaker, the director of the San Francisco Mayor’s Office of Housing, said the city is looking for ways to help developers interested in the Section 220 program. One barrier that currently exists for developers looking to use Section 220 is that the program includes statutory limitations restricting the loan amount that can be insured.

In the Bay Area, Section 220 covers up to $227,000 in construction costs for a two bedroom, $185,000 for a one bedroom or $165,000 for a studio. Even with construction costs down an estimated 20 to 30 percent over the past year, the federally insured loans would only cover about 60 to 70 percent of project costs for a modest wood-frame apartment complex in San Francisco.

Shoemaker said they are working to “adjust the federal loan limit.”

“This is something that is very promising from our standpoint,” said Shoemaker. “We are trying to better understand what barrier exists for developers trying to do that kind of work.”

While a new report from Marcus & Millichap projects an 8 percent decline in rents, developers say the rental market has been resilient. Dan Deibel of Urban Housing Group said the company have leased 103 units in 90 days at Strata, a new 192-unit apartment complex in Mission Bay.

Deibel said rents are down 15 percent from a year ago, but that leasing velocity is four units a month higher than expected. Deibel said the compay is looking at other sites to build on, but that financial partners are looking for evidence the economy has bottomed and rents are starting to climb again.

“Capital is there for the right opportunity and the right return on cost,” he said.

Breaking Ground in 2010

Assuming he gets HUD approval, Portland-Pacific President Christopher Zupsic said he plans to start building the $35 million to $40 million project in the first quarter of 2010.

Sixty percent of the eight-story building will be 500-square-foot studios and 40 percent will be two-bedrooms averaging 875 square feet. He said the “straightforward” apartments would resonate with renters looking for value. He said construction costs have fallen more than 15 percent and material costs have dropped, too.

“We also see deflation in the cost of services,” said Zupsic. “A year ago you were worrying if you could even get a tower crane. Now you look at our skyline and there are no cranes out there.”

Sangiacomo said Trinity Properties is working on construction plans for 545-unit phase two, which will break ground in 2010 after the first building opens at the end of this year. Though he is 84 years old, Sangiacomo says he plans to seen the Trinity project through to completion.

“I have not even started yet, God willing,” said Sangiacomo. “The city could stand some good housing.”

Condo Projects Shelved

Some 3,019 new units of housing came online in 2008, the final burst of a condo construction bubble that peaked in 2006 and started to deflate in late 2007. Since then, prices have dropped 20 to 30 percent. A recent Polaris Group report found there are 1,340 condominium units available for resale — 58 percent more than available in May 2008 and a 10.3-month supply. The one major condo project currently under construction, Jackson Pacific’s 180-unit One Hawthorne St., will come online in 2010.

Every major condo project expected to break ground in 2008 was shelved, including:

Urban West Associates’ 292-unit phase two of One Rincon Hill.
Bosa Development’s 318-unit phase two of the Radiance.
Crescent Heights’s 720-unit project at 1401 Market St.
Turnberry’s 227-unit tower at 45 Lansing St.

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