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Sacramento Office Market – The Tale of two Sub-markets

What keeps you up at night?  Your kid’s latest Instagram post or their curfew violation?  How about Croatia’s upcoming match versus England?

For me it is Sacramento office leasing and sales.  Last week I got up around 3:00 AM with the question: How have office values behaved in Midtown and Downtown over the last 3 years?  While the criteria for each sub-market is different – Midtown’s office market is much smaller with much smaller deals – I think you can glean some insights and uncover some opportunities. Before I get into the data, I have a recent experience that is relevant.

In March, 2017 I listed a 6400 s.f. office building located at 1419 21st in Midtown Sacramento; the initial pricing was $1.8 Million. The asking price was high – this is known as Unicorn pricing.   Let me make this perfectly clear: Unicorns – like the Loch Ness Monster and Big Foot- are a myth. If a broker begins to tell you that they can sell your property for 30% more than anyone else (without any basis) be wary.

With this being said, the owner still wanted to find the Unicorn, but we agreed that we would not wait too long.  So, within 45 days we reduced the price to $1.5 million. Then after 12 months and three escrows, the building sold for $1.2 million ($185 a foot.)  Given the building’s location, parking and lack of available alternatives, you would have thought the building would sell for more. However the property sold for less because the cost to rehab the building exceeded $65 per square foot.

While Midtown and Downtown are adjacent, they differ in many ways. However, one difference that I thought was odd – but explainable – was the appreciation of values since 2015.

Office Building Sales:

Midtown (buildings over 1,500 SF)             Downtown (buildings over 25,000 SF)

Year                 $/S.F                                        Year                 $/SF

2015                $195                                        2015               $180

2016                $248**                                     2016               $181

2017                $194                                        2017               $224

2018                $185                                        2018               $378

** For Midtown, 2016 was a frenzied year where interest rates were very low and certain brokers really pushed values up with no real logic behind the escalation. There were a few properties acquired by Bay Area Unicorns at relatively high prices.  Midtown’s 2016 price levels raised seller’s expectations, and there are properties still on the market that remain unrealistically priced.

In Midtown, sales comps under 5,000 Square feet averaged $40 a square foot higher.

For Downtown, 2018 started of with a record sales price of $421 a square foot for 621 Capitol Mall. This leads us to the odd but explainable: Why is the appreciation of values in downtown that much greater than midtown? The answer is simple: Sacramento is now on the radar of institutional investors, and Downtown is where they are looking. Midtown lacks institutional product – both from a quality level and from a project size.

Over the years, I have seen that if you have a quality project in a market where lots of inferior properties exist, there is always a flight to quality. We have seen this in the residential arena with market rate housing setting records for rents and sales prices. On the office side, Mike Heller and Mark Friedman have substantiated this theory with projects like Ice Blocks, 2600 Capitol and the mixed-use development where Mikuni’s is located.

So If you own, or you are looking to own, property in Midtown Sacramento, what is the play?

  • As an owner user, I think that if you can pick up well located assets where you are all in (after rehab costs) for less that $250 a foot you will benefit from a steady appreciation and protection from probable rent escalations. Since it can cost anywhere from $25 to $100 a square foot to stabilize a property, the price point is anywhere from $150 to $225 a foot.
  • As an Investor, Midtown is a good place to invest if you buy buildings that are not functionally obsolete, are well located, and have parking.  Depending on hold time and buying motivation (say 1031), I think higher prices can be rationalized.
  • As an owner, you can systematically invest in your property and enhance the value, knowing that the market dynamics support the investment.
  • If you are a seller, then with the right marketing program and with a proactive broker representing you, you can sell your property for a good price by emphasizing the market dynamics, to in essence, “sell the dream.”  However the dream has to be substantiated.

While we are bound to see a downturn in the overall economy, I think that the Downtown and Midtown markets will, in the worst case, flatten out.  The reason for this is Sacramento’s new Value Proposition.

If you are looking to buy, sell or lease commercial property or you are just looking for some objective input,  feel free to call me at (916) 761-1202 or email me at tom@baconcre.com.  Happy to share the underlying comparable information as well.

Sacramento Rent Control?

Sacramento Midtown Multifamily

The Costa Hawkins Repeal & Rent Control

There has been a lot of talk lately about repealing the Costa Hawkins Rent Control law that was passed in the 1990’s. Costa Hawkins essentially curtailed a jurisdiction’s capacity to impose rent control.

Now Unions and Tenant organizations are seeking to repeal Costa Hawkins (CA). What is puzzling about all this, is that while the cities are looking to reduce the cost of housing, they are doing very little to make it easy or less costly to develop new housing. By imposing rent control laws without corresponding relief in development costs, jurisdictions like Sacramento are probably going to worsen the rental market for both the Tenants and the Landlords. Property values will go down, the incentive to build new units will diminish and property management regulations will increase.  Ultimately as property values go down, so does property tax revenue – that funds education and local services (police).

  • Cities such as Sacramento and Santa Cruz are looking at rent control policies to impose in the event the repeal of CA is successful this November. Richmond and Mountain View have recently passed rent control laws.
  • When Richmond instituted rent control it was retroactively applied. For example, the rent control policies went into effect November 2015, but the rents were retroactively controlled to July 21 levels. In other words, even if the Landlord raised the tenant’s rent after July 21, When the Rent Control went into effect, the rent was rolled back to what the tenant was paying prior to July 21st, 2015. If a tenant moves into a building after rent control is imposed, the rent the landlord charges will be based on a formula established by the city or jurisdiction.
  • If this 2018 Ballot initiative passes in California, this will open the door for rent control in many neighboring communities and ultimately statewide.

Here are some key takeaways if Costa Hawkins is repealed:

  1. Rent Increases could be tied to an index such as a CPI, so landlords cannot increase rents based on market demand or what a tenant is willing to pay. Landlords will be subject to the whims of the governing body.
  2. It will be very difficult for landlords to evict a tenant without cause, even if a tenant is month to month.
  3. Tenants will not want to move and – like in San Francisco – a tenant can sublease their apartment unit out to a friend at the below market rent just to keep the unit.
  4. To evict a tenant the Landlord will have to provide a reason for the eviction other than the desire to raise rents. So, even if a tenant is on month-to-month, and the landlord has a tenant willing to pay a lot more rent, the Landlord cannot evict the tenant.
  5. It is possible that the new rent control laws will include a provision that if the owner of an apartment building decides to sell, the seller may have to pay each tenant a fee in anticipation that the tenant might be displaced when the new owner takes over. For example, if the building is sold to an investor who wants to renovate certain units, the tenants affected will have received the displacement fee from the previous landlord.
  6. The Costa Hawkins Repeal is heating up for this November’s ballot. If repealed, all multifamily (including the possibility of single family homes) will be subject to rent control laws.
  7. The California Apartment Association has received $4 million from donors to fight the repeal initiative.
  8. Unions (Tenant Unions and Labor Unions) are orchestrating -and or- backing the effort to repeal Costa Hawkins.

Historically, Landlords have been able to work around rent control, but the new rent control measures will dramatically limit the landlord’s ability to work around the laws. What landlords have done in the past include:

  • Evicting tenants to get new ones and charge higher rents
  • Converting apartments into condos
  • Converting residential units into retail or office where rent control doesn’t come into play.

If Richmond is any indicator, a repeal of Costa Hawkins will not be good for landlords. In fact, some landlords I spoke with said that the City of Sacramento could create even more draconian policies. Plus with any new governmental intervention like this, new layers of government will be created to enforce the new rules. These layers are not free, and I suspect the entire financial burden will be placed on the property owner.

For additional information related to the Repeal of Costa Hawkins check out the links below.

Sacramento City Beat

Santa Ana

Tenant’s Together

Stanford Study – San Francisco

San Diego Tribune

Richmond

East Bay Times

Opposition of the Repeal

 

Sawyer

Sacramento’s Big Man is just getting started.

How About Those Sacramento Kings?  The Kings won last night without their Big Man, Cousins.  Frankly, they looked like a whole new team, with contributions from everyone, with six players in double digits.  Willie Cauley-Stein had a career high 29 points.

Would the Downtown market be on such a winning streak without its Big Man? I don’t think so. Property is selling in the Midtown and Downtown Markets (THE CORE) for prices that are justified by increased demand for housing in Core, the Arena (The Big Man) and a multitude of other developments. Believe it or not, the demand for properties is going to increase and sustain itself, so long as the trend for migration into the Core continues. Another factor bolstering values is the replacement cost for commercial properties has increased by over 30% in the last 5 years. This is due to increased labor and material costs.

When the Arena was announced, overnight, property values in the vicinity of the site went up at least 25%. Buildings like 555 Capitol Mall, 501 J Street, The Travelers Hotel Office building and the former Greyhound Bus Station are just a few examples. For Sacramento, the Arena changes everything; consider this blog post comparing The Golden 1 Arena to San Diego’s Petco Park: For Sacramento, The Arena is the Cake

Midtown hasn’t needed the Arena to take off. For many years rents have been suppressed in this market, and as new developments come on line, the rents will be commensurate with Midtown’s value proposition and Vibe. All the new residential development, coupled with the new Sutter Hospital and the Ice Blocks are a few of the projects making it happen.

Below are a three comparable sales that demonstrate the viability of Commercial Property in the Core.

Sale #1: 831 L Street. This site consists of a 27,200 s.f. parcel with a 44,000 s.f. building with over 50 parking stalls on the site. The price was 5,000,000 which amounts to about $113 foot for the building and a land value of about $184 a foot. I see this property having two lives, one for the next 5 to 10 years as a leased building.  In its next life, the property will make way for a new development that maximizes the site.

Sale #2: 910-930 K Street. These vacant buildings sat on the market for at least 5 years, and sold about 2 years ago.  Total site consists of 20,909 s.f of land with 31,600 S.F. of buildings. PRICE: $5,300,000, that pegs the underlying land value at $250 a square foot and $167 a foot for the vacant buildings. To put this in perspective, just one block away 770 L Street, a 169,000 square foot (90% occupied) class A office building sold for $173 a foot before the Arena was announced.

Sale #3: 2020 I Street. This 9,500 S.F. building sold for $2,802,500 ($295 / SF). This building is home to Trumpette, a specialty childrens clothing store. The property sits on a relatively large lot with great parking. Wouldn’t be surprised to see some “alley activation” here.

The sales listed above are notable examples of properties that have sold at exceptional values, values that reflect where the Core is heading. This doesn’t mean that a property worth a $100 a foot is going to immediately sell for $150 a foot, but it certainly builds a solid case for optimism and positive momentum.

Sacramento’s CORE: Par, Birdie, Eagle. Albatross next?

Sacramento’s Core (Midtown and Downtown) is not very sneaky. In fact the whole world has taken notice.  One thing I didn’t now about Core is this:  Core recently took up golf, and in 2015 made the PGA Tour.    In a matter of months, Core has risen to the top of the money list!  At the  2016 Player’s Championship, Core was interviewed after a remarkable 3rd Round, and he shed some light on his success.

Reporter:  So Core, how do you feel about your round today?

Core:  Well, I gotta tell you, I don’t think I can hit the ball much better.  The first day, I played alright, but I was still working out the kinks, you know, past few years have been tough.

Reporter:  I noticed that.  Your first round you scraped it around and managed to keep yourself in the hunt.  But then you really turned it on.  What do you attribute to your resiliency and significant bounce back?

Core:  Well before I picked up my new coach….

Reporter:  Your new coach?

Core:  You know, they call him (pause) The Golden One.  (smiling) I call him GO.

Reporter:  How could I forget?  He has been a big part of your rise to the top of the money list, huh?

Core:  No doubt.  I was making progress with my trainer, HDR, and my previous coach, Trend..  But when GO showed up, things really started to click.

Reporter: So what do you see for the final round tomorrow?

Core:  I can’t imagine going as low as I did today, heck, I only had 16 putts.  But I feel pretty good. I am looking forward to solid final round.

Reporter:  Thanks, Core.  Good Luck Tomorrow!

With the exception of some notable deals, like the sale of the Wells Fargo Center, it doesn’t take a brain surgeon to note that values are up in Midtown and Downtown.  In looking at the statistics (Costar) for 2014 through 2016 here are the basics:

Commercial (non residential) properties sold for an average of $99 a square foot in 2014, $151 in 2015, and in 2016 the average price per square foot increased to $205 a foot.

Multifamily properties sold for an average of $95,000 per unit in 2014 with a GRM of 10.92. In 2015 the price per units edged up to $116,000 per unit with the GRM jumping to 13.15. In 2016 the Price per unit increased to $150,000 per unit with a GRM of 13.32.

Land sold for an average of $94 per square foot in 2014. In 2016 the average increased to $131 per square foot.

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The Ransahoff (11th & K)

This survey is only for properties selling between $1,000,000 to $10,000,000.  The price increases are not surprising given the development of the arena and the trend of people wanting to live in the Midtown and Downtown area.  However, I think you can say that a 50% increase in the price of Multifamily (price per unit) from 2015 to 2016 is more of a spike than a bump.  Notable: the Gross Rent Multiplier (GRM)increased nominally between 2015 and 2016.  This means rents escalated significantly in 2016, nearly in step with the values.

Many of the commercial properties sold (non-residential) in the midtown area were to users.  For quality properties with parking, the prices exceeded the median significantly.

Land sales have picked up considerably as well, and values are up at least 5o% from 2014.

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R Street’s Ice Blocks

For detailed Sales and leasing information including sales comps for 2016,  contact Tom Bacon at 916-761-1202 or tbacon@kiddermathews.com.