By Blanca Torres – Reporter, San Francisco Business Times
2 hours ago
The condo development site at 1554 Market St. in San Francisco has sat idle for more than a year. Work stopped in early 2018 after the developers demolished an existing building there and prepped the land for new construction.
What happened? For the developer, Z&L Properties, the economics of building condos in San Francisco proved trickier than expected. A narrowing gap between costs and sales projections hindered financing, but the company was finally able to make the numbers work, securing a construction loan in July to restart 1554 Market.
“To be honest, it’s not a great return,” said Robert Buckner, Z&L’s chief financial officer. “Even if we broke even, it would be better than leaving that project vacant. At least we are contributing to the housing market.”
Call it San Francisco’s condo conundrum. Even as the housing market remains robust and buyers line up for the chance to shell out nearly $1 million or more for even the most basic condos, developers struggle to produce more than a few hundred units each year. And as Z&L is finding, they struggle to make money doing it.
This year condo delivery has been particularly anemic, with fewer than 500 coming to the market. The next two years figure to be slightly better, with an average of 700 new units hitting the market in 2020 and 2021, according to Polaris Pacific, a condo marketing and research firm.
Over-heated construction market
The new condo market peaked in 2008 when 2,144 homes came on the market, according to Polaris. Those homes were carryovers from the real estate boom of the mid-2000s.
In the current economic recovery, condo production has not kept up with demand, developers said.
“For the traditional San Francisco developer, it is still very difficult to build middle-of-the-road priced condos,” said Eric Tao, a longtime housing developer who is partnering on 950 Market St., a 242-unit project in the Mid-Market neighborhood.
The $350 million 950 Market St. project consists of a hotel and condos expected to hit the market in late 2020. The project kicked off construction last fall after years of delays.
Tao and Joy Ou of Group I, which bought and entitled the site, comprise L37, the team behind the projec
"Many other projects, through design, create separation that keeps the wider city outside its walls. We want to do the opposite." — Joy Ou, President of Group I
Todd Johnson | San Francisco Business Times
Developers already have to deal with several challenges: scarcity of land, lengthy approval process, neighborhood opposition, increases in city fees. But by far, Tao said, the steep escalation in what contractors demand for their work has pushed the cost of producing housing too far north for developers to make money.
San Francisco ranked as the second most expensive market in the world for construction after New York, according to a 2019 report from Turner & Townsend. The report also predicted that construction costs will rise by 5 percent this year and categorized San Francisco’s construction market as “overheating” with large multifamily construction costs averaging from $219 to $290 per square foot.
Counterintuitive
Here’s the problem: Condos are a vital part of the San Francisco housing market. They make up the majority of San Francisco home sales and provide the most entry-level options for homebuyers.
Condos represent 56 percent of all home sales compared with single-family homes at 39 percent, according to Compass data. More than 80 percent of home sales in San Francisco priced under $1 million involve condos or tenants in common, where buyers share ownership of buildings.
In San Francisco’s high-priced housing market, condos are a relative bargain: The median sales price of a single-family-home reached $1.7 million in June compared with $1.25 million for a condo.
“Our economy continues to grow and employers continue to hire and they hire at the top end of the salary range,” said Matt Regan, senior vice president of public policy for the Bay Area Council, an advocacy group backed by businesses. “If we don’t build new market-rate housing for the new employees who are coming here, they are going to compete with existing residents for existing housing stock.”
In 2018, San Francisco added 2,309 new housing units, of which 1.5 percent, or about 35 units, were single-family homes. More than 2,000 were in buildings of 20 or more units, according to city data. The vast majority of new multifamily projects hit the market as rental apartments, not for sale.
The lackluster supply of new homes for sale is “so counterintuitive,” considering the region’s strong job growth and demand, said Gregg Lynn, an agent with Sotheby’s International Realty who specializes in San Francisco condo sales.
“If you were moving to Los Angeles or New York or Chicago, there would be thousands of new condos to choose from,” he said. The forthcoming uptick in supply is welcome, he said, “but I don‘t think it’s a flood. It’s not enough to change the economics of our market.”
Luxury vs. ultra-luxury
Condo projects now under construction tend to fall into two camps: ultra-luxury units that target prices upward of $2,000 per square foot, and the less expensive projects in the $1,500 per square foot range. While the latter are still pricey, they are more attainable for average buyers, said Paul Zeger, a principal with Polaris Pacific.
In the past few years, several ultra-luxury projects have moved forward, including 181 Fremont, The Avery, One Steuart Lane and 706 Mission St. Prices for upper floor and penthouse units can range from $3,000 to $5,000 per square foot.
Most new developments start at $1,300 per square foot — the baseline of what developers need to charge to turn a profit, Zeger said. Those prices reflect rapid appreciation: About a decade ago, prices surpassing $1,000 per square foot was almost unheard of.
Developers have to be creative, Zeger said, to make projects pencil, such as maximizing the number of units in a building by designing compact floorplates. Developers aim to offset the smaller homes by beefing up amenities such as roofdecks, lounges, lobbies, party rooms and gyms, Zeger said.
Meanwhile, it has been much harder for developers targeting lower price points, Tao said. The high-rise at 950 Market St. requires concrete construction and will use union labor. Smaller, stick-built projects that don’t use union labor cost less, he said.
Armed with Chinese money, Z&L Properties started buying condo development sites several years ago and amassed a pipeline of 3,400 homes.
In San Francisco, the company is finally moving forward with three projects after years of delays. It recently landed a construction loan to restart work at the 109-unit 1554 Market St., which is now slated for completion in 2021.
Another site, the 139-unit 555 Fulton, is close to welcoming residents this fall after five years of construction — more than twice as long as the project should have taken. The developer is also planning to bring 39 homes at 119 7th St. to market this fall.
The developer is holding onto hope that condo prices will continue creeping up as they have since the Great Recession.
Another condo development, Stage 1075, is close to selling out with only a two-bedroom penthouse left. The development, from Encore Capital Management, began sales in September 2017 with studios starting in the $500,000s and one-bedrooms in the $600,000s.
“We attracted many first-time homebuyers, especially those who were drawn by the convenient location,” said Michelle Antic, principal at SagePoint, the firm handling sales and marketing of Stage 1075. “We felt strongly we should have homes at relatively affordable prices.”
What some people pay for a condo in San Francisco, they could buy a larger single-family home in the suburbs. Enough buyers, however, are willing to pay the condo premium.
“Buying a condo is a way to make an entry into real estate for people to stay in the city,” Carlisle said. “For a lot of people, this is where they want to be.”